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https://www.courtlistener.com/api/rest/v3/opinions/4620951/	GERARD M. STURM AND ELIZABETH STURM, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSturm v. CommissionerDocket No. 29058-82United States Tax CourtT.C. Memo 1993-172; 1993 Tax Ct. Memo LEXIS 173; 65 T.C.M. (CCH) 2447; April 19, 1993, Filed 173 Elizabeth Sturm, a.k.a. Elizabeth Joyner, pro se. For respondent: Laurie B. Kazenoff. SWIFTSWIFTMEMORANDUM FINDINGS OF FACT AND OPINION SWIFT, Judge: Respondent determined deficiencies in petitioners' joint Federal income taxes in the amounts of $ 5,680 for 1979 and $ 9,897 for 1980. After various concessions, the sole issue for decision is whether petitioner Elizabeth Sturm (petitioner) qualifies for relief from liability as an innocent spouse under section 6013(e). 1FINDINGS OF FACT Some of the facts have been stipulated and are so found. At the time the petition was filed, petitioner and her former husband, Gerard M. Sturm, were residents of Lorton, Virginia. In 1952, Mr. Sturm received a commission as an ensign in the U.S. Navy. On August 20, 1955, petitioner and Mr. Sturm were married. Prior to the 174 marriage, petitioner worked as a dental assistant. For approximately 1 year after the marriage, petitioner worked as a dance instructor. Petitioner and Mr. Sturm had three children, born in 1956, 1958, and 1959. Between 1956 and 1972, Mr. Sturm's naval career included overseas cruises which would last between 6 months to in excess of 1 year. During Mr. Sturm's absences, petitioner would make family purchases and balance the family checkbook. Petitioner, however, was totally dependent on Mr. Sturm for her financial support, and petitioner did not work outside of the home until 1979, after all of the children went to college. After 1972, when Mr. Sturm transferred to shore duty at the Pentagon, Mr. Sturm controlled all family finances. Petitioner would purchase food, clothing, and gasoline with funds made available by Mr. Sturm for that purpose. Mr. Sturm's paycheck and other funds or savings were maintained in a separate bank account which Mr. Sturm alone controlled. On October 11, 1978, Mr. Sturm obtained a home-equity loan in the amount of $ 29,000. Petitioner signed the loan application with the understanding that the loan proceeds would be used for debt consolidation and175 for educational expenses of the children. In the late 1970's, petitioner and Mr. Sturm were experiencing marital problems and personal difficulties. Mr. Sturm had an alcohol problem. Petitioner was undergoing chemotherapy for the treatment of cancer. In 1979, petitioner obtained part-time clerical employment outside the home. In anticipation of his retirement from the Navy, Mr. Sturm became very interested in investments. In late 1979, Mr. Sturm discussed with a Mr. Robert Agnew various tax-oriented investments that Mr. Agnew was promoting. Mr. Sturm spoke with Mr. Agnew at length about two limited partnerships, including Bravo Productions, Inc. (Bravo). At a meeting in the Sturms' home, Mr. Agnew presented to Mr. Sturm and to neighbors of the Sturms information about the limited partnerships. Petitioner did not participate in the discussions concerning the investments, and petitioner was only present in the room where the meeting was held for the purpose of serving refreshments. Without consulting petitioner, Mr. Sturm decided to invest in Bravo. Mr. Sturm signed the paperwork relating to the investment, and, using money from the home-equity loan, Mr. Sturm gave Mr. Agnew176 a check for $ 10,000. Petitioner was not aware of Mr. Sturm's investment in Bravo, of the amount invested, or of any of the purported tax benefits associated with the investment. On April 15, 1980, and on July 22, 1981, Mr. Sturm presented petitioner with completed joint Federal income tax returns for 1979 and 1980, respectively. As was their custom, Mr. Sturm indicated to petitioner where she was to sign, and petitioner signed the returns without reviewing them. In 1980 and 1981, Mr. Sturm received from respondent refund checks of $ 6,258 and $ 592 relating to the 1979 and 1980 tax returns he and petitioner had filed. Mr. Sturm did not inform petitioner of the refunds. He deposited the refunds into the checking account which he controlled. The Sturms' modest lifestyle did not change in any significant way in 1980 or 1981. During 1980 and 1981, petitioner's treatment for cancer continued, including a radical mastectomy, radiation treatment, and chemotherapy. In 1984, Mr. Sturm filed for divorce. During discovery in the divorce proceedings, petitioner learned, for the first time, that Mr. Sturm had invested in Bravo. On February 6, 1986, the Virginia Circuit Court for the177 County of Fairfax (Circuit Court) issued a divorce decree terminating the marriage of petitioner and Mr. Sturm. On January 14, 1987, the Circuit Court entered an order providing that "any tax liability pertaining to * * the Bravo, Inc. investment should be borne by [Mr. Sturm] alone, because these investments were solely at the instigation of [Mr. Sturm] and were taken at his discretion". Sturm v. Sturm, Chancery No. 88682 (Va. Cir. Ct., Fairfax Cty., Jan. 14, 1987). On April 3, 1987, we entered a stipulated decision which held both Mr. Sturm and petitioner liable for the tax deficiencies attributable to the Bravo-related deductions. Mr. Sturm forged petitioner's name to the stipulated decision. Mr. Sturm did not consult with petitioner regarding the stipulated decision, and Mr. Sturm had no authority to act on petitioner's behalf. On August 14, 1987, the Circuit Court awarded the family residence to petitioner and ordered petitioner to purchase Mr. Sturm's interest in the residence. Sturm v. Sturm, Chancery No. 88682 (Va. Cir. Ct., Fairfax Cty., Aug. 14, 1987). After refinancing the residence, petitioner paid $ 34,000 to Mr. Sturm for that purpose. Mr. Sturm did178 not apply any of the $ 34,000 received from petitioner to the joint Federal income tax liabilities relating to 1979 and 1980. On June 2, 1989, counsel for petitioner filed a motion for leave to file a motion to vacate the stipulated decision that in 1987 had been entered in this case. On October 24, 1989, we granted petitioner's motion for leave to file a motion to vacate the stipulated decision, and we vacated the stipulated decision. Petitioner does not contest the amount of the deficiencies and the additions to tax. She only asserts her nonliability therefor as an innocent spouse. OPINION As a general rule, when a married couple files a joint Federal income tax return, each spouse is jointly and severally liable for the amount of tax due. Sec. 6013(d)(3); Bokum v. Commissioner, 94 T.C. 126">94 T.C. 126, 137 (1990) (Court reviewed). Under section 6013(e)(1), however, a spouse may qualify as an innocent spouse and be relieved from such joint and several liability if the following requirements, among others, are satisfied: (1) There is on such return a substantial understatement of tax relating to grossly erroneous items attributable to the other spouse; 179 (2) the spouse did not know, and had no reason to know, that there was a substantial understatement of tax on the return; and (3) taking into account all the facts and circumstances, it would be inequitable to hold the spouse liable for the deficiency attributable to the substantial understatement. The alleged innocent spouse has the burden to prove that each of the statutory requirements is satisfied. Rule 142(a); Clevenger v. Commissioner, 826 F.2d 1379">826 F.2d 1379, 1382 (4th Cir. 1987), affg. T.C. Memo. 1986-149; Bokum v. Commissioner, supra at 138. In enacting section 6013(e), however, Congress intended to remedy a perceived injustice, and we "should not hinder that praiseworthy intent by giving the exception an unduly narrow or restrictive reading." Sanders v. United States, 509 F.2d 162">509 F.2d 162, 166-167 (5th Cir. 1975) (fn. ref. omitted). An understatement is not attributable to the spouse claiming innocent spouse status if he or she was not involved in the activity giving rise to the understatement. See Bokum v. Commissioner, supra at 140-141;180 Bell v. Commissioner, T.C. Memo. 1989-107. Whether an alleged innocent spouse, in signing a joint return, knew, or had reason to know, of an understatement of tax liability is a question of fact. Clevenger v. Commissioner, supra at 1382; Shea v. Commissioner, 780 F.2d 561">780 F.2d 561, 565-566 (6th Cir. 1986), affg. in part and revg. in part T.C. Memo. 1984-310. A spouse would have reason to know of an understatement if a reasonably prudent person under the circumstances at the time of signing and filing the tax return would have either known of the understatement or would have inquired as to whether or not there was an understatement. See Stevens v. Commissioner, 872 F.2d 1499">872 F.2d 1499, 1505 (11th Cir. 1989), affg. T.C. Memo. 1988-63; Sanders v. United States, supra at 166; Terzian v. Commissioner, 72 T.C. 1164">72 T.C. 1164, 1170 (1979); Mysse v. Commissioner, 57 T.C. 680">57 T.C. 680, 698-699 (1972). Factors relevant to the determination of whether181 a spouse had reason to know of the understatement include the spouse's level of education and involvement in family financial matters, the presence of unusual or lavish expenditures during the years in issue, and the other spouse's evasiveness and deceit with regard to the family finances. Stevens v. Commissioner, supra at 1505, and cases cited therein. Whether it is inequitable to hold a spouse liable for the deficiency in tax is to be determined on the basis of all the facts and circumstances. Sec. 6013(e)(1)(D); sec. 1.6013-5(b), Income Tax Regs. Relevant factors in that analysis include: (1) Whether the spouse claiming relief significantly benefited from the understatement, Estate of Krock v. Commissioner, 93 T.C. 672">93 T.C. 672, 677 (1989), and (2) whether the spouse claiming relief has been deserted by, or divorced or separated from, the other spouse, sec. 1.6013-5(b), Income Tax Regs. Normal support is not a significant "benefit" for purposes of analyzing the equity of granting innocent-spouse relief. Estate of Krock v. Commissioner, supra at 678; Purcell v. Commissioner, 86 T.C. 228">86 T.C. 228, 242 (1986),182 affd. 826 F.2d 470">826 F.2d 470 (6th Cir. 1987); sec. 1.6013-5(b), Income Tax Regs.Respondent contends that the substantial understatements of tax attributable to the grossly erroneous Bravo-related deductions are attributable to petitioner as well as to Mr. Sturm, that petitioner either knew or had reason to know of the understatements attributable to the Bravo-related deductions, and that it would not be inequitable to hold petitioner liable for the deficiencies under the facts and circumstances of this case. We disagree. The evidence establishes that petitioner was not involved in the Bravo investment. Petitioner did not sign the Bravo investment documents, and the investment is not attributable to petitioner. Mr. Sturm made the Bravo investment with money from the home-equity loan without disclosing to or discussing with petitioner the investment. Mr. Sturm's and Mr. Agnew's testimony that petitioner was privy to the investment was not credible. Petitioner did not have actual knowledge of the Bravo deductions or of the understatements attributable thereto. Further, at the time petitioner signed the 1979 and 1980 joint Federal income tax returns, she did 183 not have reason to know of the understatements. Mr. Sturm controlled the finances of the family. No unusual expenditures were made (other than Mr. Sturm's investment in Bravo), and Mr. Sturm did not disclose to petitioner his investment in Bravo. Because petitioner was dependent upon Mr. Sturm for her support, she may have received some benefit from the tax refunds which were sent to Mr. Sturm and which were attributable to the understatement. Such benefit, however, did not exceed normal support. Under the facts and circumstances of this case, it would be inequitable to hold petitioner liable for the deficiencies in tax attributable to the Bravo investment. Having met the requirements provided in section 6013(e), petitioner is entitled to treatment as an innocent spouse. To reflect the foregoing, An appropriate order and decision will be entered. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620952/	Paris Manufacturing Company v. Commissioner.Paris Mfg. Co. v. CommissionerDocket No. 25174.United States Tax Court1951 Tax Ct. Memo LEXIS 52; 10 T.C.M. (CCH) 1064; T.C.M. (RIA) 51325; October 30, 195152 On July 16, 1945, petitioner paid $11,000 to the United States in an agreed settlement of a claim by the O.P.A. that petitioner had made overcharges on the sale of some of its manufactured products, to wit, chairs and stepstools, covering the years 1944 and part of 1945. Petitioner, in calculating its ceiling prices for these products under Maximum Price Regulation 188, took practicable precautions and its actions were in good faith and not the result of an unreasonable lack of care. Held, the payment of $11,000 is deductible under section 23 (a) (1) (A) of the Internal Revenue Code. Pacific Mills, 17 T.C. -, promulgated October 26, 1951, followed. S. W. Thaxter, Esq., for the petitioner. William C. W. Haynes, Esq., for the respondent. BLACK Memorandum Findings of Fact and Opinion The Commissioner has determined a deficiency in petitioner's income tax for the year 1945 of $5,830. The deficiency notice does not explain how the Commissioner determined the deficiency, that is to say, it does not show what adjustment he made to the net income as reported by petitioner on its return. The amended petition assigns errors as follows: "4. 53 The determination of the tax set forth in said notice of deficiency is based upon the following error: "(1) With respect to the aforementioned taxable year, the Commissioner erred in disallowing as a deduction from the petitioner's gross income for the year 1945 the sum of $11,000.00 paid to the office of Price Administration on July 17, 1945 in compromise of alleged overcharges of O.P.A. ceiling prices, as an ordinary and necessary business expense under the provision of Sec. 23 (a) (1) (A) of the Internal Revenue Code. "(2) If it be found that Commissioner did not err as stated above, he erred in including in petitioner's gross sales for 1945, approximately one half of the alleged overcharges, or $5,500.00, which represented so much of the alleged overcharges as were attributable to 1945 sales but which were paid to the O.P.A. in that year, and credited against gross income." Findings of Fact Paris Manufacturing Company, hereafter called petitioner, is a corporation which filed its income tax return for the calendar year 1945 on the accrual basis with the Collector for the District of Maine. Petitioner is a corporation engaged in the business of manufacturing54 wooden products: chairs, stepstools, and other similar articles. Petitioner was a family corporation. George Morton, now deceased, was president and treasurer in 1945, and Clarence G. Morton, a brother of George, was vice president and testified at the hearing. With the enactment of the Emergency Price Control Act of 1942 and the promulgation of regulations thereunder by the O.P.A., petitioner was required to and did provide a base period statement which set up its customers as wholesalers and jobbers, retailers and small users. This base period statement complied with O.P.A. regulations. Petitioner was aware that there were Price Control Regulations. Maximum Price Regulation 188, hereafter called MPR 188, issued pursuant to the Emergency Price Control Act, as amended, established the prices for manufacturers of chairs and stepstools. Sometime in 1944, the Maine Office of Price Administration pursuant to directives from Washington, D.C., conducted a survey of the wood manufacturing industry and during the course of this survey they investigated the petitioner and found what they believed to be violations of MPR 188. As stated above, petitioner had previous to this time complied55 with the regulations by filing a base period statement listing the prices charged to various classes of customers. The alleged violations claimed by O.P.A. concerned the sales of three items: #30 chairs, #10 chairs, and #7 stepstools. Six thousand #30 chairs were sold to a concern named Abbey Rents of Los Angeles, California, at a delivered price of $2.22 a chair, upon the understanding that they were to be used for renting purposes only. The price of $2.22 or $2.00 plus freight to Los Angeles represented a discount of 40 per cent off the March 1942 list price, a discount normally granted to retail dealers or consumers. Petitioner usually gave a discount of 50 per cent to jobbers and wholesalers. The O.P.A. officials objected to the price charged Abbey Rents because they claimed that petitioner was not giving the same discounts to the same class of customers as they did in March 1942. The same objection was made to certain sales of #10 chairs made to the Adirondack Chair Company of New York, to which company petitioner granted a 40 per cent discount because it did not believe this company to be a jobber or wholesaler for the reason that it employed no outside salesmen. Another source56 of controversy with the O.P.A. was the sale of a plain unpainted #7 stepstool for the same price as had formerly been charged for a painted one containing rubber treads on the steps. However, this represented no saving in cost to petitioner because a finer grain of wood had to be used in manufacturing the unpainted stepstool. The paint and rubber were left off because they were unobtainable on account of war scarcity. After the O.P.A. investigation, the enforcement attorney wrote the petitioner making a triple damage claim. The exact amount of this claim is not known, though the O.P.A. enforcement attorney testified it was somewhere between $27,000 and $33,000. Several conferences were held between the O.P.A. officials and representatives of the petitioner in an effort to reach an amicable settlement. In these conferences Milton C. Wheeler, enforcement attorney for the O.P.A. in the Maine District, represented O.P.A. He knew about the investigation by O.P.A. representatives of petitioner for alleged O.P.A. violations and that these investigators had reported that in the course of its business petitioner had violated O.P.A. Regulation 188 in the sale of #30 chairs, #10 chairs, and57 #7 unpainted stepstools. At the final conference of the parties Wheeler, acting in behalf of O.P.A., offered to accept $11,000 in settlement of the O.P.A.'s triple damage claims. Petitioner agreed to accept this offer and paid that amount by its check No. 8549 dated July 16, 1945, and drawn to the order of the Treasurer of the United States. Petitioner treated this payment to O.P.A. as a deduction from gross sales for the year 1945, and consequently it does not appear on the return as a separate item deduction for ordinary and necessary business expenses. Petitioner in good faith when it sold 6,000 #30 chairs to Abbey Rents of Los Angeles believed that company was not a jobber or wholesaler and was not entitled to its customary discount of 50 per cent off list price customarily given to jobbers and wholesalers, but was only entitled to a discount of 40 per cent customarily given to customers who were either retailers or users of chairs. Petitioner in good faith when it sold certain #10 chairs to Adirondack Chair Company believed that company was not a jobber or wholesaler and was not entitled to its customary discount of 50 per cent off list price customarily given to jobbers58 and wholesalers, but was only entitled to a discount of 40 per cent customarily given to customers who were either retailers or users of chairs. Petitioner in good faith believed that when it sold the #7 unpainted stepstools in question at the same price as it had formerly sold #7 painted stepstools, it was not violating MPR 188. Petitioner used a better grade of wood in the manufacture of these unpainted chairs and the manufacturing cost of these chairs was fully as much as the #7 painted chairs which had been sold previously. Therefore, petitioner believed it was violating no O.P.A. regulation in settling them at the same price. In calculating its ceiling prices on its #30 chairs, its #10 chairs, and its #7 stepstools during the period in question, petitioner did not fail to take practicable precautions in applying the provisions of MPR 188 and petitioner's actions were in good faith and not the result of an unreasonable lack of care. Opinion BLACK, Judge: The main contention of petitioner in this proceeding is that it is entitled to take as a deduction as an ordinary and necessary business expense under section 23 (a) (1) (A) of the Internal Revenue Code59 the $11,000 which it paid in 1945 to the Treasurer of the United States. in settlement of alleged violations of O.P.A. regulations. It was petitioner's contention that its violation of O.P.A. regulations, if any, was innocently done, that it had no wilful intent to violate such regulations, and that it took reasonable precautions to avoid such violations. We think petitioner has met its burden of proof on this issue and on the facts we have found that petitioner did not fail to take reasonable precautions in applying the provisions of MPR 188 in its sales to customers and petitioner's actions were in good faith and not the result of an unreasonable lack of care. Petitioner's president, Clarence G. Morton, its auditor, Orey Tolman, and its bookkeeper, H. W. Dennison, all testified at the hearing and we are well convinced from their testimony that petitioner did not wilfully violate MPR 188 and that any violations which it may have committed were innocently done and that petitioner had taken all reasonable precautions to avoid any such violations. Respondent's principal witness was Milton G. Wheeler who was O.P.A. enforcement officer of the Maine District at the time such alleged*60 violations occurred. There is nothing in his testimony which leads us to believe that petitioner's violations of MPR 188, if any, were wilful or were made without petitioner having taken all reasonable precautions to avoid any violation of the regulation in question. This being true, under the doctrine of our decision in Pacific Mills, 17 [T.C.] -, promulgated October 26, 1951, the decision in the instant case must be for the petitioner. Of course, the facts in the instant case are not the same as those in the Pacific Mills case because the two businesses are different and the dealings in the Pacific Mills case were much more extensive than the dealings in the instant case. However, those are not distinctions of principle, but merely of facts. We, therefore, hold following Pacific Mills that petitioner is entitled to deduct the $11,000 in question under section 23 (a) (1) (A) of the Code. As a result of this holding, it is unnecessary for us to decide petitioner's alternative contention. Decision will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620955/	Hugh McK. Jones, Petitioner, v. Commissioner of Internal Revenue, RespondentJones v. CommissionerDocket No. 57509United States Tax Court29 T.C. 200; 1957 U.S. Tax Ct. LEXIS 47; November 13, 1957, Filed 1957 U.S. Tax Ct. LEXIS 47">47 Decision will be entered under Rule 50. Petitioner created five trusts in the year 1951, and transferred to the trustees of each, without consideration, securities valued at $ 21,645. Four of these trusts were for the respective primary benefits of his four adult children, and the other was for the joint primary benefit of four grandchildren who were minors. Each of the four children's trusts gave the entire trust income to the primary beneficiary for life, and the remainder to others; and each also granted a power to the corporate trustee to encroach upon the principal of the trust, from time to time when it believed it proper to do so, in order to make advancements for the benefit of any beneficiary of such sums as the trustee might consider reasonable and proper in the circumstances, to provide for the beneficiary's proper maintenance, education, and support in accordance with the standard of living to which he was accustomed, or to provide for any emergency which might arise affecting him, occasioned by sickness or casualty. The fifth trust for the grandchildren provided, in substance, that the trustees should divide the trust estate into four equal shares; apply for the1957 U.S. Tax Ct. LEXIS 47">48 benefit of each grandchild until he attained the age of 21 years, so much of the income and principal of his share as the trustees might deem necessary for his education, maintenance, and support; and, after the grandchild reached the age of 21 years, dispose of the remaining income and principal in the manner specified. Held:1. In the case of the four trusts for petitioner's children, the rights of the primary beneficiaries to receive income, but not their rights to receive possible advancements from principal, were present interests within the meaning of section 1003 (b), I. R. C. 1939; and that the values of such present interests were determinable because: The corporate trustee's power to encroach upon principal was limited by an ascertainable standard; the grantor's intention was that the corporate trustee, in determining the need for any encroachment, should consider the beneficiary's other available resources; and that, in view of the financial circumstances of the several beneficiaries when the trusts were created, the possibility of encroachments occurring to defeat the flow of trust income, was so remote as to be negligible. Values of the present interests of 1957 U.S. Tax Ct. LEXIS 47">49 the beneficiaries determined to be more than $ 3,000 each; and four exclusions from gifts, of $ 3,000 each, allowed pursuant to said section 1003 (b).2. In the case of the trust for the grandchildren, the rights of such grandchildren to receive such unascertained amounts of trust income and principal as the trustees might deem necessary for specified purposes, were future interests within the meaning of said section 1003 (b); and, accordingly, that no exclusion from gifts, in respect thereof, is allowable. Thomas S. McPheeters, Jr., Esq., and William H. Charles, Esq., for the petitioner.William H. Welch, Esq., for the respondent. Pierce, Judge. PIERCE 29 T.C. 200">201 Respondent determined deficiencies in gift tax in respect of the petitioner, for the years 1951 and 1952 in the amounts of $ 4,331.79 and $ 27.93, respectively. 1957 U.S. Tax Ct. LEXIS 47">50 The issues for decision are:(1) Whether, in determining the amount of petitioner's gifts for the year 1951, there should be allowed pursuant to section 1003 (b) of the 1939 Code, 1 four exclusions of not to exceed $ 3,000 each, in respect of the interests of his four living adult children in four separate irrevocable trusts which he created in said year. The answer depends on whether the values of the present interests (as distinguished from future interests) of said beneficiaries in the trusts are susceptible of determination.29 T.C. 200">202 (2) Whether, in determining the amount of petitioner's gifts for 1951, 1957 U.S. Tax Ct. LEXIS 47">51 there also should be allowed pursuant to said section of the Code, four other exclusions, in respect of the interests of four minor grandchildren of the petitioner in a fifth irrevocable trust which he created in said year. The answer to this depends on whether the interests of said beneficiaries in the trust were future interests, within the meaning of said section.No question need be decided with respect to the year 1952. The deficiency for said year resulted solely from the increased rate of tax which became applicable for said year, by reason of the additional amount of gifts determined for the preceding year 1951.FINDINGS OF FACT.Several of the facts have been stipulated. The stipulation, together with the exhibits thereto attached, is incorporated herein by reference.The petitioner, Hugh McK. Jones, is a resident of St. Louis County, Missouri. His gift tax return for the year 1951 was filed with the then collector of internal revenue for the first district of Missouri; and his gift tax return for 1952 was filed with the district director of internal revenue for the St. Louis, Missouri, district.On September 21, 1951, the petitioner, who was then 70 years of age, created1957 U.S. Tax Ct. LEXIS 47">52 five separate irrevocable trusts, by entering into five separate indentures of trust which were executed under date of September 20, 1951, by him as the grantor, and by himself and the St. LouisUnion Trust Company, a corporation of the city of St. Louis, Missouri, as cotrustees. Four of these trusts were created for the respective primary benefits of his four living adult children; and the fifth trust was created for the joint primary benefit of four minor children of a deceased son. At the time of the creation of said trusts, petitioner transferred to the trustees of each, without actual consideration, marketable securities of the then fair market value of $ 21,645, as the initial trust estate.More specific facts respecting said trusts and the beneficiaries thereof are as follows:Facts re Trusts for Children.The primary beneficiaries of the four trusts for the benefit of petitioner's children were, respectively: His son, Hugh McK. Jones, Jr.; his daughter Florence T. Jones (whose present name is Florence Jones Terry); his daughter Grace J. Borg (whose present name is Grace Borg Tupper); and his daughter Carroll Jones McPheeters. All of these children were adults at the1957 U.S. Tax Ct. LEXIS 47">53 time of the creation of the trusts.29 T.C. 200">203 The four indentures for said trusts were essentially the same for present purposes. The indenture of the trust for the son, Hugh McK. Jones, Jr., which is typical, provided in substance and so far as here material, as follows:Section Two provided, in substance, that the entire net income of the trust estate should be paid to Hugh McK. Jones, Jr., son of the grantor, for and during his natural life; and that upon the death of said son, the trustees should continue to hold the trust estate, in further trust, for the benefit of the then living descendants of said son, per stirpes, or in the absence of such descendants for the benefit of certain other described persons exclusive of the grantor, for such periods and in accordance with such terms and conditions as were mentioned in the indenture.Section Four provided:SECTION FOUR: The Grantor hereby authorizes the St. Louis Union Trust Company, Trustee, to encroach upon the principal of the trust estate for the use and benefit of any of the beneficiaries of the trust created hereby to provide for their proper maintenance, education and support, in accordance with the standard of living to1957 U.S. Tax Ct. LEXIS 47">54 which they have been accustomed, or to provide against any emergency which may arise affecting them occasioned by sickness, accident, ill health, misfortune or otherwise, and the said Trustee may advance such sum or sums out of the principal of the trust estate for the use and benefit of said beneficiaries as it shall consider reasonable and proper under the circumstances and may make such advancements from time to time when it believes it proper to do so and for the best interests of said beneficiaries.The financial circumstances of each said child of the petitioner, on the date of said gifts in trust, were as follows:(a) Hugh McK. Jones, Jr., was 31 years of age, married, and the father of three children. He was an architect engaged in his profession in Guilford, Connecticut. He lived with his family in Guilford, in a house which he and his wife owned jointly, which cost approximately $ 47,000 and was subject to a mortgage of about $ 15,000. In addition, he owned unimproved real estate near Guilford, which was acquired and held for development and subdivision purposes, and which had a cost of $ 14,500 and was unencumbered. Also, he was the beneficiary of the following trusts: 1957 U.S. Tax Ct. LEXIS 47">55 (1) Trust under conveyance of Hugh McK. Jones, Jr. (himself), dated January 7, 1949, with St. Louis Union Trust Company, trustee, T. D. 16,083. The assets of this trust consisted of securities having a market value in September 1951 of approximately $ 100,000, and the net income from said trust during the year 1951 was approximately $ 5,700. Said Hugh McK. Jones, Jr., was entitled to all the income from said trust and had the right to revoke the same, in whole or in part, at any time.(2) Trust under conveyance of Carroll West Jones (his mother) dated September 21, 1951, St. Louis Union Trust Company and Hugh 29 T.C. 200">204 McK. Jones, trustees, T. D. 17,124. The assets of this trust consisted of marketable securities worth on September 21, 1951, $ 21,500. Said Hugh McK. Jones, Jr., was entitled to all of the net income of said trust during his lifetime. The income from this trust paid or payable to Hugh McK. Jones, Jr., for his taxable year ended December 31, 1952, was $ 974.54.(3) Trust under conveyance of Carroll West Jones dated December 31, 1941, St. Louis Union Trust Company and Hugh McK. Jones, trustees, T. D. 13,218.1957 U.S. Tax Ct. LEXIS 47">56 The assets of this trust consisted of marketable securities having a value on September 21, 1951, of approximately $ 16,000. Under the terms of this trust said Hugh McK. Jones, Jr., was entitled to all of the income during its continuance. The income from this trust payable to Hugh McK. Jones, Jr., for 1951 was $ 719.97. Said trust terminated on December 31, 1951, and said Hugh McK. Jones, Jr., was entitled to and received distribution of the corpus thereof, free of trust.The 1951 earned income of Hugh McK. Jones, Jr., from his profession as an architect was approximately $ 4,500. The total joint gross income of him and his wife for the year 1951 was $ 11,444; and that for the years 1950 and 1949 was $ 10,846 and $ 9,935, respectively.(b) Florence T. Jones was 44 years of age, unmarried, and had no dependents. She was a registered nurse, employed by St. Luke's Hospital in St. Louis, Missouri. She lived in St. Louis County in a house owned by petitioner and furnished to her by him. She owned marketable securities having a value of approximately $ 20,000, and cash of approximately $ 1,000. Also, she was the beneficiary of the following trusts:(1) Trust under conveyance of1957 U.S. Tax Ct. LEXIS 47">57 Robert McK. Jones (her grandfather) dated May 31, 1923, Hugh McK. Jones, trustee, St. Louis Union Trust Company, agent, T. D. 10,716. The assets of this trust consisted of securities having a market value in September 1951 of approximately $ 125,000, and the net income from said trust during the year 1951 was approximately $ 6,750. Said Florence T. Jones was entitled to all of the income from said trust during her life, and in the discretion of the trustee the trust was terminable at any time in whole or in part and the principal thereof was distributable to her.(2) Trust under conveyance of Carroll West Jones (her mother) dated September 21, 1951, St. Louis Union Trust Company and Hugh McK. Jones, trustees, T. D. 17,125. The assets of this trust consisted of marketable securities worth on September 21, 1951, $ 21,500. Said Florence T. Jones was entitled to all of the net income of said trust during her lifetime. The income from this trust paid or payable to Florence T. Jones for her taxable year ended December 31, 1952, was $ 975.21.29 T.C. 200">205 (3) Trust under conveyance of Carroll West Jones dated December 31, 1941, St. Louis1957 U.S. Tax Ct. LEXIS 47">58 Union Trust Company and Hugh McK. Jones, trustees, T. D. 13,214. The assets of this trust consisted of marketable securities having a value on September 21, 1951, of approximately $ 17,000. Under the terms of this trust said Florence T. Jones was entitled to all of the income during its continuance. The income from this trust payable to Florence T. Jones for the year 1951 was $ 763.68. Said trust terminated on December 31, 1951, and said Florence T. Jones was entitled to and received distribution of the corpus thereof, free of trust.The 1951 earned income of Florence T. Jones from her employment as a nurse was approximately $ 3,000. Her total gross income for the year 1951 was $ 11,594; and that for the years 1950 and 1949 was $ 10,030 and $ 6,235, respectively.(c) Grace J. Borg was 39 years of age, married, and the mother of one child who was a student at Harvard. Her husband was a partner in a New York brokerage firm. She lived with her husband in Greenwich, Connecticut, in a house owned jointly by them, which cost approximately $ 40,000 and was encumbered by a mortgage of approximately $ 17,000. She owned securities which had a market value of1957 U.S. Tax Ct. LEXIS 47">59 approximately $ 20,000. Also, she was the beneficiary of the following trusts:(1) Trust under conveyance of Robert McK. Jones (her grandfather) dated May 31, 1923, Hugh McK. Jones, trustee, St. Louis Union Trust Company, agent, T. D. 10,717. The assets of this trust consisted of securities having a market value in September 1951 of approximately $ 100,000, and the net income from said trust during the year 1951 was approximately $ 5,500. Said Grace J. Borg was entitled to all of the income from said trust during her life, and in the discretion of the trustee the trust was terminable at any time in whole or in part and the principal thereof was distributable to her.(2) Trust under conveyance of Carroll West Jones (her mother) dated September 21, 1951, St. Louis Union Trust Company and Hugh McK. Jones, trustees, T. D. 17,123. The assets of this trust consisted of marketable securities worth on September 21, 1951, $ 21,500. Said Grace J. Borg was entitled to all of the net income of said trust during her lifetime. The income from this trust paid or payable to Grace J. Borg for her taxable year ended December 31, 1952, was $ 1957 U.S. Tax Ct. LEXIS 47">60 992.13.(3) Trust under conveyance of Carroll West Jones dated December 31, 1941, St. Louis Union Trust Company and Hugh McK. Jones, trustees, T. D. 13,216. The assets of this trust consisted of marketable securities having a value on September 21, 1951, of approximately $ 13,000. Under the terms of this trust said Grace J. Borg was entitled 29 T.C. 200">206 to all of the income during its continuance. The income from this trust payable to Grace J. Borg for 1951 was $ 614.19. Said trust terminated on December 31, 1951, and said Grace J. Borg was entitled to and received distribution of the corpus thereof, free of trust.Grace J. Borg had income for the year 1951, exclusive of that from trusts, of approximately $ 750. The evidence does not disclose the amount of the total gross income of her and her husband for said year, but their standard of living was comparable to that of the other members of the family.(d) Carroll Jones McPheeters was 36 years of age, married, and the mother of three children. Her husband was a lawyer who had his office in St. Louis, Missouri. She lived with her family in St. Louis County, in a house owned jointly with her husband, which1957 U.S. Tax Ct. LEXIS 47">61 cost approximately $ 50,000 and was unencumbered. She owned marketable securities having a value of approximately $ 26,000, and cash of approximately $ 7,000. Also, she was the beneficiary of the following trusts:(1) Trust under conveyance of Robert McK. Jones (her grandfather) dated May 31, 1923, Hugh McK. Jones, trustee, St. Louis Union Trust Company, agent, T. D. 10,715. The assets of this trust consisted of securities having a market value in September 1951 of approximately $ 120,000, and the net income from said trust during the year 1951 was approximately $ 6,500. Said Carroll Jones McPheeters was entitled to all of the income from said trust during her life, and in the discretion of the trustee the trust was terminable at any time in whole or in part and the principal thereof was distributable to her.(2) Trust under conveyance of Carroll West Jones (her mother) dated September 21, 1951, St. Louis Union Trust Company and Hugh McK. Jones, trustees, T. D. 17,126. The assets of this trust consisted of marketable securities worth on September 21, 1951, $ 21,500. Said Carroll Jones McPheeters was entitled to all of the net1957 U.S. Tax Ct. LEXIS 47">62 income of said trust during her lifetime. The income from this trust paid or payable to Carroll Jones McPheeters for her taxable year ended December 31, 1952, was $ 974.54.(3) Trust under conveyance of Carroll West Jones dated December 31, 1941, St. Louis Union Trust Company and Thomas S. McPheeters, Jr., trustees, T. D. 13,217. The assets of this trust consisted of marketable securities having a value on September 21, 1951, of approximately $ 17,000. Under the terms of this trust said Carroll Jones McPheeters was entitled to all of the income during its continuance. The income from this trust payable to Carroll J. McPheeters for the year 1951 was $ 777.21. Said trust terminated on December 31, 1951, and said Carroll Jones McPheeters was entitled to and received distribution of the corpus thereof, free of trust.29 T.C. 200">207 Carroll Jones McPheeters had income from all sources for the calendar year 1951, exclusive of gains from the sale of capital assets, of $ 8,768. The joint gross income of her and her husband for said year, including capital gains of $ 1,074, was $ 30,094. Such joint income for the years 1950 and 1949 was $ 27,300 and $ 25,400, respectively. 1957 U.S. Tax Ct. LEXIS 47">63 In addition to the foregoing, all of said children of the petitioner were joint beneficiaries of an irrevocable trust under conveyance of Robert McK. Jones (their grandfather), dated June 12, 1928, and amended on March 6, 1931, and December 31, 1932, under which their mother and St. Louis Union Trust Company were the trustees (trust No. 6931). The assets of this trust consisted of two policies of insurance on the life of petitioner in the aggregate face amount of $ 100,000, together with certain securities of which the income was to be used to pay the insurance premiums with any excess income to be accumulated and added to the principal. Upon the death of petitioner, one-fifth of the principal of the trust estate was to be distributed to each of petitioner's said children if living, or if they were not living then to their then living descendants, or in the absence of such descendants to the other living children of the petitioner or their descendants.At the time of the creation of the four trusts here directly involved, the petitioner was as before stated 70 years of age; and his wife Carroll W. Jones, who was the mother of said children, was of the same age. At said time, each1957 U.S. Tax Ct. LEXIS 47">64 of petitioner's said children was living in a modest and comfortable, but not extravagant, manner.At the time of the trial herein on December 4, 1956, the petitioner, his said wife, and all of his said children were still living. To that date, the corporate trustee of each of said trusts had never encroached upon the principal of any of said trusts, pursuant to the power granted to it in section Four of the several trust indentures; and no request had been received by it that any such encroachment be made.Facts re Trust for Grandchildren.The fifth trust above mentioned, of which petitioner's grandchildren were the primary beneficiaries, provided in part as follows:SECTION TWO: (a) The Trustees shall divide the trust estate into four equal shares for the respective benefit of Robert McK. Jones III, Mary Elizabeth Jones, Carroll West Jones and Thomas West Jones, the children of Grantor's deceased son, Robert McK. Jones II. The Trustees, during the minority of said grandchildren of the Grantor, shall use and apply so much of the net income and also of the principal of their respective shares as they may deem necessary for their proper education, maintenance and support until1957 U.S. Tax Ct. LEXIS 47">65 they respectively reach the age of twenty-one years, after which time the entire net income from the share of each such grandchild shall be paid to him or her direct during the further continuance of the trust; as and when each such grandchild reaches the age of twenty-one years, such grandchild shall receive one-fourth of his or 29 T.C. 200">208 her respective share of the trust estate, free from trust; as and when each such grandchild reaches the age of twenty-five years, such grandchild shall receive one-third of the residue of his or her share of the trust estate free from trust; and as and when each such grandchild reaches the age of thirty years, such grandchild shall receive the remainder of his or her share, free from trust.Other paragraphs of said section Two further provided, in substance, that in the event any of said beneficiaries should die before receiving his or her share of the trust estate, then upon his or her death the property constituting such share should be paid over to his or her descendant, per stirpes, subject to certain conditions provided; or in the absence of such descendants, then to be paid to or be administered in trust for the benefit of certain other described1957 U.S. Tax Ct. LEXIS 47">66 persons exclusive of the grantor, all in accordance with the terms and conditions of said indenture.On the date of the creation of said trust, said grandchildren of the petitioner were, respectively, 18, 16, 13, and 9 years of age. The three older grandchildren were students in private schools in St. Louis County, Missouri; and the youngest was a student in a public school. The amounts of their gross incomes for the year 1951 were:Robert McK. Jones, III$ 1,359.93Mary Elizabeth Jones1,142.99Carroll W. Jones1,171.24Thomas W. Jones1,170.04In addition, each of said grandchildren was at the date of the creation of the present trust, the owner of property held for him or her by their mother and the St. Louis Union Trust Company, as curators. The values of such properties, which consisted of marketable securities, were as of said date as follows:Robert McK. Jones, III$ 15,400Mary Elizabeth Jones15,650Carroll W. Jones15,600Thomas W. Jones15,300Also, said grandchildren were equal beneficiaries of the following trusts:(1) Trust under conveyance of Carroll West Jones (their grandmother) dated September 21, 1951, St. Louis Union Trust Company and1957 U.S. Tax Ct. LEXIS 47">67 Hugh McK. Jones, trustees, T. D. 17,127. The assets of this trust consisted of marketable securities which were worth in the aggregate $ 21,500; and the amount of income paid or payable therefrom to each of said grandchildren for the calendar year 1952, was $ 243.81.(2) Certain trusts created by Grace R. Jones (mother of petitioner) dated March 13, 1943. The assets of these trusts had an aggregate market value on September 21, 1951, of approximately $ 10,000; and the amount of income paid or payable therefrom to each of said grandchildren for the year 1951 was $ 121.29 T.C. 200">209 The practice of the St. Louis Trust Company, in cases where a request for encroachment upon the principal of a trust of which it was a trustee was received from a beneficiary, was for one of its trust officers to determine the relevant facts pertinent to the provisions of the particular trust, including: The purpose for which the encroachment was sought; the financial circumstances of the beneficiary seeking the encroachment; and the other assets owned by or available to such beneficiary. Such trust officer would then submit a report, together with his recommendation for approval1957 U.S. Tax Ct. LEXIS 47">68 or disapproval of the encroachment, to the trust estate committee of the trustee; and the committee would thereupon act independently on the facts and recommendation so submitted to it.The petitioner, in his 1951 gift tax return, claimed four exclusions of $ 3,000 each (total $ 12,000) in respect of the four transfers in trust for the benefit of his children; and four other exclusions in the amounts of $ 1,490.68, $ 1,786.47, $ 2,059.93, and $ 2,546.53 (total $ 7,883.61), in respect of the fifth transfer in trust for the benefit of his grandchildren.The respondent, in his notice of deficiency, determined that none of said exclusions was allowable. He determined that, although the gifts of trust income to petitioner's children were present interests within the meaning of section 1003 (b) of the 1939 Code, the values of such interests were not susceptible of determination; and that the interests of petitioner's grandchildren in the fifth trust were future interests within the meaning of said section.The values of the present interests of petitioner's children in the trusts created for their benefit were determinable; and the value of each such present interest, as of the date of1957 U.S. Tax Ct. LEXIS 47">69 the creation of the trusts, was more than $ 3,000.The interests of petitioner's grandchildren in the trust created for them were future interests.OPINION.I.The first question for decision is whether, in determining the total amount of petitioner's gifts for the year 1951, there should be allowed pursuant to section 1003 (b) of the 1939 Code, four exclusions of not more than $ 3,000 each, in respect of the four separate trusts which petitioner created in said year for the primary benefit of his four living adult children.As hereinbefore shown in our Findings of Fact, each of said trusts was created by a separate irrevocable trust indenture; and, in each case, the property which petitioner transferred without consideration 29 T.C. 200">210 to the trustees, as the principal of the trust, consisted of marketable securities of the value of $ 21,645. All of said trust indentures were substantially the same for present purposes. Each provided that the entire net income of the trust should be paid to the named primary beneficiary for and during his or her life; and that, from and after the death of such beneficiary, the principal of the trust should be administered and disposed of for1957 U.S. Tax Ct. LEXIS 47">70 the benefit of others, in the manner mentioned in the indenture. Also each of the indentures, in a separate section thereof, granted to the corporate trustee a power to encroach upon the principal of the trust "from time to time when it believes it proper to do so," in order to make advancements for the benefit of any beneficiary of such sums "as it shall consider reasonable and proper under the circumstances," "to provide for their proper maintenance, education and support, in accordance with the standard of living to which they have been accustomed, or to provide against any emergency which may arise affecting them occasioned by sickness, accident, ill health, misfortune or otherwise."It now is well settled that gifts in trust are to be regarded for gift tax purposes as gifts to the beneficiaries rather than to the trustees ( Helvering v. Hutchings, 312 U.S. 393">312 U.S. 393); that a right given to a primary beneficiary to receive trust income currently is a present interest as distinguished from a future interest, within the meaning of said section 1003 (b); and that the right of remaindermen to have the benefit of the trust principal after the death 1957 U.S. Tax Ct. LEXIS 47">71 of the primary beneficiary is a future interest. Fondren v. Commissioner, 324 U.S. 18">324 U.S. 18. Also it is now settled that where, as in the instant case, there is a gift of income coupled with a power in the trustee to encroach upon principal, at such times and in such amounts as it deems proper, to meet certain possible needs, the interest of the primary beneficiary in such possible advancements from principal as the trustee may make, is likewise a future interest. 324 U.S. 18">Fondren v. Commissioner, supra at 18; Commissioner v. Disston, 325 U.S. 442">325 U.S. 442, 325 U.S. 442">446, 325 U.S. 442">447; Kniep v. Commissioner, 172 F.2d 755, 756 (C. A. 8). Thus it follows, in the instant case, that since the exclusions from gifts provided by section 1003 (b) of the Code are allowable only in respect of present interests as distinguished from future interests, any such exclusions in respect of the four transfers in trust here considered, may be allowed solely with regard to the rights of the primary beneficiaries to receive income, and not with regard to the rights either of said beneficiaries or of1957 U.S. Tax Ct. LEXIS 47">72 the remaindermen to receive advancements or distributions from the principal. If such rights of the primary beneficiaries to receive income are found to have any determinable value whatever, then the first $ 3,000 of such value must be excluded from the total amount of petitioner's gifts for the year 1951; but, otherwise, no such exclusion is allowable.29 T.C. 200">211 The respondent, in his notice of deficiency, determined that no exclusion was allowable in respect of any of the four transfers in trust here considered, on the ground that, although the right of each primary beneficiary to receive income was a present interest, the values of such present interests were not susceptible of determination. His position on brief is in substance that, since the corporate trustee might possibly encroach upon the principal of each trust to an extent where no principal would remain from which the beneficiaries could receive income, no value for the income rights of these beneficiaries is ascertainable. Thus, in practical effect, the right of each primary beneficiary to receive income was assigned a zero value -- notwithstanding that each of the transfers in trust, in respect of which the right1957 U.S. Tax Ct. LEXIS 47">73 of the primary beneficiary to receive income for life was a material part, was valued and taxed as a gift in the amount of $ 21,645. We think this was erroneous.The valuation of the life interest in any trust estate, and also the valuation of the remainder interests, are necessarily subject to many uncertainties. For example, no one can determine as of the date of a particular transfer in trust, how long the life beneficiary may live; or whether the trust estate will appreciate, depreciate, or be lost entirely; or what income, if any, the trust estate may yield during each year of the primary beneficiary's life. But yet in most cases, some value must be determined for the life estate or for the remainder, or for both, if the gift tax is to be operative. Thus, the applicable Treasury regulations for both gift taxes and estate taxes have made provision that the values of life interests and of remainders shall be determined by resort to probabilities, through use of mortality tables and the application of presumed rates of income yield. See Regs. 108 (gift tax), sec. 86.19, as amended; and Regs. 105 (estate tax), sec. 81.10, as amended. As was said by the Court of Appeals for 1957 U.S. Tax Ct. LEXIS 47">74 the First Circuit in McMurtry v. Commissioner, 203 F 2d. 659, 666:The whole problem of valuing individual life interests by resort to mortality tables is at best a matter of educated guesswork. The courts cannot demand perfection in an area so fraught with speculation and uncertainty. * Also, where in situations like the present, either a donor or a testator has made a gift of trust income for life and, being aware of the uncertainties of our world, has granted a power to the trustee to encroach upon the trust estate, from time to time in its discretion, to provide for certain possible needs or emergencies that may affect the income beneficiary, there is created still another factor of uncertainty in the valuation of the interest of the life beneficiary or remaindermen. But in these situations likewise, the courts have recognized in numerous cases that resort may be made to probabilities; and that, for tax purposes, the value of the life interest or remainder is determinable 29 T.C. 200">212 if: (a) The power of encroachment is limited by an ascertainable standard, 2 and (b) the possibility of encroachments being made in accordance with such standard1957 U.S. Tax Ct. LEXIS 47">75 is so remote as to be negligible. Ithaca Trust Co. v. United States, 279 U.S. 151">279 U.S. 151, 279 U.S. 151">154; Lincoln Rochester Tr. Co. v. Commissioner, 181 F.2d 424 (C. A. 2); Berry v. Kuhl, 174 F.2d 565 (C. A. 7); Commissioner v. Wells Fargo B. & U. Tr. Co., 145 F.2d 130 (C. A. 9); Commissioner v. Robertson's Estate, 141 F.2d 855 (C. A. 4); Commissioner v. Bank of America, Etc., 133 F.2d 753 (C. A. 9); Estate of Oliver Lee, 28 T.C. 1258; William H. Robertson, 26 T.C. 246; Estate of Leonard O. Carlson, 21 T.C. 291; Estate of Anna Finley Kenny, 11 T.C. 857; Estate of Edwin E. Jack, 6 T.C. 241; Estate of James M. Schoonmaker, 6 T.C. 404. See also McHugh v. United States, 135 Ct. Cl. 520">135 Ct. Cl. 520, 142 F. Supp. 927">142 F. Supp. 927, in which the above principle was recognized in determining1957 U.S. Tax Ct. LEXIS 47">76 the value for gift tax purposes of the life beneficiary's interest in the possibility of encroachment upon principal by the trustee. See also Hartford-Connecticut Trust Co. v. Eaton, 36 F.2d 710, in which the Court of Appeals for the Second Circuit, in an opinion by Judge Learned Hand, applied this same principle in a case involving the income tax for a trust.Applying the foregoing principle in the instant case, 1957 U.S. Tax Ct. LEXIS 47">77 we think that the values of the income interests of petitioner's children in the trusts here considered, are determinable for the following reasons:1. It is our opinion that the corporate trustee's power of encroachment here involved was limited by an ascertainable standard. In numerous decided cases, encroachment provisions similar to the present have been interpreted to have for their purpose the maintenance of the accustomed standard of living of the person for whose benefit the encroachment was permitted; and the provisions have been held to establish sufficiently fixed and definite standards to make possible the valuation of beneficiaries' interests. Such provisions include those authorizing encroachments, "to suitably maintain her [the life beneficiary] in such comfort as she now enjoys," 279 U.S. 151">Ithaca Trust Co. v. United States, supra; "on account of any sickness, accident, want or other emergency," Commissioner v. Wells Fargo B. & U. Tr. Co., supra; "in case she [the life beneficiary] should, by reason of accident, illness or 29 T.C. 200">213 other unusual circumstances so require," Commissioner v. Bank of America, Etc., supra;1957 U.S. Tax Ct. LEXIS 47">78 "to take care of any emergency, illness or necessity," Estate of Oliver Lee, supra; and "[as the trustee] shall deem necessary for her maintenance and support," William H. Robertson, supra.See also Lincoln Rochester Tr. Co. v. Commissioner, supra, containing a review of authorities on this subject. Such powers of encroachment are distinguishable from others, held not to be limited by an ascertainable standard, where the criterion was indefinite and subjective, such as for the "happiness," or "pleasure," or "desire" of the beneficiary. Merchants Bank v. Commissioner, 320 U.S. 256">320 U.S. 256; and Henslee v. Union Planters Bank, 335 U.S. 595">335 U.S. 595.2. We think also that here the possibility that an encroachment would occur to defeat the flow of income to the primary beneficiary was so remote as to be negligible.Our interpretation of section Four of each of the trust instruments is that the trust principal was not to be used, unless the life beneficiaries' other resources should prove insufficient to meet specified contingencies which1957 U.S. Tax Ct. LEXIS 47">79 did not exist at the time when the gifts in trust were made. None of the trust instruments effected an absolute gift of support and maintenance that was made a charge upon both income and principal; but, rather, the gift was of income, coupled with a provision in a separate section that the corporate trustee was authorized to encroach upon the principal, from time to time in its discretion, to provide for certain specified circumstances. The value of the principal of each trust was only $ 21,645; and, if this yielded income at the rate of 4 per cent as used in the gift tax regulations, the annual income would be only about $ 866. All of the beneficiaries were, at the time of the creation of the trusts, adults enjoying an accustomed mode of living which required income greatly in excess of such amount; and it cannot reasonably be assumed that petitioner intended the trust principal to be consumed in providing their entire support. To the contrary, each of the trust instruments contained elaborate provisions for investment of the trust funds, for contingent remainders to unborn children, for trust administration for the benefit of remaindermen who might be minors, and also for cross1957 U.S. Tax Ct. LEXIS 47">80 remainders. Our interpretation of the instruments as a whole, to the effect that other resources of the beneficiaries should be considered, accords with the practical interpretation of the trustee, as described in the testimony of the trust officer who had charge of the trusts. And it accords also, with the interpretation which the courts have applied in other cases, to trust instruments containing similar encroachment provisions. Estate of Anna Finley Kenny, supra;Estate of Leonard O. Carlson, supra.See also Estate of Edwin E. Jack, supra;Berry v. Kuhl, supra;Commissioner v. Wells Fargo B. & U. Tr. Co., supra;29 T.C. 200">214 Commissioner v. Robertson's Estate, supra;Hartford-Connecticut Trust Co. v. Eaton, supra.31957 U.S. Tax Ct. LEXIS 47">81 When, with this interpretation in mind, we look to the financial conditions of the several beneficiaries as of the date of the creation of the trusts, we find that each was living in a modest and comfortable, but not extravagant, manner; and that each possessed substantial other resources.Hugh, Jr., who was 31 years of age, was an architect. He and his wife lived in a house which cost approximately $ 47,000 and was subject to a mortgage of about $ 15,000. He also owned unencumbered real estate which had a cost of $ 14,500. And, in addition, he was the beneficiary of a trust of $ 100,000, created by himself, which yielded him an income of approximately $ 5,700, and which he had the right to revoke in whole or in part at any time; of another trust of $ 21,500, created by his mother, which yielded him an income of approximately $ 975; and of still another trust of approximately $ 16,000, created by his mother, which was to terminate about 3 months after the present trusts were created. The total gross income of Hugh, Jr., and his wife for the year 1951 was $ 11,444.Florence, who was 44 years of age and unmarried, was a registered nurse. She had marketable securities that had a1957 U.S. Tax Ct. LEXIS 47">82 value of approximately $ 20,000, and cash of approximately $ 1,000. Also she was the beneficiary of a trust of approximately $ 125,000, created by her grandfather, which yielded her an income of approximately $ 6,750, and of which the principal could, in the discretion of the trustee, be distributed to her at any time in whole or in part; of another trust of $ 21,500, created by her mother, which yielded her income of approximately $ 975; and of still another trust of approximately $ 17,000, created by her mother, which yielded her an income of approximately $ 764, and of which the principal was to be distributed to her approximately 3 months after the present trusts were created. The gross income of Florence for the year 1951 was $ 11,594.Grace, who was 39 years of age, was the wife of a partner in a New York brokerage firm. She lived with her husband in a house which cost approximately $ 40,000 and was subject to a mortgage of approximately $ 17,000. She owned securities valued at approximately $ 20,000. And, in addition, she was the beneficiary of a trust of approximately $ 100,000, created by her grandfather, which yielded her an income of 29 T.C. 200">215 about $ 5,500, and of1957 U.S. Tax Ct. LEXIS 47">83 which the principal could, in the discretion of the trustee, be distributed to her at any time in whole or in part; of another trust of $ 21,500, created by her mother, which yielded her an income of about $ 992; and of still another trust of approximately $ 13,000, created by her mother, which yielded her an income of about $ 614, and of which the principal was to be distributed to her approximately 3 months after the present trusts were created. The standard of living of her and her husband was comparable to that of the other members of the family.Carroll, who was 36 years of age, was the wife of a St. Louis lawyer. They lived in a house which cost approximately $ 50,000 and was unencumbered. She owned securities valued at about $ 26,000 and cash of about $ 7,000. Also, she was the beneficiary of a trust of approximately $ 120,000, created by her grandfather, which yielded her an income of about $ 6,500, and of which the principal could, in the discretion of the trustee, be distributed to her at any time, in whole or in part; of another trust of approximately $ 21,500, created by her mother, which yielded her an income of about $ 975; and of still another trust of approximately1957 U.S. Tax Ct. LEXIS 47">84 $ 17,000, created by her mother, which yielded her an income of about $ 777, and of which the principal was to be distributed to her about 3 months after the present trusts were created. The total gross income of Carroll and her husband for the year 1951 was in excess of $ 30,000.In addition, all of said children of the petitioner were joint beneficiaries of an insurance trust created by their grandfather, under which, upon the death of petitioner, they if living were to receive 20 per cent of the proceeds of insurance on his life in the amount of $ 100,000. It is obvious also, from all the foregoing, that these children were natural objects of the bounty, not only of their grandfather, but also of their father and mother who on the material date were each 70 years of age.Computations which we have made indicate that, if the values of the several gifts of income here involved are computed in accordance with Regulations 108, section 86.19, as amended, without regard to the encroachment provisions, such values would be approximately:Hugh, Jr$ 14,600Florence12,200Grace13,200Carroll13,800Since we have determined that the possibility of encroachment on principal1957 U.S. Tax Ct. LEXIS 47">85 is so remote as to be negligible, it is our opinion based on the foregoing authorities that, notwithstanding such possibility, the above-mentioned values should be given effect. As was said by the Supreme Court in Ithaca Trust Co. v. United States, supra (279 U.S. 151">279 U.S. at 154, 155):29 T.C. 200">216 There was no uncertainty appreciably greater than the general uncertainty that attends human affairs.Like all values, as the word is used by the law, it [the value of property at a given time] depends largely on more or less certain prophecies of the future, * * the value of the wife's life interest must be estimated by the mortality tables. * * The following cases, on which respondent relies principally, are distinguishable: William Harry Kniep, 9 T.C. 943, affd. 172 F.2d 755 (C. A. 8); Sylvia H. Evans, 17 T.C. 206, affd. 198 F.2d 435 (C. A. 3); Jennie Brody, 19 T.C. 126. In the Kniep case, the Commissioner did compute and determine a value for the present interest of the life beneficiary; the taxpayer1957 U.S. Tax Ct. LEXIS 47">86 presented no proof that such computation was erroneous, or that the possibility of encroachment was negligible; and the Commissioner's determination was approved. In the Evans case, also, the taxpayer raised no issue and presented no evidence whatever that the possibility of encroachment was so remote as to be negligible. And in the Brody case, the trustees had a power to accelerate distribution of the principal, which was not limited by any standard.We hold, on the basis of all the foregoing, that the value of the income interests of petitioner's children in the trusts here considered are susceptible of determination; that the value of each such interest as of the date of the creation of the trusts was more than $ 3,000; and that, in computing petitioner's total gifts for the year 1951, there should be allowed four exclusions of $ 3,000 each in respect of such interests, pursuant to section 1003 (b) of the 1939 Code.II.We shall next consider the fifth trust, which petitioner created in the year 1951 for the joint benefit of his grandchildren.At the time when this trust was created, said grandchildren were, respectively, 18, 16, 13, and 9 years of age. The trust1957 U.S. Tax Ct. LEXIS 47">87 indenture provided, in substance, that the trustees should divide the trust estate into four equal shares for the respective benefits of said grandchildren; that, during the minority of said grandchildren, the trustees should "use and apply so much of the net income and also of the principal of their respective shares as they [the trustees] may deem necessary for their proper education, maintenance and support until they respectively reach the age of twenty-one years"; and that thereafter the income and principal should be disposed of in the manner specified.In 325 U.S. 442">Commissioner v. Disston, supra, where the facts were similar to those here, the Supreme Court said (325 U.S. 442">325 U.S. at 448-449):29 T.C. 200">217 The subsequent provision for payments for maintenance and support may be said to indicate a departure from the policy of accumulation only when necessary, in the reasonable discretion of the trustees. If that is the appropriate interpretation of the trust instruments, then little difference from the Fondren case is involved. * * * [In the Fondren case (324 U.S. 18">324 U.S. 18) the interests of the life beneficiaries1957 U.S. Tax Ct. LEXIS 47">88 were held to be future interests.]But, even though the trustees were under a duty to apply the income for support, irrespective of outside sources of revenue, there is always the question how much, if any, of the income can actually be applied for the permitted purposes. The existence of a duty so to apply the income gives no clue to the amount that will be needed for that purpose, or the requirements for maintenance, education and support that were foreseeable at the time the gifts were made. In the absence of some indication from the face of the trust or surrounding circumstances that a steady flow of some ascertainable portion of income to the minor would be required, there is no basis for a conclusion that there is a gift of anything other than for the future. The taxpayer claiming the exclusion must assume the burden of showing that the value of what he claims is other than a future interest. * In the instant case, there is an "absence of some indication from the face of the trust or surrounding circumstances that a steady flow of some ascertainable portion of income to the minor would be required."We hold therefore, on the basis of the above-mentioned authorities, that1957 U.S. Tax Ct. LEXIS 47">89 the interest of each of petitioner's grandchildren in the trust here considered, must be deemed a future interest. Accordingly, no exclusion under section 1003 (b) of the 1939 Code is allowable in respect of such interests.Decision will be entered under Rule 50. Footnotes1. SEC. 1003. NET GIFTS.(b) Exclusions from Gifts. -- * * * (3) Gifts after 1942. -- In the case of gifts (other than gifts of future interests in property) made to any person by the donor during the calendar year 1943 and subsequent calendar years, the first $ 3,000 of such gifts to such person shall not, for the purposes of subsection (a), be included in the total amount of gifts made during such year.↩2. The concept of "an ascertainable standard" is recognized also in the estate tax provisions of the 1939 Code, relating to the tax effects of a power of appointment, where it is said:SEC. 811. GROSS ESTATE.(f) Powers of Appointment. -- * * (3) Definition of general power of appointment. -- * * (A) A power to consume, invade, or appropriate property for the benefit of the decedent which is limited by an ascertainable standard relating to the health, education, support, or maintenance of the decedent shall not be deemed a general power of appointment.↩3. Since the intention of the present grantor is determinable, we regard it unnecessary to resort to local law. Estate of Anna Finley Kenny, 11 T.C. 857, 863. Nevertheless, in Winkel v. Streicher, 295 S.W.2d 56, the Supreme Court of Missouri (the State in which the present trusts were created) recognized that the intention of the trustor must govern in each particular case; and that a distinction is to be made between situations where there is an absolute gift of support that is made a charge on both income and principal, and where the gift is of income, coupled with a provision for encroachment. See also the extensive review of cases on this subject in 2 A. L. R. 2d 1431↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620956/	BROWN-CRUMMER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Brown-Crummer Co. v. CommissionerDocket No. 25867.United States Board of Tax Appeals19 B.T.A. 750; 1930 BTA LEXIS 2335; April 28, 1930, Promulgated 1930 BTA LEXIS 2335">2335 Held, under the facts shown, proceeds received by the petitioner from coupons clipped from municipal bonds held in pledge by a bank to secure loans, are tax-exempt income to it. Ray G. Ransom, Esq., for the petitioner. P. M. Clark, Esq., for the respondent. LANSDON 19 B.T.A. 750">750 OPINION. LANSDON: The respondent asserted deficiencies in income taxes against the petitioner for the calendar years 1922 and 1924, in the respective amounts of $5,927.70 and $9,922.29, from which this appeal is prosecuted. The error alleged is that the respondent wrongfully increased the petitioner's taxable income for the years by the amount of receipts derived by it from tax-exempt bonds, which it sold to and later repurchased from the First National Bank in Wichita, Kans., 19 B.T.A. 750">751 in accordance with certain repurchase agreements entered into at the date of sale. The reasons assigned by the respondent for his denial of the petitioner's claims for deduction of the amounts in controversy are contained in a statement enclosed with his deficiency letter to petitioner, under date of February 8, 1927, reading as follows: 1. Net income has been increased by interest1930 BTA LEXIS 2335">2336 on municipal bonds deposited with First National Bank of Wichita under "repurchase agreements", inasmuch as the First National Bank is also claiming certain interest payments which they contend are merely a reimbursement to them of the interest on the bonds. There cannot be two tax-exempt items of income arising from the same bonds. * * * At the hearing of this case when it was regularly called for trial, it was agreed in open court by the attorneys for the petitioner and respondent that no evidence be introduced, but that the issues herein presented be submitted, considered and decided upon the transcript of the record made in First National Bank in , and be promulgated after or along with the decision in those cases. Inasmuch as the record in First National Bank in , shows that the identical interest payments, here in controversy (therein claimed by that appellant), were not received by it but by this petitioner, it follows that the respondent erred in denying the deductions herein claimed and that this appeal must be sustained. Reviewed by the Board. Decision will be1930 BTA LEXIS 2335">*2337 entered under Rule 50.SMITH and TRAMMELL dissent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620959/	Richard L. Mulvania, Petitioner v. Commissioner of Internal Revenue, RespondentMulvania v. CommissionerDocket No. 12671-82United States Tax Court81 T.C. 65; 1983 U.S. Tax Ct. LEXIS 61; 81 T.C. No. 5; July 20, 1983, Filed 1983 U.S. Tax Ct. LEXIS 61">61 On Sept. 16, 1981, the Commissioner mailed a notice of deficiency to P at an address which may not have been his "last known address." On Oct. 2, 1981, P received the notice of deficiency. He delivered the notice to his accountant, who in turn forwarded it to an attorney. A petition was not filed with this Court until June 8, 1982. Held, regardless of whether the notice of deficiency was mailed to P at his last known address, the notice is valid because of his actual receipt of it early enough to file a timely petition, and the Commissioner's motion to dismiss will be granted. Paul Frederic Marx, for the petitioner.Marshall W. Taylor, for the respondent. Simpson, Judge. Sterrett, J., dissenting. Goffe, J., agrees with this dissent. SIMPSON81 T.C. 65">65 This matter is before us on the parties' cross motions to dismiss for lack of jurisdiction. The petitioner claims that the notice of deficiency was invalid because it had not been mailed to him at his last known address. Sec. 6212(b)(1), I.R.C. 1954. 1 The Commissioner claims that the petition was not filed within 90 days after the mailing of the notice of deficiency. Sec. 6213(a). At the conclusion1983 U.S. Tax Ct. LEXIS 61">63 of the hearing on such motions, the Court took them under advisement.FINDINGS OF FACTMost of the facts have been stipulated, and those facts are so found. The petitioner, Richard L. Mulvania, resided in Newport Beach, Calif., when he filed the petition in this case.On or before April 15, 1977, the petitioner filed a separate Federal income tax return for 1976 with the Internal Revenue Service Center at Fresno, Calif. His address, as shown on that return, was 57 Linda Isle Drive, Newport Beach, Calif. (the Linda Isle address). He has resided at such address since February 1977. Prior to 1977, the petitioner resided at 4191 Silliman Drive, Huntington Beach, Calif. (the Silliman address). 81 T.C. 65">66 During September 1981, his former wife, Frances, and their children resided at the Silliman address.During 1976, the petitioner was an investor in King Merchants, Ltd., a partnership1983 U.S. Tax Ct. LEXIS 61">64 (King Merchants). After the Commissioner began an audit of King Merchants, the petitioner contributed to a partnership defense fund, and the partnership retained a San Francisco attorney.Between February 20 and March 11, 1980, the petitioner consented to extending until September 30, 1981, the time for assessment of a deficiency for 1976, but such extension was restricted to a deficiency due to his participation in King Merchants. On September 16, 1981, the Commissioner mailed a notice of deficiency to the petitioner at the Silliman address. A copy of the notice of deficiency was also mailed to the petitioner's accountant, as holder of a power of attorney, and was received by him in the ordinary course of the mail. However, the accountant did not contact the petitioner when he received the copy of the notice of deficiency; he decided that when he received the original notice from the petitioner, he would forward it to the San Francisco attorney.On September 28, 1981, Frances Mulvania telephoned the petitioner and informed him that she had a "bill" or "statement" from the IRS for him and that he owed the IRS some money. She did not tell him what taxable year the document concerned. 1983 U.S. Tax Ct. LEXIS 61">65 On October 2, 1981, the petitioner's children arrived at his residence for a custodial visit, and they brought the notice of deficiency to the petitioner from the Silliman address.On October 5 or 6, 1981, the petitioner's wife, Carol, took the notice of deficiency to the accountant's office. The accountant forwarded it to the San Francisco attorney on October 13, 1981. By April 1982, no petition had been filed with this Court, and on April 23, 1982, the Commissioner sent a notice of demand for payment of the 1976 deficiency to the petitioner at the Linda Isle address. The petitioner then retained his present counsel, and the petition was filed on June 8, 1982.OPINIONThe matter before us presents two issues: First, whether the notice of deficiency was mailed to the petitioner at his last known address, and second, whether the notice was nonetheless 81 T.C. 65">67 valid even if it was not so mailed. The petitioner has conceded that if the notice of deficiency was valid, the petition is untimely. We have concluded that the notice of deficiency is valid even if it was not mailed to the petitioner at his last known address. Such conclusion obviates the need for us to decide whether1983 U.S. Tax Ct. LEXIS 61">66 the notice was mailed to the petitioner at his last known address. 2Section 6212(a) provides that, if the Commissioner determines a deficiency in income tax, "he is authorized to send notice of such deficiency to the taxpayer by certified mail or registered mail." Such notice of deficiency "shall be sufficient" if mailed to the taxpayer at his last known address, unless the Commissioner has been properly notified1983 U.S. Tax Ct. LEXIS 61">67 that a fiduciary has been substituted for the taxpayer. Sec. 6212(b)(1). If the notice is mailed to a taxpayer in the United States, he has 90 days after the mailing of the notice to file his petition for redetermination of the deficiency with the Tax Court. Sec. 6213(a). These provisions were designed to afford a taxpayer notice of the Commissioner's determination and an opportunity to litigate the validity of such determination in this Court without first paying the claimed deficiency. Berger v. Commissioner, 404 F.2d 668">404 F.2d 668 (3d Cir. 1968), affg. 48 T.C. 848">48 T.C. 848 (1967); DeWelles v. United States, 378 F.2d 37">378 F.2d 37 (9th Cir. 1967); Lifter v. Commissioner, 59 T.C. 818">59 T.C. 818 (1973).In every income tax case, the Commissioner must issue the taxpayer a notice of deficiency. Sec. 6213(a). The notice constitutes the taxpayer's ticket to the Tax Court, and without it, there could be no prepayment judicial review of the asserted deficiency. DaBoul v. Commissioner, 429 F.2d 38">429 F.2d 38 (9th Cir. 1970), affg. per curiam an unpublished order of this Court; Wilt v. Commissioner, 60 T.C. 977">60 T.C. 977 (1973).1983 U.S. Tax Ct. LEXIS 61">68 However, a notice of deficiency is not invalid merely because it is not sent to the taxpayer's last known address. The language of section 6212(b)(1) is clearly permissive; the notice of deficiency "shall 81 T.C. 65">68 be sufficient" if it is sent to the last known address. In enacting the predecessor of section 6212(b)(1), Congress did not create a mandatory address to which a notice of deficiency had to be mailed; rather, Congress provided the Commissioner a "safe harbor" address to which he could send the notice, and it would be effective even though the taxpayer did not actually receive such notice because he had moved, died, or become incompetent. See sec. 281(d), Rev. Act of 1926, 44 Stat. (Part 2) 62; S. Rept. 52, 69th Cong., 1st Sess. (1926), 1939-1 C.B. (Part 2) 332, 355; sec. 272(k), Rev. Act of 1928, 45 Stat. 854; H. Rept. 2, 70th Cong., 1st Sess. (1927), 1939-1 C.B. (Part 2) 384, 399; S. Rept. 960, 70th Cong., 1st Sess. (1928), 1939-1 C.B. (Part 2) 409, 430; 404 F.2d 668">Berger v. Commissioner, supra;Delman v. Commissioner, 384 F.2d 929">384 F.2d 929, 384 F.2d 929">933 (3d Cir. 1967),1983 U.S. Tax Ct. LEXIS 61">69 affg. a Memorandum Opinion of this Court. Providing the taxpayer with actual notice of the deficiency in a timely manner is the essence of the statutory scheme. Clodfelter v. Commissioner, 527 F.2d 754">527 F.2d 754, 527 F.2d 754">756 (9th Cir. 1975), affg. 57 T.C. 102">57 T.C. 102 (1971); Boren v. Riddell, 241 F.2d 670">241 F.2d 670, 241 F.2d 670">672 (9th Cir. 1957); Olsen v. Helvering, 88 F.2d 650">88 F.2d 650, 88 F.2d 650">651 (2d Cir. 1937), affg. a Memorandum Opinion of this Court; Brzezinski v. Commissioner, 23 T.C. 192">23 T.C. 192, 23 T.C. 192">195 (1954). There is no indication that by providing the safe harbor, Congress intended to invalidate the Commissioner's use of alternative methods of communication which in fact result in actual notice to the taxpayer. 527 F.2d 754">Clodfelter v. Commissioner, supra;23 T.C. 192">Brzezinski v. Commissioner, supra.It has been held repeatedly that an error in the address to which the notice of deficiency is mailed does not render the notice invalid so as to defeat Tax Court jurisdiction when the petition is timely filed. 527 F.2d 754">Clodfelter v. Commissioner, supra;1983 U.S. Tax Ct. LEXIS 61">70 Goodman v. Commissioner, 71 T.C. 974">71 T.C. 974 (1979); Zaun v. Commissioner, 62 T.C. 278">62 T.C. 278 (1974); 59 T.C. 818">Lifter v. Commissioner, supra;23 T.C. 192">Brzezinski v. Commissioner, supra. However, the petitioner contends that when the petition is not timely filed, the error in an address is prejudicial as a matter of law and that the notice of deficiency is invalid. Such argument was rejected by this Court in Looper v. Commissioner, 73 T.C. 690">73 T.C. 690, 73 T.C. 690">698-699 (1980), where we stated that whether a taxpayer has been prejudiced by an improperly addressed notice is a question of fact. The petitioner's failure to file a timely petition is a relevant factor in the inquiry, but alone is not decisive.81 T.C. 65">69 In the case before us, the petitioner actually received the notice of deficiency on October 2, 1981, 16 days after the Commissioner mailed it. He promptly had it delivered to his accountant, who forwarded it to the partnership attorney in San Francisco. Under the circumstances, we need not decide who has the burden of proving that the petitioner actually received the misaddressed1983 U.S. Tax Ct. LEXIS 61">71 notice without prejudicial delay. It is clear on this record that the petitioner received actual notice of the deficiency with ample time remaining to file a petition. At that time, the petitioner became responsible for filing a timely petition with this Court. There is no explanation for the failure to file such a petition, but it is apparent that inaction, after the receipt of the notice, was responsible for the late filing. Hence, the petitioner's failure to file a timely petition cannot be said to have been the direct result of any error in the address to which the notice of deficiency was mailed. Shelton v. Commissioner, 63 T.C. 193">63 T.C. 193, 63 T.C. 193">198 (1974); Zikria v. Williams, 535 F. Supp. 481">535 F. Supp. 481, 535 F. Supp. 481">485 (W.D. Pa. 1982). Clearly, the purpose of section 6212(a) was served in this case: the petitioner received "his ticket to the Tax Court and ample opportunity to file a petition for review." Delman v. Commissioner, 384 F.2d 929">384 F.2d at 934. 3 We agree with the Ninth Circuit that, "if mailing results in actual notice without prejudicial delay (as clearly was the case here), it meets the conditions of § 6212(a)1983 U.S. Tax Ct. LEXIS 61">72 no matter to what address the notice successfully was sent." Clodfelter v. Commissioner, 527 F.2d 754">527 F.2d at 757; fn. ref. omitted.A contrary conclusion is not compelled by the decisions in Weinroth v. Commissioner, 74 T.C. 430">74 T.C. 430 (1980); Keeton v. Commissioner, 74 T.C. 377">74 T.C. 377 (1980); 63 T.C. 193">Shelton v. Commissioner, supra;Heaberlin v. Commissioner, 34 T.C. 58">34 T.C. 58 (1960);1983 U.S. Tax Ct. LEXIS 61">73 and Carbone v. Commissioner, 8 T.C. 207">8 T.C. 207 (1947). In none of those cases was there a finding that the taxpayer received actual notice of the Commissioner's determination with sufficient time to prepare and file a petition; in Weinroth, Shelton, and Carbone, the taxpayers received no notice at all until the Commissioner billed them for the deficiencies. Where the 81 T.C. 65">70 Commissioner does not rely on actual notice but chooses to utilize the safe harbor of section 6212(b)(1), he must send the notice to the taxpayer at his last known address. Clodfelter v. Commissioner, 527 F.2d 754">527 F.2d at 757; Berger v. Commissioner, 404 F.2d 668">404 F.2d at 674. Where the notice is sent to the wrong address and never delivered, or delivered with prejudicial delay, the statutory purpose is not served, and it would be manifestly unfair to deny the taxpayer his prepayment hearing; but that is not this case. Zikria v. Williams, 535 F. Supp. 481">535 F. Supp. at 485; Goolsby v. Tomlinson, 246 F. Supp. 674">246 F. Supp. 674 (S.D. Fla. 1965).We hold that the notice of deficiency herein is valid. Accordingly, 1983 U.S. Tax Ct. LEXIS 61">*74 we will deny the petitioner's motion to dismiss and grant the Commissioner's motion to dismiss this case since the petition was not timely filed.An appropriate order will be entered. STERRETTSterrett, J., dissenting: I respectfully dissent for the same reasons stated in Frieling v. Commissioner, 81 T.C. 42">81 T.C. 42 (1983). Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect during the years in issue, unless otherwise indicated.↩2. The statute of limitations for 1976, as extended, expired on Sept. 30, 1981, unless tolled prior thereto. The petitioner has not raised the statute of limitations as a defense in these proceedings, but such issue has been resolved against him by our decision in Frieling v. Commissioner, 81 T.C. 42">81 T.C. 42↩ (1983), decided today, wherein we held that the running of the statute of limitations is tolled by the timely mailing of a notice of deficiency which is actually received without prejudicial delay, even though such notice is not mailed to the last known address of the taxpayer.3. The petitioner also argues that he was prejudiced by the delay in receiving the notice in that he did not have the full 90 days to study it and prepare a petition. This argument is also foreclosed by our decision in Frieling v. Commissioner, 81 T.C. 42">81 T.C. 42, 81 T.C. 42">57 (1983), where we stated "However, so long as the notice of deficiency is timely mailed by the Commissioner and is received without prejudicial delay by the taxpayer in compliance with section 6212(a)↩, the notice is effective for all purposes from the time of its mailing."	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620960/	GEORGE G. PROSKAUER and SUSAN PROSKAUER, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, RespondentProskauer v. CommissionerDocket No. 10271-81.United States Tax CourtT.C. Memo 1983-395; 1983 Tax Ct. Memo LEXIS 391; 46 T.C.M. 679; T.C.M. (RIA) 83395; July 11, 1983. Charles R. Hembree and Kathleen Harris, for the petitioners. Genevieve K. Murtaugh, for the respondent. KORNERMEMORANDUM FINDINGS OF FACT AND OPINION KORNER, Judge: Respondent determined deficiencies in petitioners' Federal income tax as follows: YearDeficiency1977$22,031.6819785,067.301983 Tax Ct. Memo LEXIS 391">393 All such amounts were placed in issue by the petition herein and, in addition, petitioners claimed an overpayment of tax for the year 1977 in the amount of $6,600. After concessions, the issues which we must decide are: (1) Whether expenses incurred in connection with a house owned by Buck Pond Farm, Inc., an electing small business corporation, in the years 1977 and 1978 were deductible as ordinary business expenses by the corporation; and (2) whether expenditures in 1977 and 1978 by Buck Pond Farm, Inc. to redeem some of its shares from a shareholder, and legal expenses in 1977 in connection therewith, were deductible by the corporation as ordinary and necessary expenses, such claimed deductions affecting the net corporate losses in each year, all or a portion of which were reported in petitioners' joint returns as shareholders of said corporation. FINDINGS OF FACT Some of the facts have been stipulated, and those facts are so found. The petitioners, George G. Proskauer and Susan Proskauer, husband and wife (hereinafter "George" and "Susan"), were residents of Versailles, Kentucky, at the time the petition herein was filed. For the calendar years 1977 and 1978, they1983 Tax Ct. Memo LEXIS 391">394 filed joint Federal income tax returns with the Internal Revenue Service Center at Memphis, Tennessee. George is a medical doctor, and practiced privately for a number of years in various locations, specializing in the field of pathology. In more recent years, terminating in the year 1977, he operated pathological laboratories in Akron and Cuyahoga Falls, Ohio, through a corporation known as George G. Proskauer, Inc., in which he and Susan were the sole shareholders. Susan, who was a businesswoman in her own right, developed an interest in horses and horsebreeding in the late 1940's. During the early 1950's she purchased her first yearling and, starting with this base, she bought and sold horses over the years, improving and upgrading her holdings until during the early 1970's, working in conjunction with George G. Proskauer, Inc., an investment of about $800,000 in thoroughbred horses had been built up, owned in part by George G. Proskauer, Inc. and in part by Susan. In the year 1973, Susan, together with Victor and Lucille Heerman, formed Buck Pond Farm, Inc. (hereinafter "Buck Pond" or "the corporation"), a Delaware corporation. From its formation until September 17, 1976, Susan1983 Tax Ct. Memo LEXIS 391">395 owned 500 shares of the corporation's stock, and Victor and Lucille Heerman jointly owned 500 shares, representing the total outstanding stock of Buck Pond. During this same period, Susan and Victor Heerman were officers and directors of the corporation. For its fiscal years ending June 30, 1977, and June 30, 1978, Buck Pond was an electing small business corporation under the provisions of section 1371, et seq., of the Internal Revenue Code. 1Since the time of its formation, Buck Pond has operated a thoroughbred horse farm in Woodford County, Kentucky. Its activities, and the sources of its income in the years before us, included boarding horses, stud fees, tobacco sales and the sales of yearlings and broodmares. Buck Pond also acted as syndicate manager for the stallion Blood Royal; supplied customers or found buyers for any syndicate members desiring to sell their Blood Roval season; and acted as agent for others in the purchase and sales of thoroughbreds, 1983 Tax Ct. Memo LEXIS 391">396 receiving commissions from such transactions. Buck Pond Farm, in addition to fields and pastures, had barns, stables, foaling facilities and a paddock for the horses. The corporation maintained on the premises eight houses for the use of farm workers and their families, and paid all expenses in connection with such houses. There was a separate building used as corporate offices, in which the corporation's financial records were kept, as well as records of individual horses who were or had been on the farm. A separate guest house for visitors was also maintained. There was, in addition, a house (hereinafter the "main house") consisting of approximately nine rooms and a basement, originally built in the late 18th Century by the father of the late Chief Justice of the United States John Marshall. The main house included, inter alia, four bedrooms, a living room, dining room and den. From the inception of the corporation until the fall of 1976, Mr. and Mrs. Heerman lived in the main house, and were the active managers-in-residence of the Buck Pond operations, in general charge of all matters. Beginning at least as early as 1975, and continuing until the fall of 1976, increasing1983 Tax Ct. Memo LEXIS 391">397 disagreements and differences developed between Susan and Mr. Heerman with regard to the development and operation of Buck Pond Farm. Although apparently making occasional visits there, Susan was not in residence at Buck Pond, but was living with George in Ohio. Relations between Susan and the Heermans deteriorated to the point where Susan determined that the stockholder relationship between them had to be terminated in one way or another. She felt that the Heermans were spending more money than the corporation could afford, and she was alarmed by the corporation's condition and the financial prospects. She accordingly undertook to invoke the provisions of a buy-sell agreement which she and the Heermans had entered into in 1974, and sought to buy out the Heermans' stock, so that she could get rid of the Heermans and take over the management of Buck Pond herself. For undisclosed reasons, the Heermans refused to sell their stock to Susan under the buy-sell agreement, and Susan's attempts along this line were abandoned, although the agreement provided the remedy of specific performance against a defaulting party. Instead, under date of September 17, 1976, a tripartite agreement1983 Tax Ct. Memo LEXIS 391">398 was entered into between Susan, the Heermans, and Buck Pond, under which, inter alia: a. Buck Pond discharged its indebtedness of $328,646 to the Heermans by the payment of $65,729.25 in cash plus four installment promissory notes, each in the same amount and payable annually over a period of four years, with interest at 6%. b. Buck Pond redeemed all of the Heermans' stock at a total price of $46,354, with $9,270.75 being paid in cash at the time of the execution of the contract, and with the balance payable in four equal annual installments of equivalent amount, represented by promissory notes bearing 6% interest. c. The payment of such promissory notes issued by Buck Pond was guaranteed by Susan personally. d. The Heermans resigned as officers and directors of Buck Pond. e. The Heermans agreed to vacate the main house by November 1, 1976. f. The prior buy-sell agreement between Susan and the Heermans was formally voided. So far as the record shows, this agreement was carried out according to its terms: the Heermans severed all connection with Buck Pond, vacated the main house, and the stipulated annual payments by Buck Pond to the Heermans with respect to1983 Tax Ct. Memo LEXIS 391">399 their stock were made by Buck Pond in its fiscal years 1977 and 1978, each in the amount of $9,270.75. After the surrender of the Heermans' stock to Buck Pond, Susan remained the sole shareholder of the corporation. In negotiating and preparing the above agreement, Buck Pond incurred and paid legal fees of $10,225 in its fiscal year 1977. In March, 1977, petitioners moved into the main house at Buck Pond Farm. A few months thereafter, in June, 1977, George G. Proskauer, Inc. was merged into Buck Pond. Susan and George each surrendered their stock in George G. Proskauer, Inc. and received stock of Buck Pond under the terms of the merger agreement, and they were thereafter the sole shareholders of the corporation. 2After taking up residence at the main house at Buck Pond Farm, Susan and George became the active overall1983 Tax Ct. Memo LEXIS 391">400 managers of the Buck Pond operation. They had a farm manager who looked after the barns, the fields, the pastures and gave day-to-day attention to the horses. Susan and George concentrated on attracting clients and building the farm into a profitable operation. In this, their labors were both joint and several: a. George, as a physician, attended to the health of the horses, sometimes alone and sometimes in consultation with a veterinarian. He attended foalings, and examined the afterbirth for evidence of medical problems. He performed microscopic examinations of sperm at each breeding of a stallion to check fertility. b.Susan, as a student of pedigrees and blood lines, maintained extensive records in this area, including all breedings and foalings taking place at Buck Pond Farm. She consulted with customers and prospective customers in connection with breeding; boarding, buying and selling horses at Buck Pond. c. George and Susan together met with customers and prospective customers who came to the farm, and ran the financial aspects of the corporation's business. In this connection, they entertained frequently at the main house, serving luncheons, dinners, and putting1983 Tax Ct. Memo LEXIS 391">401 up customers and prospective customers overnight. The main house contained four bedrooms, of which George and Susan used two and used the other two for guest rooms. 3 Other than their own bedrooms, George and Susan used all parts of the house -- living rooms, dining room, den, and kitchen -- for both personal and business purposes. 4 They made themselves available at short notice to receive, entertain and consult with customers and prospective customers in this fashion. They also entertained friends who were not customers or prospective customers. They worked hard to make Buck Pond a profitable operation, and, after March, 1977, devoted full time to the corporate business. So far as this record shows, the main house at Buck Pond Farm was their full-time residence after March, 1977. Buck Pond reported net losses in its Form 1120S tax returns for its fiscal years ending June 30, 1977, and June 30, 1978. Petitioners, in turn, claimed a portion of the corporation's net loss in their calendar1983 Tax Ct. Memo LEXIS 391">402 year returns for 1977 and 1978, respectively, based upon their stock ownership in the corporation for each year. Upon audit of the corporation's returns, respondent disallowed expenses claimed by the corporation for depreciation, utilities, gas and fuel and insurance attributable to the main house, in the amounts of $10,591 for fiscal year 1977 and $11,969 for fiscal year 1978. Respondent also disallowed as a deduction the legal fees of $10,225 incurred by the corporation in connection with its redemption of the Heermans' stock. As the result of these and other adjustments not in issue herein, the net operating losses of the corporation were reduced, and respondent therefore made appropriate reductions in the losses claimed by petitioners in their individual returns for 1977 and 1978. Respondent's statutory notice of deficiencies to petitioners followed. In their petition herein, as amended, petitioners placed the above actions of respondent in issue and, in addition, claimed additional corporate deductions for 1977 and 1978 in the amount of $9,270.75 in each year, on account of the payments made by Buck Pond to the Heermans in those years in redemption of the Heermans' stock.1983 Tax Ct. Memo LEXIS 391">403 For all or part of each of the corporations' fiscal years 1977 and 1978, the main house at Buck Pond Farm was used as a residence by shareholders of the corporation. The payments made by the corporation in its fiscal years 1977 and 1978 to the Heermans in redemption of their stock of the corporation, and the legal expenses incurred by the corporation in connection therewith in the year 1977, were expenses incurred by the corporation in connection with the acquisition of a capital asset. OPINION The issues which we must decide in the instant case all involve claimed ordinary income deductions (under section 162(a)) by Buck Pond Farm, Inc., an electing small business corporation within the meaning of section 1371 for its fiscal years ending June 30, 1977, and June 30, 1978. 5 The corporations' net losses for these two years were claimed by petitioners in their joint individual income tax returns for calendar years 1977 and 1978 in accordance with the provisions of section 1374. The parties are in agreement as to the propriety of such treatment; the dispute is as to the allowability of the claimed deductions in arriving at the net losses of the corporation for the two years1983 Tax Ct. Memo LEXIS 391">404 in issue. 1. Expenses Of The Main House.In its return, the corporation claimed deductions on account of depreciation, utilities, insurance, and gas and fuel in each year with respect to the main house, which concededly was a corporate asset. Respondent disallowed the claimed deductions on the ground that they were barred by the specific provisions of section 280A, having determined that the house was used as a residence in the period in question by shareholders of an electing small business corporation. Petitioners contend that section 280A has no application to the facts of the present case. Alternatively, petitioners contend that even if section 280A applies in the present situation, the corporation is still entitled to the claimed deductions by reason of the provisions of section 280A(c)(1). The relevant portions of section 280A are reproduced in the footnote. 61983 Tax Ct. Memo LEXIS 391">405 In enacting section 280A as part of Pub. L. 94-455, 90 Stat. 1569-1572. Congress intended to eliminate the imprecise and subjective "appropriate and helpful" standard which had been employed in certain previous court decisions, see Bodzin v. Commissioner,60 T.C. 820">60 T.C. 820 (1973), revd. 509 F.2d 679">509 F.2d 679 (4th Cir. 1975), cert. denied 423 U.S. 825">423 U.S. 825, (1975), since Congress perceived a * * need for definitive rules to resolve the conflict that exists between several recent Court decisions and the position of the Internal Revenue Service as to the correct standard governing the deductibility of expenses attributable to the maintenance of an office in the taxpayer's personal residence. [S. Rept. No. 94-938, pp. 49, 185-186, 1976-3 C.B. (Vol. 3); H. Rept. No. 94-658, pp. 695, 852-853, 1976-3 C.B. (Vol. 2); Joint Committee Expanation, pp. 1, 151-153, 1976-3 C.B. (Vol. 2).] On its face, the facts in the instant case appear to bring it clearly within the ambit of section 280A. There can be no question that the main house, owned by the corporation, was a "dwelling unit." It is also undisputed in this record that the Heermans, up to November, 1976, 1983 Tax Ct. Memo LEXIS 391">406 and petitioners, after March, 1977, used the main house as their residence, and did so at a time when they were shareholders of the corporation, which was an electing small business corporation. Petitioners seek to avoid the impact of section 280A by contending that since the entire house was used by the corporation for business purposes, viz., conferring with and entertaining clients, the entire house should be considered as a working business asset of the corporation, and the personal use of the house as the shareholders' residence should be ignored. Thus, petitioners appear to contend that although section 280A may apply to an office in a home, it does not apply to a home in an office. Essentially the same argument was advanced by the taxpayer in Baie v. Commissioner,74 T.C. 105">74 T.C. 105 (1980), where we said "we find this argument ingenious and appealing, but, unfortunately, insufficient to overcome the unambiguous mandate of the statute." 74 T.C. 105">Baie v. Commissioner,supra, at 110. Even if the entire main house were used for business purposes, the application of section 280A cannot be narrowed as petitioners urge; quite aside from the requirements1983 Tax Ct. Memo LEXIS 391">407 of section 280A(c), next discussed, the plain language of section 280A(a) will not permit it. In any case, petitioners have not shown that the entire main house was used for business purposes; we doubt, for instance, that petitioners' own bedrooms were used for business purposes, and there is no proof in this record that no personal effects, as opposed to business records, were stored in the basement.We accordingly hold that section 280A applies in the present situation. Alternatively, petitioners urge that even if section 280A is applicable here, the exceptions provided in section 280A(c)(1)(A) and (B) would permit the corporation to take the present claimed deductions. Here again, we must disagree with petitioners. We have no doubt on this record that the main house made an important contribution to the conduct of the corporation's business. It enabled the petitioners to be right on the spot and immediately available to meet, confer with and entertain customers and prospective customers of Buck Pond. It was a gracious place, and it provided an excellent setting for the cultivation of the clients who provided the corporation's income from horse breeding and maintenance. 1983 Tax Ct. Memo LEXIS 391">408 We have no doubt that petitioners exploited it to the fullest. It is not clear to us, however, that the main house could be considered the "principal place of business" for the corporation, as is required by section 280A(c)(1)(A), inasmuch as Buck Pond maintained a separate building which was its business office, and in which were housed all its business records and files of horses who were or had been maintained at the Farm. 7 What is clear is that the main house, which also served as the Heermans and Petitioners' residence, was not used "exclusively" for the purposes outlined in those two subsections. The business use of the main house was undoubtedly extensive, but it was so inextricably intertwined with its personal use by the corporation's shareholders as a residence that we cannot find that any portion of the main house was used exclusively for the enumerated business purposes, as section 280A(c)(1) requires.81983 Tax Ct. Memo LEXIS 391">409 On this issue, therefore, we hold for the respondent. 2. Expenses In Connection With Acquiring the Corporation's Stock.After a long-simmering dispute, Susan apparently determined that Mr. Heerman's management of Buck Pond was unsatisfactory, that she could no longer work with him as a co-shareholder, and that something had to be done to get him out of the corporation as an officer and shareholder. She first attempted to exercise her rights under an existing buy-sell agreement with the Heermans and purchase their stock. When this proposal was refused, an alternative arrangement was evolved, whereunder the corporation arranged to pay off its existing indebtedness to the Heermans and purchase their stock, with payments being made on the installment basis. Petitioners contend that the installment payments for the Heermans' stock which were made in 1977 and 1978, together with the legal expense incurred by the corporation in 1977 in negotiating and preparing the settlement agreement, should be deductible as ordinary and necessary expenses of the corporation under section 162(a), in that such payments were necessary to assure the corporation's continued existence.Respondent, 1983 Tax Ct. Memo LEXIS 391">410 on the other hand, has taken the more traditional position that no deductions are allowable with respect to such payments, since they were made in connection with the acquisition of a capital asset by the corporation, viz., the repurchase of its own stock. Normally, the purchase of stock, including the purchase of the issuing corporation's own stock, is to be considered a capital transaction, section 263, for which no deduction would be allowable under sectioin 162(a), Harder Services, Inc. v. Commissioner,67 T.C. 585">67 T.C. 585 (1976), affd. without opinion 573 F.2d 1290">573 F.2d 1290 (2d Cir. 1977); See United States v. Hilton Hotels Corp.,397 U.S. 580">397 U.S. 580 (1970), and the same treatment is to be given any incidental expenses connected with such purchase, such as legal fees, Woodward v. Commissioner,397 U.S. 572">397 U.S. 572 (1970); Third National Bank in Nashville v. United States,427 F.2d 343">427 F.2d 343 (6th Cir. 1970). Petitioners contend, however, that an exception to the general rule exists where the acquisition of the corporation's stock is made necessary in order to assure the corporation's continued existence, citing 1983 Tax Ct. Memo LEXIS 391">411 Five Star Manufacturing Company v. Commissioner,355 F.2d 724">355 F.2d 724 (5th Cir. 1966), revg. 40 T.C. 379">40 T.C. 379 (1963). In that case, the taxpayer corporation, whose central income-producing asset was its license to manufacture and sell an article under a patent held by a third party, found itself in a situation where the patent holder had cancelled the license to the taxpayer, and had attached, through court proceedings, two-thirds of its inventory of finished goods. The corporation had no working capital and no credit. The patent holder would consent to renew the license and release his hold on the corporate assets only if one of the two shareholders was eliminated from any interest in the corporation. This was accomplished; the taxpayer corporation bought in the shareholder's stock, (apparently with infusions of money from the other shareholder) the stranglehold which the patent holder had on the corporation was released, and it survived and continued in business. Under these circumstances, the Court of Appeals for the Fifth Circuit concluded that the corporation's expenditures in buying the stock of the shareholder should be considered as ordinary and necessary1983 Tax Ct. Memo LEXIS 391">412 and deductible under section 162(a), since without such purchase the corporation would promptly have been put out of business. The Five Star case, however, was decided in 1966, under the factual "primary purpose" test which, at the time, was in frequent, if somewhat haphazard, use by the courts in deciding whether an expenditure was to be considered capital in nature or an ordinary and necessary expense. In 397 U.S. 572">Woodward v. Commissioner,supra, the Supreme Court, acknowledging the confused state of the law in this area, see Woodward,397 U.S. 572">397 U.S. at 576, rejected the "primary purpose" test, and substituted therefor a standard which looks to the fundamental nature of the transaction, rather than the reasons for entering into it, as being determinative of the tax treatment to be afforded. The "primary purpose" test no longer correctly applies the law. Anchor Coupling Company v. United States,427 F.2d 429">427 F.2d 429, 427 F.2d 429">431 (7th Cir. 1970). Recognizing the important change in the law wrought by the Supreme Court in 1970 in 1983 Tax Ct. Memo LEXIS 391">413 397 U.S. 572">Woodward v. Commissioner,supra, the Fifth Circuit, author of the opinion in Five Star, has limited that case to its own facts and to those extraordinary situations where, as in Five Star, the purchasing corporation was faced with extinction, absent the purchase in question. Jim Walter Corp. v. United States,498 F.2d 631">498 F.2d 631, 498 F.2d 631">639 (5th Cir. 1974); Markham & Brown, Inc. v. United States,648 F.2d 1043">648 F.2d 1043 (5th Cir. 1981). The Court of Appeals for the Third Circuit has taken the same restrictive approach. H.&G. Industries, Inc. v. Commissioner,495 F.2d 653">495 F.2d 653 (3d Cir. 1974), affg. 60 T.C. 163">60 T.C. 163 (1973). This Court has followed the rationale of Jim Walter,Markham & Brown and H.&G. Industries. In 67 T.C. 585">Harder Services, Inc. v. Commissioner,supra, the taxpayer corporation repurchased an employee's stock as part of terminating his employment, all of which was done in order to extricate the taxpayer from an unfavorable financial and management situation. The taxpayer, relying on the Five Star case, claimed the right to an ordinary deduction under section 162(a) with respect to the amounts1983 Tax Ct. Memo LEXIS 391">414 paid to redeem its stock. This Court, in line with the above cases, refused to extend the attenuated authority of the Five Star case beyond the extreme situation where corporate survival was at stake, and held that the expenditure was capital in nature. In our opinion, the present case falls within the rationale of Harder Services and requires the same conclusion. The petitioners here have not convinced us that the corporate survival of Buck Pond was at stake, and that, but for the corporation's purchase of the Heermans' stock, the corporation would have gone out of existence. Granted that there was dissension here between the shareholders as to the financial policies to be pursued in developing Buck Pond Farm, we do not think that the present record establishes that the corporation was in extremis in September of 1976 and that the corporation's continued existence could be assured only by buying out the Heermans' stock. We note, for example, that in the buy-out agreement which was finally negotiated and carried out, the corporation undertook to pay substantial sums of money to the Heermans, and apparently did so, thus indicating that the corporation still had considerable1983 Tax Ct. Memo LEXIS 391">415 financial strength. What would have happened had Mr. Heerman remained in control at Buck Pond can only be a matter of speculation. Further, no explanation is offered by petitioners as to why Susan did not pursue her rights in 1976 under the existing buy-sell agreement between herself and the Heermans. That agreement by its terms provided for enforcement by specific performance in the existing circumstances, and would have enabled Susan to accomplish the desired result of getting rid of the Heermans as shareholders, without involving the corporation at all, and at no cost to it, at least so far as the purchase price of the stock was concerned. We accordingly conclude that, whatever life may be left in the narrow exception to the general rule for which the Five Star case stands, petitioners have failed to bring themselves within it. 67 T.C. 585">Harder Services, Inc. v. Commissioner,supra; see Atzingen-Whitehouse Dairy, Inc. v. Commissioner,36 T.C. 173">36 T.C. 173 (1961), and cf. MFA Central Cooperative v. Bookwalter,427 F.2d 1341">427 F.2d 1341 (8th Cir. 1970), cert. denied 1983 Tax Ct. Memo LEXIS 391">416 405 U.S. 1045">405 U.S. 1045 (1972). Further, and in addition to the general rule that the cost of acquiring capital assets, including attendant expenses, is not deductible as ordinary and necessary expense under section 162(a), we note, as we did in 67 T.C. 585">Harder Services, Inc. v. Commissioner,supra, that the instant transaction comes squarely within the terms of section 311(a), which denies recognition of any gain or loss to a corporation for expenditures in connection with acquiring its own stock. 967 T.C. 585">Harder Services, Inc. v. Commissioner,supra;White Star Drive-In Laundry & Cleaners v. United States, an unreported case ( N.D.Ill. 1972, 30 A.F.T.R.2d (RIA) 72-5610, 72-2U.S.T.C. par. 9683). We accordingly sustain respondent on this issue. Decision will be entered for respondent.Footnotes1. All references to statutes 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. The record indicates that among the assets transferred to Buck Pond in the merger was the fractional interest of George G. Proskauer, Inc. in certain horses owned jointly with Susan. The record does not disclose whether, or on what terms, Susan transferred to Buck Pond her interest in such horses. The horses were kept and maintained at Buck Pond Farm.↩3. The separate guest house was also available. ↩4. Conferences with customers were held in the living room, dining room and den, where a library of pedigree records was maintained.↩5. This case is unaffected by the Subchapter S Revision Act of 1982, Pub. L. 97-354, 96 Stat. 1669, which in general is effective with respect to taxable years beginning after December 31, 1982.↩6. In relevant part, section 280A reads as follows:(a) General Rule.--Except as otherwise provided in this section, in the case of a taxpayer who is an individual or an electing small business corporation, no deduction otherwise allowable under this chapter shall be allowed with respect to the use of a dwelling unit which is used by the taxpayer during the taxable year as a residence. (c) Exceptions for Certain Business or Rental Use; Limitation on Deductions for Such Use.-- (1) Certain Business Use.--Subsection (a) shall not apply to any item to the extent such item is allocable to a portion of the dwelling unit which is exclusively used on a regular basis -- (A) as the principal place of business for any trade or business of the taxpayer, (B) as a place of business which is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of his trade or business, or In the case of an employee, the preceding sentence shall apply only if the exclusive use referred to in the preceding sentence is for the convenience of his employer. (d) Use as Residence.-- (1) In General.--For purposes of this section, a taxpayer uses a dwelling unit during the taxable year as a residence if he uses such unit (or portion thereof) for personal purposes for a number of days which exceeds the greater of -- (A) 14 days, or (2) Personal Use of Unit.--For purposes of this section, the taxpayer shall be deemed to have used a dwelling unit for personal purposes for a day if, for any part of such day, the unit is used -- (A) for personal purposes by the taxpayer or any other person who has an interest in such unit, or by any member of the family * * of the taxpayer or such other person; (f) Definitions and Special Rules.-- (1) Dwelling Unit Defined.--For purposes of this section -- (A) In general.--The term "dwelling unit" includes a house, apartment, condominium, mobile home, boat, or similar property, and all structures or other property appurtenant to such dwelling unit. (2) Personal Use By Electing Small Business Corporation.--In the case of an electing small business corporation, subparagraphs (A) and (B) of subsection (d)(2) shall be applied by substituting "any shareholder of the electing small business corporation" for "the taxpayer" each place it appears.↩7. Respondent did not disallow any claimed expenses with respect to this office. ↩8. Consistent with their position that the entire main house should be considered as devoted exclusively to business use, petitioners herein have made no attempt to allocate any portion of the main house expenses to specific areas which were claimed to be used exclusively for business purposes. Cf. Gomez v. Commissioner,T.C. Memo. 1980-565; Barnes v. Commissioner,T.C. Memo. 1982-439↩.9. Section 311(a) reads as follows: (a) General Rule.--Except as provided in subsections (b), (c) and (d) of this section and section 453(d) [not relevant here], no gain or loss shall be recognized to a corporation on the distribution, with respect to its stock, of -- (1) its stock (or rights to acquire its stock), or (2) property.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620962/	ARTHUR L. BLAKESLEE, III and MARY B. BLAKESLEE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBlakeslee v. CommissionerDocket No. 10593-75.United States Tax CourtT.C. Memo 1977-371; 1977 Tax Ct. Memo LEXIS 68; 36 T.C.M. 1511; T.C.M. (RIA) 770371; October 27, 1977, Filed Sherin v. Reynolds,John S. Mason, Jr., and John E. Drew, for the petitioners. Justin S. Holden, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined a deficiency in petitioners' 1977 Tax Ct. Memo LEXIS 68">69 Federal income tax for the calendar year 1973 in the amount of $183,333. Certain issues raised in the pleadings have been conceded by respondent, leaving for decision whether petitioners properly reported the amount of $464,300 which they received in 1973 as a long-term capital gain. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Arthur L. Blakeslee, III and Mary B. Blakeslee, husband and wife, filed a joint Federal income tax return for calendar year 1973 with the Director, Internal Revenue Service Center at Andover, Massachusetts. At the time of filing the petition in this case, they resided in West Hartford, Connecticut. Arthur L. Blakeslee, III was employed by The Life Insurance Company of Virginia after college in 1949. After two years there, he returned to school and obtained a master's degree in business administration from the Harvard Graduate School of Business Administration. He then joined the management consulting firm of Bowles, Andrews and Towne in Richmond, Virginia. In 1955, he began working on the account of one of the firm's clients, Variable Annuity Life Insurance Company (VALIC). VALIC was a company founded by1977 Tax Ct. Memo LEXIS 68">70 John D. Marsh to market commercially the variable annuity. In his capacity as a consultant, Mr. Blakeslee assisted Mr. Marsh and other VALIC officers in such tasks as organizing the company, developing variable annuity contract forms, and establishing the company's operating procedures. Throughout the late 1950's, Mr. Blakeslee assisted VALIC with problems it encountered with the Securities and Exchange Commission (SEC) relating to whether the variable annuity contracts were securities subject to SEC regulation. This controversy was ultimately resolved against VALIC by the Supreme Court in 1959. In 1959 and 1960, Mr. Blakeslee assisted VALIC in its relations with the SEC. In 1960 at Mr. Marsh's request, Mr. Blakeslee quit his job with Bowles, Andrews and Towne and became the second ranking executive of VALIC at a salary of $22,500. Mr. Blakeslee had purchased some stock in VALIC while employed with Bowles, Andrews and Towne. As one of his requirements for joining VALIC and for the purpose of obtaining an equity participation in the company, he acquired an option to purchase 5,000 more shares of stock, 1,000 per year, at a price of $12 per share. This stock was to be purchased1977 Tax Ct. Memo LEXIS 68">71 from a pool of stock created by Mr. Marsh and the other shareholder of VALIC. Other key employees likewise had an opportunity to purchase stock. Mr. Blakeslee exercised his option to the fullest extent consonant with his period of service and ultimately obtained 4,416 shares of VALIC stock by this means. Mr. Blakeslee left VALIC in April 1965 to start his own management consulting firm specializing in the variable annuity area within the life insurance industry. He consulted with approximately twelve insurance companies and principally guided them in establishing their variable annuity operations, developing their contracts and registering them and their contracts with the SEC. When Mr. Blakeslee was employed by Bowles, Andrews and Towne he had participated in its profit sharing plan. He also invested in the stock of one client company that he thought had promise. Thereafter when he owned his own consulting firm, he made a practice of investing in the stock of his clients when he thought they offered "real opportunities for capital growth." In 1965, Mr. Marsh, the founder and chief executive officer of VALIC, resigned his position with that company and became interested1977 Tax Ct. Memo LEXIS 68">72 in a similar company, Participating Annuity Life Insurance Company (PALIC). Mr. Marsh acquired control of PALIC on March 25, 1966. On June 28, 1966, Mr. Blakeslee purchased 3,864 shares of the common stock of PALIC from Mr. Marsh at a price of $6.47 per share. Ten percent of these shares were purchased on behalf of Mr. Blakeslee's father, who paid Mr. Blakeslee for them. Mr. Blakeslee's interest constituted 7/10's of one percent of the ownership of PALIC. Mr. Blakeslee operated his own management consulting business at the time of the purchase and he continued to do so for approximately one year after the purchase of this stock. During that year PALIC was one of his clients. Soon after gaining control of PALIC, Mr. Marsh determined that PALIC needed additional capital if it was to fully realize its potential, since the capital and surplus requirement for variable annuity life insurance companies was $16 million in California, one of PALIC's potential markets. Investors were sought, beginning in the summer of 1966, and Mr. Blakeslee advised and consulted with Mr. Marsh regarding various sources of additional capital. A potential supplier of capital, Aetna Life Insurance Company1977 Tax Ct. Memo LEXIS 68">73 (Aetna), was found. However, one of its conditions was that it eventually acquire 100 percent of the stock of PALIC. On February 15, 1967, the shareholders of PALIC were notified that Aetna was offering to purchase all of the outstanding stock of PALIC, other than that of Mr. Marsh, $8for per share. At this time, Aetna and Mr. Marsh were negotiating an agreement under which Mr. Marsh would sell his PALIC stock at a future date at a price to be determined by an agreed formula. Mr. Blakeslee participated in these negotiations. Mr. Marsh was unwilling to sell his stock outright because he wanted to participate in the growth of the company. Through Mr. Marsh, Mr. Blakeslee attempted to obtain a similar agreement with Aetna but was unsuccessful. Mr. Blakeslee received a letter from Mr. Marsh dated February 16, 1967, in which their then current understanding of their future relationship with PALIC was outlined. This letter recited in pertinent part: 1) You will become Executive Vice President at a salary of $35,000. per year, with an increase of $5,000. at the end of one (1) year. 2) You will be the only officer holding such title and as Executive Vice President you will, 1977 Tax Ct. Memo LEXIS 68">74 in the absence of the President, act for him in all matters. 3) At the annual Stockholders Meeting in April of 1968, I will use my best efforts to cause your election to the Board of Directors, and will recommend your selection as a member of the Executive Committee. 4) You will sell to me the shares which you now own in PALIC under the following conditions: A. $8.00 per share, plus B. Ten percent (10%) of PALIC's underwriting gain and loss, plus ten percent (10%) of the value of the business on the books of the Company at the time of my termination as PALIC's Chief Executive Officer. The manner in which these items will be calculated will be the same as contained in the agreement between myself and the Aetna Life & Casualty Company concerning [* * ] 1 will be determined, and the date on which such amounts will be payable, if different from my contract with the Aetna, will be in accordance with the arrangements reduced to writing in a separate undertaking. 5) This Agreement is contingent upon the consummation of the sale of the controlling interest of PALIC to the Aetna1977 Tax Ct. Memo LEXIS 68">75 Life & Casualty Company, and no announcement of your affiliation with PALIC will be made until it is effective. At such time you will notify all of your clients of this affiliation, and as soon as possible thereafter you will complete the major projects for such clients in which you are then engaged and join PALIC as Executive Vice President. In the interim, you will continue as a consultant to PALIC, devoting as much time as possible to its needs at the rate of $25. per hour. However, on February 17, 1967, Aetna sent to Mr. Marsh a memorandum of its understanding with him. This memorandum stated that the parties, Aetna and Marsh, had tentatively agreed to purchase and sell, respectively, all of the stock then owned by Mr. Marsh. The memorandum stated that the parties did not contemplate that Mr. Marsh would either dispose of any stock or purchase any additional stock. Furthermore, Aetna's obligation in the memorandum was expressly conditioned on its acquisition of all shares of PALIC not owned by Mr. Marsh. Mr. Marsh was to become President and Chief Executive Officer of PALIC. Because Mr. Marsh could not acquire additional stock under his agreement with Aetna, on February 23, 1967, he1977 Tax Ct. Memo LEXIS 68">76 sent to Mr. Blakeslee a letter outlining a revised understanding. It was essentially identical to the letter of February 16 except that item four was deleted and replaced with a paragraph that read: 4) A separate Agreement will be developed between us, which will in essence give you a ten percent (10%) participation in any amounts which I receive from the Aetna for my tock which exceeds $2,357,000. This agreement was intended to give the same result as the February 16 agreement. On March 7, 1967, Aetna, Mr. Marsh and First Pyramid Life Insurance Company, which owned 24.6 percent of PALIC, entered into a formal agreement for the sale of PALIC stock held by them. First Pyramid sold its stock for $8 per share. The terms of sale with respect to Mr. Marsh were substantially those of the February 17 memorandum. The sales price was to be determined by a formula based on future performance of the company, and the actual exchange would occur no later than January 1, 1973. On March 12, 1967, Mr. Blakeslee sold his PALIC stock to Aetna for the offered price of $8 per share. He was willing to sell his stock to Aetna at this price because of the agreement he had reached with Mr. Marsh. 1977 Tax Ct. Memo LEXIS 68">77 Aetna also acquired all of the PALIC stock held by PALIC's other shareholders, except that held by Mr. Marsh. The closing was held on March 30, 1967. Mr. Marsh's stock was placed in escrow pursuant to his agreement with Aetna. On March 27, 1967, both Mr. Blakeslee and Mr. Marsh executed a letter that would "serve as an understanding of our future relationship in" PALIC. The terms of the understanding were identical to those of the letter Mr. Marsh sent Mr. Blakeslee on February 23, 1967. Shortly after March 27, 1967, Mr. Blakeslee began to disengage from his management consulting business. He commenced employment with PALIC 2 as its Executive Vice President on July 10, 1967. In the 27 months Mr. Blakeslee worked as a private consultant his net earnings were $160,000. His initial salary at PALIC was $35,000. Mr. Marsh and Mr. Blakeslee executed a document entitled "Participation Agreement" on September 10, 1968. This agreement stated in pertinent part: 1977 Tax Ct. Memo LEXIS 68">78 WHEREAS, Marsh, by a Purchase Agreement dated March 7, 1967, to which reference is hereby specifically made, has contracted to sell all of his shares of capital stock of Participating Annuity Life Insurance Company ("PALIC") to Aetna Life Insurance Company ("Aetna"), the sale to be consummated on a date ("Sale Date") to be determined under Article III of the said Purchase Agreement, and WHEREAS, the consideration to be received by Marsh under the said Purchase Agreement is to be calculated, in part, by a formula which takes account of the financial success of PALIC during the period from April 1, 1967, to the Sale Date, and WHEREAS, Marsh believed that the employment of Blakeslee as Executive Vice-President of PALIC would materially enhance the financial success of PALIC and thereby increase the total consideration to be received by Marsh for his shares of capital stock of PALIC, and WHEREAS, by a letter agreement dated March 27, 1967, Blakeslee agreed to become Executive Vice-President of PALIC on the condition that a separate agreement be developed under which Blakeslee would participate in that part of the consideration to be received by Marsh under the said Purchase Agreement1977 Tax Ct. Memo LEXIS 68">79 which is attributable to financial success of PALIC, NOW THEREFORE, in consideration of the mutual promises and agreements hereinafter set out, and in accordance with the March 27, 1967, understanding of the parties, it is agreed that: ARTICLE ONEBlakeslee agrees that, while an officer of PALIC, he will devote his entire time and attention and his best energies and abilities to the promotion of the financial success of PALIC. ARTICLE TWOIf Blakeslee continues to serve as an officer of PALIC at all times from the date of this Participation Agreement to the Sale Date, Marsh agrees to pay Blakeslee an amount equal to ten percent (10%) of the amount by which the total consideration received by Marsh from Aetna under the said Purchase Agreement exceeds $2,357,000.00. ARTICLE THREEIf, after the date of this Participation Agreement but before the Sale Date, Blakeslee ceases to serve as an officer of PALIC, Marsh will pay to Blakeslee, if living, otherwise to Blakeslee's estate, an amount equal to the amount that otherwise would have been payable to Blakeslee under ARTICLE TWO of this Participation Agreement, multiplied by a fraction, the numerator of which shall1977 Tax Ct. Memo LEXIS 68">80 be the period during which Blakeslee serves as an officer of PALIC prior to the Sale Date plus the period from April 1, 1967, to July 10, 1967, and the denominator of which shall be the period from April 1, 1967, to the Sale Date; provided however, that if Blakeslee resigns from his position with PALIC on or before July 10, 1969, Blakeslee shall receive nothing under this Participation Agreement. ARTICLE FOURAny amount payable under ARTICLE TWO or ARTICLE THREE of this Participation Agreement shall be paid in a single payment, without interest, not later than sixty (60) days after receipt by Marsh from Aetna of the total consideration to which Marsh is entitled under the Purchase Agreement. On January 1, 1973, Mr. Marsh received $7 million from Aetna for the sale of his PALIC stock pursuant to their agreement of March 7, 1967, as amended on December 16, 1971. That same month Mr. Blakeslee received $464,300 from Mr. Marsh in accordance with their agreement of September 10, 1968. This amount was 10 percent of the amount Mr. Marsh received for his stock in excess of $8 per share. At the time Mr. Blakeslee received this payment, he was President and Chief Executive Officer1977 Tax Ct. Memo LEXIS 68">81 of PALIC and had a salary of $82,000 per year. At the time of the trial in this case, Mr. Blakeslee was a vice president of Aetna. On their Federal income tax return for 1973, petitioners reported the $464,300 received by Mr. Blakeslee as a long-term capital gain. It was described on the return, without further explanation, as "net proceeds from joint venture with John D. Marsh which commenced in 1967." In his notice of deficiency mailed to petitioners, respondent determined "that the sum of $464,300 you received from John D. Marsh during the tax year 1973 is taxable as ordinary income." OPINION Petitioners assert that the issues before the Court are whether Mr. Blakeslee's contractual agreements with Mr. Marsh constitute "a property right or a capital asset as defined by" section 1221, I.R.C. 1954, 3 and whether the $464,300 payment received by Mr. Blakeslee in 1973 pursuant to these agreements should be taxed as a long-term capital gain. Respondent has argued that under those agreements Mr. Blakeslee had only a right to receive income under an employment contract and that he held no capital asset. 1977 Tax Ct. Memo LEXIS 68">82 For the taxable year 1973, section 1222(3) defined long-term capital gain to be "gain from the sale or exchange of a capital asset held for more than 6 months * ." 4Section 1221 states that "the term 'capital asset' means property held by the taxpayer (whether or not connected with his trade or business), but does not include" certain classes of assets not here relevant. In a sense contract rights are property rights, and thus they may fall within the definition of "capital asset." However, all property rights are not capital assets, even though they do not fall within a specifically excluded category of section 1221. Commissioner v. Gillette Motor Transport,Inc.,364 U.S. 130">364 U.S. 130, 364 U.S. 130">134-135 (1960). Therefore, each distinguishable right under a contract must be examined to determine whether it qualifies as a capital asset. See Commissioner v. Ferrer,304 F.2d 125">304 F.2d 125, 304 F.2d 125">131-33 (2d Cir. 1962), affirming in part and reversing in part 35 T.C. 617">35 T.C. 617 (1961). As noted by the Court in 304 F.2d 125">Commissioner v. Ferrer,supra at 129-30, characterization of a particular contract right is a difficult task, made more so by the lack of any1977 Tax Ct. Memo LEXIS 68">83 universal standard for the determination. However, the Court did provide the following analysis: One common characteristic of the group [of cases] held to come within the capital gain provision is that the taxpayer had either what might be called an "estate" in * * , or an "encumbrance" on * , or an option to acquire an interest in * , property which, if itself held, would be a capital asset. In all these cases the taxpayer had something more than an opportunity, afforded by contract, to obtain periodic receipts of income, by dealing with another * , or by rendering services * , or by virtue of ownership of a larger "estate" * . 1977 Tax Ct. Memo LEXIS 68">84 We find that Mr. Blakeslee did not have rights under his contract similar to those described in the first sentence of this analysis. Instead, his rights are described in the second sentence. He had only an opportunity to obtain receipt of income by rendering services, and this is not a capital asset. See Pounds v. United States,372 F.2d 342">372 F.2d 342 (5th Cir. 1967); Hodous v. Commissioner,14 T.C. 1301">14 T.C. 1301 (1950); McFall v. Commissioner,34 B.T.A. 108">34 B.T.A. 108 (1936). Neither the agreement of September 10, 1968, under which Mr. Blakeslee was paid, nor the written understandings of the parties underlying it granted to Mr. Blakeslee any rights in Mr. Marsh's stock. The 1968 agreement provided only that Mr. Marsh would pay Mr. Blakeslee an amount of money, determined by a formula, in return for the performance of certain activities by Mr. Blakeslee as an officer of PALIC. The formula used in calculating the amount of money due Mr. Blakeslee on performance of the activities contained two variables, the amount Mr. Marsh received for stock he was selling to Aetna in excess of $2,357,000 (Mr. Marsh's 294,660 shares multiplied by $8 per share) and the length1977 Tax Ct. Memo LEXIS 68">85 of Mr. Blakeslee's service as an officer of PALIC. There is a critical distinction between an interest in specific property and a claim against Mr. Marsh personally for a sum of money, the amount of which is determined by some mathematical relationship to the sales price of the specific property. Although in one sense Mr. Blakeslee participated in the success of Palic/ by becoming entitled to increased amounts of money on its success, he did so not as an owner of stock or any interest in stock. Mr. Blakeslee became entitled to the increased amount of money only upon performance of certain services under his contract and only because of that performance. The earlier understandings between Mr. Marsh and Mr. Blakeslee do not change the nature of their ultimate bargain. In the February 16, 1967, understanding, Mr. Blakeslee was to perform services as an officer of PALIC and was to sell his PALIC stock to Mr. Marsh. The sales price was to be $8 per share plus a factor reflecting the success of the company. This plan became unfeasible when Aetna required Mr. Marsh not to purchase additional stock as a condition of its agreement to acquire the stock then held by Mr. Marsh for a flexible1977 Tax Ct. Memo LEXIS 68">86 price. Had Mr. Marsh purchased Mr. Blakeslee's stock, his agreement with Aetna would have encompassed a higher amount of stock. This did not occur. However, Mr. Marsh was willing to pay Mr. Blakeslee 10 percent of the amount he received from Aetna in excess of $8 per share for the stock he held without purchasing Mr. Blakeslee's stock. They determined to develop an agreement that would "in essence give [Mr. Blakeslee] a ten percent (10%) participation in any amounts which [Mr. Marsh] received from the Aetna for [his] stock which exceeds $2,357,000." Only a right to a portion of certain proceeds was granted by the terms of these understandings. No interest in the stock itself was mentioned. Indeed, it would appear that Mr. Marsh was not only precluded from acquiring more stock but also from disposing of any of his stock under his agreement with Aetna. The only consideration for the payment stated in the letters of February 23, 1967, and March 27, 1967, was performance of services by Mr. Blakeslee. In fact, petitioners do not even argue that they received any interest specifically in Mr. Marsh's stock. 5 Nor have they offered any proof, much less any "strong proof," that1977 Tax Ct. Memo LEXIS 68">87 the form of the agreements did not reflect the substance of their agreement. See Ullman v. Commissioner,264 F.2d 305">264 F.2d 305, 264 F.2d 305">308 (2d Cir. 1959), affg. 29 T.C. 129">29 T.C. 129 (1957); Pritchett v. Commissioner,63 T.C. 149">63 T.C. 149, 63 T.C. 149">171 (1974). Instead, petitioners have advanced several other arguments for the purpose of showing that Mr. Blakeslee held a capital asset. We find that none of these arguments have merit. Petitioners argue that consideration other than Mr. Blakeslee's services was given in exchange for payment under Mr. Blakeslee's contract. They assert that this other consideration was an agreement by Mr. Blakeslee to sell his stock in PALIC to Aetna. Petitioners assume that their receipt of $464,300 under1977 Tax Ct. Memo LEXIS 68">88 these circumstances would be taxed as a long-term capital gain. We need not address this assumption, since the facts asserted find no support in the record. It is true that purchase by Aetna of all outstanding PALIC stock was a condition of its contract with Mr. Marsh and that sale of Mr. Blakeslee's stock occurred near the time of his agreements with Mr. Marsh. However, there is no evidence in this record that sale of Mr. Blakeslee's stock to Aetna was bargained for as consideration for Mr. Marsh's obligations under the contract. The terms of the contract indicate no such consideration, and, absent strong proof that the form of the contract does not reflect the true bargain, petitioners cannot succeed in attacking the form they themselves chose. See 264 F.2d 305">Ullman v. Commissioner,supra;63 T.C. 149">Pritchett v. Commissioner,supra.The fact that Mr. Blakeslee was willing to sell his PALIC stock to Aetna at $8 per share because he had reached his understanding with Mr. Marsh speaks only to Mr. Blakeslee's motives and not to the bargain reached between the parties. There is no evidence that Mr. Blakeslee would not have sold his stock to Aetna for $8 per share1977 Tax Ct. Memo LEXIS 68">89 as did the other PALIC stockholders had he not negotiated the contract with Mr. Marsh. Petitioners argue that Mr. Blakeslee merely substituted one capital asset, his PALIC stock, for another, his contract rights, or that he merely substituted the evidentiary form of his capital asset from stock in PALIC to his contract rights. The record is lacking in evidence to support this contention. Also, the first of these arguments merely begs the question whether the contract rights were a capital asset. If the record supported petitioners' contention of an exchange of a capital asset for other property (which it does not) it would not automatically follow that the other property was a capital asset. The status of the property received in exchange for the capital asset would be determined by its own character and the manner in which the property is held. In any case, neither argument has any basis in fact. No substitution occurred such as described, except in the loose sense that Mr. Blakeslee may have deemed it so. The PALIC stock was sold in one distinct, closed transaction, and the contract rights were acquired in another. Surrender of the stock and acquisition of the contract rights1977 Tax Ct. Memo LEXIS 68">90 were not related in any sense helpful to petitioners. Petitioners also assert that "the origin of the payment to the petitioner is * * * capital in nature" because of the holdings in Thermoclad Co. v. Commissioner,T.C. Memo. 1974-289, and Kutz v. United States,392 F. Supp. 539 (M.D. Pa. 1975). The Kutz case involved a transaction quite similar to that in the instant case, but the taxpayer involved was the payor of the contract payments and not the payee. In the Kutz case, the payor attempted to deduct the payment under section 212. The district court held that the payor's expense was capital since the origin of the expense was the process of sale of a capital asset. Petitioners gain nothing from the analysis in this case. Mr. Blakeslee's receipt is not characterized by the origin of the payor's expense but by the origin of his receipt, which was the contract between him and Mr. Marsh. We have found this contract to be other than a capital asset. Thermoclad Co. v. Commissioner,supra, deals with a redemption of stock under facts totally different from the facts in the instant case. Neither of these cases aids1977 Tax Ct. Memo LEXIS 68">91 petitioners' argument in this case. Finally, petitioners make two related arguments for their position that the payment received by Mr. Blakeslee could not be compensation for services, the characterization urged by respondent. They argue that there was no employer-employee relationship between Mr. Blakeslee and Mr. Marsh and that the amount paid, when added to Mr. Blakeslee's Aetna salary, would be considered unreasonable compensation. Petitioners' argument on this point is misplaced.Income received by Mr. Blakeslee is ordinary income unless petitioners establish it to be otherwise under some specific statutory provision, regardless of its characterization as compensation for services. Petitioners have failed to establish that they are entitled to any treatment of the $464,300 received other than as ordinary income. However, we find that in fact this sum was received as compensation for services. Under his agreement, Mr. Blakeslee received the amount in return for the services he was to perform. That he was employed by Aetna to perform those same services does not alter this fact. One need not be a common law employee to receive compensation for services. See, e.g., General Artists Corp. v. Commissioner,17 T.C. 1517">17 T.C. 1517 (1952),1977 Tax Ct. Memo LEXIS 68">92 affd. 205 F.2d 360">205 F.2d 360 (2d Cir. 1953), cert. denied 346 U.S. 866">346 U.S. 866 (1953). Furthermore, the amount of Mr. Blakeslee's compensation was bargained at arm's length with Mr. Marsh. There is no reason to believe that on the facts of this case the amount was unreasonable or that it was paid for something other than services. In any event, section 61 includes in gross income all "compensation for services," not just reasonable compensation for services. We hold that the $464,300 received by Mr. Blakeslee from Mr. Marsh in 1973 was ordinary income and not capital gain. Decision will be entered under Rule 155. Footnotes1. One line of this letter was apparently omitted in the original by typographical error.↩2. By this time, the corporate name of PALIC had been changed to Aetna Variable Annuity Life Insurance Company. However, for simplicity, we have continued to call the corporation PALIC throughout this Opinion.↩3. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise stated.↩4. In our view this case could properly be disposed of on the basis that the receipt of $464,300 by Mr. Blakeslee pursuant to the terms of his contract does not satisfy the "sale or exchange" requirement of sec. 1222(3) regardless of whether the contract was a capital asset. See Tombari v. Commissioner,299 F.2d 889">299 F.2d 889, 299 F.2d 889">892 (9th Cir. 1962), affg. 35 T.C. 250">35 T.C. 250 (1960); United States v. Fairbanks,95 F.2d 794">95 F.2d 794 (9th Cir. 1938), affd. 306 U.S. 436">306 U.S. 436 (1939); Watson v. Commissioner,27 B.T.A. 463">27 B.T.A. 463, 27 B.T.A. 463">465↩ (1932). The record is clear that Mr. Blakeslee sold his PALIC stock to Aetna in 1967 and retained no interest in that stock. He never acquired any interest in Mr. Marsh's stock. In 1973 he received a payment of $464,300 from Mr. Marsh pursuant to his contract with Mr. Marsh. He did not "sell" or "exchange" this contract. However, the parties argued this case only on the issue of whether Mr. Blakeslee held a capital asset. We will therefore consider and decide this issue.5. Petitioners have argued that under his contract Mr. Blakeslee was given an "equity interest" in PALIC under which he had a "right to participate in the capital growth and appreciation"of PALIC. However, as we have noted, Mr. Blakeslee's right to receive money and thus "participate" in the growth of PALIC was derivative in nature and, by the terms of his contract, originated not from any equity in PALIC but from his employment contract.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620963/	ESTATE OF WILLIAM M. TUCK, DECEASED, LESTER L. DILLARD, EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Tuck v. CommissionerDocket No. 9681-87.United States Tax CourtT.C. Memo 1988-560; 1988 Tax Ct. Memo LEXIS 589; 56 T.C.M. 827; T.C.M. (RIA) 88560; December 8, 1988. Kurt R. Magette, for the petitioner. John C. McDougal, for the respondent. RAUMMEMORANDUM OPINION RAUM, Judge: The Commissioner determined a deficiency in Federal Estate taxes due from the Estate of William M. Tuck in the amount of $ 4,689,85. The sole issue for decision is whether decedent's $ 10,000 bequest for perpetual care of a family cemetery in which decedent is not buried may be deducted by his estate as a funeral expense under section 2053(a)(1), I.R.C. 1954. The case was submitted on the basis of a stipulation of facts. The decedent, William M. Tuck, was a prominent attorney and politician. He was born in Halifax County, Virginia, on September 28, 1896, and was a resident of the town of South Boston in Halifax County, Virginia, at his death on June 9, 1983. He had been the Lieutenant Governor1988 Tax Ct. Memo LEXIS 589">591 of Virginia (1942-1946), its Governor (1946-1950), and from 1953 to 1969 a member of the United States House of Representatives. The people of South Boston were proud to have the decedent as a resident of their town, and they dedicated a portion of the town museum "to his honor". The museum, which contains numerous artifacts and portraits of the decedent, is located in downtown South Boston. At the time of his death, decedent owned a 270-acre family farm, sometimes referred to as the "homeplace", in Red Bank District of Halifax County, about 12 to 15 miles from South Boston. It contained a family cemetery plot of more or less than one acre, which decedent referred to in his will as the "Tuck Family Cemetery Plot". In Article III of the will, he gave some 15 acres (including the one-acre family cemetery) to the trustees of five local churches to be used as a community cemetery for those churches. He also bequeathed $ 10,000 to the trustees "for the development, improvement, maintenance and beautification of said cemetery". In the alternative, if the churches declined to accept the bequest, decedent provided that the one-acre Tuck family cemetery along with the $ 10,000 would1988 Tax Ct. Memo LEXIS 589">592 go to Virginia Bank/Citizens of South Boston, Virginia, to be held in trust to provide a burial place for members of decedent's family and the money was to be used to develop, maintain, and beautify the family cemetery. Although the record does not explicitly so state, it would appear that the churches did not accept the 15-acre gift along with the $ 10,000. Also, Virginia Bank refused to accept the one-acre family cemetery and the $ 10,000. The executors of the estate thereupon established a trust with Lester L. Dillard, III, as trustee. The trust was funded with the $ 10,000 bequest for the purpose of maintaining the family cemetery pursuant to decedent's directions. Decedent's wife had predeceased him and was buried in the Oak Grove Cemetery in South Boston, within walking distance of the town museum. He left no instructions as to where he wished to be buried, but Article I of his will provided for the payment of "all expenses incident to my demise, as well as [of] the cost of erecting a suitable and modern marker at my last resting place, the selection of which is to be made by my hereinafter named Executors". He was not buried in the Tuck family cemetery, but instead1988 Tax Ct. Memo LEXIS 589">593 in the Oak Grove Cemetery where his wife was buried. A significant factor in selecting that cemetery was its proximity to the town museum, thereby making it easily accessible to visitors and the townspeople, who had affection and respect for him. A headstone was erected reciting his political career. The parties have stipulated that the "burial location provides a historical and educational benefit to the community and the Commonwealth". On the estate tax return, the following items were claimed as deductible "funeral expenses": Powell Funeral Home, Inc. - funeral4,336.80Rev. James Rowles - service100.00Giles Florist - flowers44.20South Boston Memorials - marker598.00United Virginia Bank - Cemeteryperpetual care10,000.00Total15,079.00The only adjustment made by the Commissioner in his determination of deficiency was his disallowance of a deduction for the $ 10,000 bequest as a "funeral expense". Section 2053(a) of the Internal Revenue Code provides for a deduction for "funeral1988 Tax Ct. Memo LEXIS 589">594 expenses", administration expenses, and other claims against the estate, "as are allowable by the laws of the jurisdiction, * * * under which the estate is being administered". Like provisions have been in our estate tax law for many years, as far back as 1916. 1 In our judgment, the $ 10,000 bequest does not qualify as a "funeral expense", or, for that matter, any "expense" at all incurred by the estate. It was merely a bequest for the benefit of the Tuck family cemetery at the family farm. As we interpret the term "funeral expenses", it means expenses incurred in connection with the decedent's funeral. Thus, the Commissioner has allowed as funeral expense deductions here $ 4,336.80 paid to the funeral home, $ 100 for a clergyman's services, $ 44.20 for flowers, and $ 598 for a marker -- expenses all incurred in1988 Tax Ct. Memo LEXIS 589">595 connection with the decedent's burial at the Oak Grove Cemetery. The $ 10,000 bequest for the perpetual care of the Tuck family cemetery, some 12-15 miles away, stands on an entirely different footing. It was not an obligation incurred by the executors in connection with decedent's funeral. Squarely in point is Estate of Gillespie v. Commissioner,8 T.C. 838">8 T.C. 838 (1947), where the decedent had bequeathed $ 5,000 for the perpetual care of a lot in a cemetery in which members of his family were buried. The decedent himself, however, was buried in an entirely different cemetery. In approving the disallowance of the claimed deduction, the Court stated that the deduction (p. 840) "relates to expenses of the decedent's funeral, not to the expenses of the funeral of any other, or to costs of perpetual care of the burial places of others". Petitioner seeks to distinguish Gillespie on the ground that the decedent in that case never intended to be buried in the family burial lot, a fact that was noted in the Gillespie opinion. 8 T.C. 838">8 T.C. 840. However, in our view, 1988 Tax Ct. Memo LEXIS 589">596 that fact was not critical to the decision therein. The point in that case was that the term "funeral expenses" as used in the statute was construed to refer to the expenses of the decedent's funeral, not to those of the funerals of others. Moreover, there is no solid or reliable evidence in the present case that the decedent herein wished to be interred in his family cemetery at the family farm rather than in the cemetery where his wife was buried, or where his executors might choose to have him buried. Indeed, Article I of his will is fairly susceptible of being read as leaving the selection of his "last resting place" to his executors. And we have but little confidence in the affidavits and stipulated hypothetical testimony of close friends and associates of the decedent in support of petitioner's contention that Governor Tuck wished to be buried in the family cemetery. We find such affidavits and stipulated testimony to be too loose and speculative to serve as a reliable guide to the decedent's intentions, particularly in the light of the foregoing provision of Article I of his will. 1988 Tax Ct. Memo LEXIS 589">597 Also, we note that among the funeral expenses listed in the estate tax return there was no expenditure for a plot at the Oak Grove Cemetery where he was in fact buried. This suggests that the plot had already been acquired years ago for both him and his wife with the expectation that both spouses would be buried in the same place. In any event, we are thoroughly satisified on this record that petitioner's contentions as to the decedent's wishes do not serve to render Gillespie inapplicable. Even if such presumed wishes were relevant, petitioner has failed in our view to carry its burden of proof in this respect. This case is to be sharply distinguished from Estate of Cardeza v. Commissioner,5 T.C. 202">5 T.C. 202, 5 T.C. 202">220-221 (1945), affd. 173 F.2d 19">173 F.2d 19 (3d Cir. 1949). There, the decedent bequeathed $ 25,000 for the perpetual care, maintenance, and beautification, as specified, of the mausoleum in which she was to be interred. She further directed that after the death of her son, his wife, and his lineal descendants, the mausoluem was to be sealed and no others placed therein or interred in the lot surrounding it. There, the expenses were plainly occasioned1988 Tax Ct. Memo LEXIS 589">598 by and directly related to the decedent's own interment and only secondarily to funerals of members of her family. There is a bright line between Cardeza and Gillespie, a line that was recognized in Rev. Rul. 57-530, 1957-2 C.B. 621, which reflects administrative practice in the IRS, and which has now been outstanding for some 30 years. The fact that the Court in Cardeza did not make any allocation of the $ 25,000 between the portion thereof relating directly to the decedent and the portion relating to her descendants was arguably at least in accord with regulations which have been in effect for many years in substantially the same form, and which may fairly be construed as taking a practical view of the matter. Section 20.2053-2, Estate Tax Regs., provides that the term funeral expenses includes "A reasonable expenditure for a tombstone, monument, or mausoleum, or for a burial lot, either for the decedent or his family, including a reasonable expenditure for its future care". 2 (Emphasis supplied.) Petitioner relies upon the underscored words as establishing1988 Tax Ct. Memo LEXIS 589">599 that the term "funeral expenses" may refer to expenditures made exclusively for members of the decedent's family. Although such an interpretation is theoretically possible, we think that, in the light of the obvious purpose of the statute in coupling funeral expenses together with administration expenses and claims against the estate, a sounder interpretation would simply be that the existence of concomitant benefit to members of the decedent's family would not preclude the deductibility of a funeral expense actually incurred in connection with the decedent's own funeral and that as a practical matter the necessity for an allocation would be dispensed with. In any event, the line has been drawn between cases in which the expenses were incurred in connection with the decedent's own interment (Cardeza) and those where the funeral of the decedent bears no relevance to the expenditures1988 Tax Ct. Memo LEXIS 589">600 in question (Gillespie). What we have here is merely a bequest for the benefit of members of the decedent's family, unrelated to his own funeral. We hold that they are not deductible as expenses incurred by the estate in connection with the decedent's funeral. They are not funeral expenses of this decedent. To take into account a credit for death taxes paid to the Commonwealth of Virginia, Decision will be entered under Rule 155.Footnotes1. Sec. 203(a)(1) of the Revenue Act of 1916, ch. 463, 39 Stat. 756, 778; sec. 403(a)(1), Revenue Act of 1918, ch. 18, 40 Stat. 1057, 1098; sec. 303(a)(1), Revenue Act of 1926, ch. 27, 44 Stat. 9, 72; sec. 812(b)(1), Internal Revenue Code of 1939↩, ch. 2, 53 Stat. 123.2. Like provisions first appeared in Article 40 of Regulations 37 (1916, 1917, 1919, and 1921), followed by Article 34, Regulations 63 (1919); Article 31, Regulations 70 (1926 and 1929); sec. 81.31, Regulations 105 (1942); and finally in the regulations now in effect, quoted in the text above.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620970/	DENNIS G. CRUM and CLORA A. CRUM, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCrum v. CommissionerDocket No. 31646-81.United States Tax CourtT.C. Memo 1984-328; 1984 Tax Ct. Memo LEXIS 344; 48 T.C.M. 381; T.C.M. (RIA) 84328; June 27, 1984. James R. Luppino, for the petitioners. James M. Eastman, for the respondent. FEATHERSTONMEMORANDUM OPINION FEATHERSTON, Judge: This case has been assigned to Special Trial Judge Randolph F. Caldwell, Jr., pursuant to section 7456(c), 1 and Rules 180, et seq. Respondent has moved for partial summary judgment with respect to two of the issues in the case. Upon due consideration of the record, the Court agrees with and adopts the opinion of the Special Trial Judge, set forth hereinbelow, disposing of respondent's motion. OPINION OF THE SPECIAL TRIAL JUDGE CALDWELL, Special Trial Judge: This matter is before the Court on respondent's motion for partial summary judgment pursuant to Rule 121. The issues for decision are: 1. Whether Domus IV (Domus), a California limited partnership,1984 Tax Ct. Memo LEXIS 344">346 is entitled to a depreciation deduction for 1975, 1976, and 1977 under the income forecast method or the straight line method; and 2. Whether petitioners are entitled to claim an investment tax credit for 1975 on a motion picture film in an amount greater than that allowed by respondent. Respondent determined deficiencies in petitioners' Federal income taxes as follows: YearDeficiency1972$6,104197316,50619743,247197562,79619768,701197718,634The deficiencies resulted from the disallowance of petitioners' distributive share of Domus' reported losses for the years 1975-1977 which were predicated on claimed depreciation deductions and an investment tax credit, as well as other adjustments not now before us. Petitioners were residents of Fresno, California, at the time the petition was filed. At all material times, petitioners had a 13.6-percent partnership interest in Domus, a California limited partnership. Domus had an 80-percent interest in a joint venture between it and ACQ Corporation (ACQ), a California corporation. On December 15, 1975, ACQ purchased from Cinema Verite a motion picture film titled "Aaron Loves Angela" (the1984 Tax Ct. Memo LEXIS 344">347 film). According to the terms of the purchase agreement executed by the parties, ACQ paid Cinema Verite with a check in the amount of $170,000, plus a nonrecourse note in the amount of $4,672,000. The sole and exclusive source of payment for the note was from proceeds of the film. On December 15, 1975, Domus purchased the film from ACQ. According to the terms of the purchase agreement executed by the parties, Domus paid ACQ with a check in the amount of $275,000 plus a nonrecourse note in the amount of $4,672,600. The sole and exclusive source of payment for the note was from proceeds of the film. Domus and the joint venture each filed Form 1065 partnership returns during 1975, 1976, and 1977. The 1975 returns were the initial returns filed by both partnerships. All items of income, expense, and credit reported on the joint venture's 1975, 1976, and 1977 returns related to its ownership of the film. On its 1975 return, the joint venture elected to depreciate the film pursuant to the income forecast method. On its 1976 return, the joint venture changed its method of depreciation to the straight line method. The joint venture never sought respondent's consent to change its1984 Tax Ct. Memo LEXIS 344">348 method of depreciation, nor was consent ever given. The joint venture reported no gross income or any other kind of income on its 1976 and 1977 returns. The first issue is whether Domus may change its method of computing depreciation from the income forecast method to the straight line method. The income forecast method of depreciation is an acceptable method of depreciation.This Court has held in several recent cases that once an acceptable method of depreciation is chosen, the taxpayer cannot change that method without the consent of respondent. Greene v. Commissioner,81 T.C. 132">81 T.C. 132, 81 T.C. 132">137-140 (1983); Wildman v. Commissioner,78 T.C. 943">78 T.C. 943, 78 T.C. 943">952-953 (1982); Mitchell v. Commissioner,42 T.C. 953">42 T.C. 953, 42 T.C. 953">968 (1964). See also sec. 1.167(c)-1(a), Income Tax Regs.Notwithstanding recent case law and the applicable regulations, petitioners advance two arguments in support of thier position that they be allowed to change depreciation methods. Petitioners' first argument is that the notice of deficiency did not raise as an issue Domus' depreciation method. The notice of deficiency stated that petitioners' income for the taxable years ended December 31, 1975 through1984 Tax Ct. Memo LEXIS 344">349 December 31, 1977, is increased in each year to reflect petitioners' distributive share of adjustments which have been made to the ordinary net income or loss of Domus. An attached exhibit listed depreciation as one of the adjustments. Therefore, the notice of deficiency did raise depreciation as an issue. Petitioners' second argument is that Wildman and Mitchell are distinguishable from the instant case because those cases involved a change from the income forecast method and the straight line method, respectively, to an accelerated method of depreciation, whereas Domus changed from the income forecast method to the straight line method. Therefore, according to petitioners, the change to the straight line method should be allowed without Commissioner's consent. In two recent cases, 2 this Court has held that the taxpayer may not change from the income forecast method to the straight line method without respondent's consent. On brief, petitioners seek to distinguish these cases on the ground that the taxpayers in Tarricone v. Commissioner,T.C. Memo. 1983-674 and Bizub v. Commissioner,T.C. Memo. 1983-280 did not raise the change in1984 Tax Ct. Memo LEXIS 344">350 depreciation issue at trial, but rather raised that issue for the first time on brief. Regardless of when the issue was first raised, both decisions considered the taxpayers' arguments and rejected them. Furthermore, our review of Tarricone v. Commissioner,supra, does not indicate that the taxpayer's argument was first raised on brief. In any event, these two cases are dispositive of petitioners' second argument. Petitioners also contend that, although the returns filed by the joint venture for 1976 and 1977 reported no net receipts or taxable income, that does not establish that there were no receipts or taxable income. Petitioners assert that whether or not the joint venture or Domus had net receipts or taxable income is a question of fact to be decided at trial. We disagree with petitioners. Other than their mere assertion, petitioners offered no evidence to contradict the figures reported on the partnership returns. See Waring v. Commissioner,412 F.2d 800">412 F.2d 800, 412 F.2d 800">801 (3d Cir. 1969), affg. a Memorandum1984 Tax Ct. Memo LEXIS 344">351 Opinion of this Court. There is nothing in the record in the form of counter-affidavits or other "acceptable materials" (Rule 121(d)) that shows that either the joint venture of Domus had "net receipts" derived from exploitation of the film. Accordingly, petitioners have failed to show that there is a genuine issue as to any material fact with respect to this issue. Fife v. Commissioner,82 T.C. 1">82 T.C. 1 (1984); Tarricone v. Commissioner,supra;81 T.C. 132">Greene v. Commissioner,supra.The second issue concerns whether petitioners are entitled to an investment tax credit in an amount greater than that allowed by respondent in the notice of deficiency. For the taxable year 1975, petitioners claimed that their distributive share of the investment tax credit claimed by Domus with respect to the film was $52,642.Petitioners claimed $26,785 of that amount as a credit on their 1975 return, and claimed the balance of $6,104, $16,506, and $3,247 as carrybacks to 1972, 1973, and 1974, respectively. Respondent contends that petitioners' distributive share of the credit is $1,541.33. This amount is derived from only the $170,000 which ACQ paid1984 Tax Ct. Memo LEXIS 344">352 Cinema Verite by check for the film; it does not include the nonrecourse note in the amount of $4,672,000. In other words, respondent contends that petitioners' distributive share of the credit is limited to the amount that ACQ was "at risk." Section 48(k)(1) and section 1.48-8(a)(4)(ii), Income Tax Regs., provide that an investment credit is allowable to a taxpayer with respect to any motion picture film only if such film is new section 38 property which is a qualified film, and only to the extent that the taxpayer has an "ownership interest" in such film (i.e., a depreciable interest in at least part of the film).A taxpayer's "ownership interest" in a qualified film is determined on the basis of the taxpayer's proportionate share of any loss which may be incurred with respect to the production costs of such film. Sec. 48(k)(1)(C). The proportionate share of any loss which can be incurred with respect to production costs by a taxpayer is the amount that the taxpayer's capital is at risk. Sec. 1.48-8(a)(4)(i), Income Tax Regs. If a taxpayer's capital is considered at risk under the principles of section 465, the taxpayer's capital will be considered to be at risk under this paragraph. 1984 Tax Ct. Memo LEXIS 344">353 Regardless of whether a taxpayer is at srisk under the principles of section 465, a taxpayer's capital will be considered at risk under this paragraph of the regulation (i.e., sec. 1.48-8(a)(4)(i), Income Tax Regs.) if the taxpayer will suffer the economic loss if the qualified film fails to generate sufficient revenue to cover or repay production costs. Section 465(b) provides that a taxpayer shall be considered at risk for an activity with respect to the amount of money contributed by the taxpayer to the activity and amounts borrowed with respect to such activity. A taxpayer shall be considered at risk with respect to borrowed amounts to the extent that the taxpayer is personally liable for the repayment of such amounts. However, a taxpayer shall not be considered at risk with respect to amounts protected against loss through nonrecourse financing. If a partnership has an ownership interest in a qualified film, its credit is apportioned among the partners on the basis of their percentage of capital at risk in the partnership at the time the film was placed in service. Sec. 1.48-8(a)(4)(iv), Income Tax Regs.If the person who produces and incurs the qualified production1984 Tax Ct. Memo LEXIS 344">354 costs of a qualified film then sells it, and the purchase price is payable solely out of the proceeds generated from the exhibition of the film, since the producer's capital at risk equals the production costs of the film, the producer is entitled to the investment credit with respect to the film. On the other hand, if as part of the purchase agreement the purchaser pays the producer a sum certain in addition to any amount payable from the proceeds of exhibition, then the purchaser is entitled to the investment credit to the extent that the fixed purchase price does not exceed the qualified United States production costs of the film. Sec. 1.48-8(a)(4)(v), Ex. (3), Income Tax Regs. Finally, if a taxpayer purchases a part of the film before it is placed in service, the purchaser's qualified United States production costs are equal to the lesser of (1) the qualified United States production costs of the seller at the time of the sale or at the time of completion if later, reduced by the amount of any prior purchase, or (2) the fixed purchase price of that part of the film purchased. Sec. 1.48-8(g)(1), Income Tax Regs.In the instant case, Domus acquired its 80-percent interest in1984 Tax Ct. Memo LEXIS 344">355 the film from ACQ for $275,000 plus a nonrecourse note. ACQ had acquired the rights to the film from Cinema Verite for $170,000 plus a nonrecourse note. Although the record does not indicate the amount of Cinema Verite's qualified United States production costs, since ACQ was only at risk to the extent of $170,000, ACQ's United States qualified production costs can be no more than $170,000. Similarly, since $170,000 is less than the $275,000 paid by Domus to ACQ, Domus' qualified United States production costs can be no more than $170,000. Sec. 1.48-8(g)(1), Income Tax Regs. Therefore, Domus' qualified investment for purposes of computing the credit is no more than the amount allowed by respondent--$170,000. Using this $170,000 amount, respondent determined that petitioners' share of the investment credit was no more than $1,541.33, computed as follows: $170,000 qualified investment multiplied by 66-2/3 applicable percentage 3 (secs. 46(c)(2) and 48(k)(2)) multiplied by 10-percent credit rate (sec. 1.46-1(g)(2), Income Tax Regs.) multiplied by petitioners' 13.6-percent share. To counter1984 Tax Ct. Memo LEXIS 344">356 respondent's determination petitioners make two arguments.Petitioners' first argument is that the facts admitted do not establish the amount of Cinema Verite's qualified United States production costs. Although petitioners' argument is correct, it does not affect this issue. As already stated, the purchaser's qualified United States production costs are equal to the lesser of the total qualified United States production costs of the seller or the fixed purchase price of the film. Sec. 1.48-8(g), Income Tax Regs. Since ACQ's fixed purchase price for the film was $170,000, the amount of their qualified production costs can be no more than this amount. Petitioners' second argument is apparently that since section 1.48-8, Income Tax Regs., was not proposed until 1977 and not adopted until April 4, 1979, they are not bound by these regulations. However, petitioners have cited no authority for the proposition that section 1.48-8, Income Tax Regs., does not properly interpret section 48(k). Cf. 82 T.C. 1">Fife v. Commissioner,supra.In short, petitioners have not shown that there is a genuine issue as to any material fact for trial with respect to either of these two issues. 1984 Tax Ct. Memo LEXIS 344">357 Therefore, respondent's motion for partial summary judgment will be granted. An appropriate order will be issued.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise noted. All Rule references are to the Tax Court Rules of Practice and Procedure unless otherwise noted.↩2. See Tarricone v. Commissioner,T.C. Memo. 1983-674; Bizub v. Commissioner,T.C. Memo. 1983-280↩.3. Petitioners did not elect to use the alternative percentage rate under sec. 48(k)(3)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620972/	RAY L. CORONA, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCorona v. CommissionerDocket No. 11391-90United States Tax CourtT.C. Memo 1992-406; 1992 Tax Ct. Memo LEXIS 426; 64 T.C.M. 196; July 16, 1992, Filed 1992 Tax Ct. Memo LEXIS 426">426 Decision will be entered for respondent. During the early 1980s, P owned shares of stock of a State chartered bank, a part of whose deposits were insured by the FDIC. The parties have stipulated that the bank was insolvent in 1984. For several years, including the year at issue (1984), the bank was subject to increasing scrutiny by both the State banking authorities and the FDIC. Those authorities took several regulatory actions against the bank and its officers and directors, requiring the correction of various unsafe or unsound banking practices. In 1986, the State authorities appointed the FDIC as liquidator of the bank, and it was closed. For 1984, P claimed a loss, resulting from the alleged worthlessness of his bank shares. See sec. 165(a), (g), I.R.C.Held, P has failed to meet his burden of proving that, during 1984, his shares had lost all potential value, within the meaning of Morton v. Commissioner, 38 B.T.A. 1270">38 B.T.A. 1270, 38 B.T.A. 1270">1278-1279 (1938), affd. 112 F.2d 320">112 F.2d 320 (7th Cir. 1940), and were thus worthless. For Ray L. Corona, pro se. For Respondent, Sergio Garcia-Pages. HALPERNHALPERNMEMORANDUM FINDING OF FACT AND OPINION HALPERN, Judge1992 Tax Ct. Memo LEXIS 426">427 : By notice of deficiency dated March 21, 1990, respondent determined a deficiency in petitioner's Federal income tax for the tax year ended December 31, 1984, in the amount of $ 445,986.34, together with an addition to tax in the amount of $ 111,497. That addition was imposed under section 6661, on account of a substantial understatement of income tax liability. The only issue for decision is whether petitioner's stock in the Sunshine State Bank (SSB) became worthless in 1984. 1Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. FINDINGS OF FACT At the time the Petition in this case was filed, petitioner1992 Tax Ct. Memo LEXIS 426">428 resided in Miami, Florida. Some of the facts have been stipulated and are so found. The stipulations of facts filed by the parties and attached exhibits are incorporated herein by this reference. Sunshine State BankSSB was a State Bank, chartered by the State of Florida and doing a banking business in Miami, Florida. At least a part of SSB's deposits was insured by the Federal Deposit Insurance Corporation (FDIC), and SSB was subject to the Federal Deposit Insurance Act as an insured nonmember bank. SSB was closed in May 1986, subsequent to a determination by the Comptroller of the State of Florida and Head of the Department of Banking and Finance (Florida Comptroller) that SSB was insolvent and that the appointment of a liquidator was in the public interest. FDIC was appointed as liquidator of SSB on May 23, 1986. At all times relevant here, petitioner owned a controlling interest in SSB. During 1984, on at least two occasions, petitioner purchased from SSB shares of SSB stock: On February 29, 1984, petitioner purchased 200,000 shares, for $ 2 million; on September 30, 1984, petitioner purchased 62,500 shares, for $ 625,000. In a statement of net worth made as of1992 Tax Ct. Memo LEXIS 426">429 January 15, 1986, petitioner showed 278,071 shares of SSB stock as an asset, with a cost of $ 3,111,450 and a present market value equal to cost. At least until December 1984, petitioner, Rafael L. Corona, his father, and Ricardo R. Corona, his brother, were all either directors or senior officers of SSB, or both. Regulatory HistoryDuring the 5 years leading up to its closure, SSB was subject to increasing scrutiny by both the Florida Department of Banking and Finance (Florida Banking Department) and FDIC. During those years, FDIC conducted six examinations of SSB: as of July 10, 1981, February 19, 1982, February 4, 1983, September 30, 1983, August 20, 1984, and October 1, 1985. At each examination, FDIC prepared a Report of Examination, documenting a continuing decline in SSB's overall financial condition. Some of the findings of these examinations, such as assets subject to adverse classification and SSB's book and adjusted capital and reserves, are summarized in the following chart: SUNSHINE STATE BANKAdversely Classified Assets 1ExaminationDate as ofSubstandardDoubtfulLoss7/10/81$ 558,000$ 96,000$ 46,0002/19/82640,000165,000173,0002/4/8322,560,000472,000803,0009/30/8326,215,0001,285,0004,746,0008/20/8436,625,0003,698,0007,806,00010/1/8526,966,00012,908,00018,022,0001992 Tax Ct. Memo LEXIS 426">430 Total AssetsPercentage ofBook CapitalAdjusted 1ExaminationAdverselyTotal Assetsand ReservesCapital andDate as ofClassifiedClassified(Unadjusted)Reserves7/10/81$ 700,0002/19/82978,0001.90%2/4/8323,835.00029.33%$ 4,567,000$ 3,528,0009/30/8332,246,00031.98%5,549,000161,0008/20/8448,129,00046.71%6,144,000(3,511,000)10/1/8557,896,00054.53%1,377,000(23,327,000)1992 Tax Ct. Memo LEXIS 426">431 Highlights of some of SSB's involvement with FDIC and the Florida Banking Department from 1983 to 1986 are as follows: -- FDIC Report of Examination as of February 4, 1983In its Report of Examination as of February 4, 1983, FDIC concluded that SSB's then current level of capital protection was inadequate. FDIC concluded that an injection of at least $ 3,200,000 in new capital was required. SSB was rated in each of five categories: capital, asset condition, quality of management, earnings (future and potential), and liquidity. Where a rating of "1" represents the best possible condition and where a rating of "5" represents the worst possible condition, SSB was given a rating of 5 in three of five categories and a rating of 4 in two categories. Overall, SSB was given a rating of 5, which rating indicated an extremely high immediate or near term probability of failure, absent urgent financial assistance and decisive corrective measures. -- Consolidated FDIC Action; 1985 FDIC Consolidated OrderBased on its examinations as of February 4, 1983, and September 30, 1983, FDIC initiated various actions against SSB and its officers and directors. On August 3, 1983, November1992 Tax Ct. Memo LEXIS 426">432 22, 1983, and March 12, 1984, FDIC issued three separate Notices of Charges and of Hearing, charging SSB with engaging in unsafe and unsound practices and committing violations of the law. On March 12, 1984, FDIC issued a Notice of Intention to Remove from Office and to Prohibit from Participation against petitioner, his father, and his brother, alleging unsafe and unsound banking practices, violations of laws, and breaches of fiduciary duties. The actions initiated by those notices were consolidated in April 1984 (Consolidated FDIC Action). Hearings were held before an administrative law judge (ALJ) during the summers of 1984 and 1985. Recommended decisions were issued by the ALJ in November 1984 and July 1985. Following the filing of exceptions and briefs, FDIC's board of directors, in August 1985, decided upon an order, which generally became effective on October 1, 1985 (the 1985 FDIC Consolidated Order). Pursuant to that order, SSB and it directors and officers were ordered to cease and desist from certain unsafe or unsound banking practices and violations of law and to carry out various actions and reforms in SSB's banking practices. 21992 Tax Ct. Memo LEXIS 426">433 -- FDIC Temporary Order to Cease and Desist, November 28, 1983At the time that the actions giving rise to the Consolidated FDIC Action were being initiated, FDIC issued a Temporary Order to Cease and Dentist to SSB and its directors and officers,effective on November 28, 1983 (1983 FDIC Temporary Order). FDIC issued that order after determining that the practices and violations at issue in the Consolidated FDIC Action were likely, prior to the completion of such action, to cause insolvency or significant dissipation of SSB's assets or earnings, or to weaken SSB's condition or prejudice the interests of SSB's depositors. The 1983 FDIC Temporary Order required SSB to cease and desist from any such practices or violations. -- Florida Memorandum of Understanding, January 25, 1984After completion of the FDIC examination as of September 30, 1983, SSB and the Florida Banking Department entered into a Memorandum of Understanding, dated January 25, 1984 (1984 Florida Memorandum). That memorandum states that such examination "reflects severe weaknesses, which if not immediately corrected, would further jeopardize the financial viability of the Bank." The 1984 Florida Memorandum1992 Tax Ct. Memo LEXIS 426">434 required SSB, among other things, (1) to reduce brokered deposits to 10 percent of total deposits within 45 days and to notify the Florida Banking Department of all brokered deposits in excess of 5 percent of total deposits, (2) to maintain a loan/deposit ratio of 70 percent and reduce total deposits to $ 100 million or less absent a capital/deposit ratio of 6.5 percent, and (3) to increase its capital by $ 3 million within 270 days. In 1984, SSB complied with many, but not all, of the provisions of the 1984 Florida Memorandum. Among other things, by September 30, 1984, petitioner had contributed an additional $ 2,625,000 in capital to SSB, by purchasing additional shares of SSB stock. -- FDIC Order of Correction, March 15, 1984In turn, FDIC also took action based on the FDIC examination as of September 30, 1983. FDIC found that SSB had been engaging in unsafe or unsound banking practices and was in an unsafe or unsound condition to continue operations as an insured bank. In particular, FDIC found that SSB was operating with inadequate capital and reserves, an excessive volume of poor quality loans, and a management whose policies and practices jeopardized the safety 1992 Tax Ct. Memo LEXIS 426">435 of SSB's deposits and were detrimental to SSB. FDIC issued an order of correction, effective March 15, 1984, providing that, if FDIC were to continue to insure SSB's deposits, SSB had to undertake certain corrective measures (1984 FDIC Order of Correction). That order required SSB (1) to increase capital and reserves by not less than $ 8,200,000, (2) to write-down within 20 days certain assets adversely classified as either loss or doubtful, (3) to provide and retain a chief executive officer and a senior lending officer, who were not current employees of SSB, and (4) to notify FDIC when brokered deposits represented 5 percent or more of total deposits. -- FDIC's Response to the Federal Indictments Against Petitioner and His Father, Raphael CoronaOn December 13, 1984, FDIC reviewed recent indictments, charging petitioner and his father with multiple Federal crimes involving dishonesty or breach of trust, including racketeering (RICO) and mail fraud. See generally United States v. Corona, 885 F.2d 766">885 F.2d 766 (11th Cir. 1989). 3 FDIC found that the continued participation by petitioner or his father in SSB's affairs posed a threat to SSB's depositors or threatened1992 Tax Ct. Memo LEXIS 426">436 to impair public confidence in SSB. Accordingly, petitioner was suspended as chairman of SSB's board of directors, his father was suspended as a director of SSB, and both were prohibited from further participation in SSB's affairs. However, neither petitioner nor his father fully complied with those orders.-- 1985 FDIC Order to Cease and DesistAlso on December 13, 1984, after reviewing the Federal indictments, FDIC issued to SSB, petitioner, his father, and his brother a Notice of Charges and of Hearing and a Temporary Order to Cease and Desist, alleging unsafe or unsound banking practices. Those FDIC actions resulted in a consent agreement dated March 13, 1985, between FDIC, SSB, and the named individuals. Pursuant to that agreement, 1992 Tax Ct. Memo LEXIS 426">437 FDIC issued an Order to Cease and Desist, prohibiting SSB from assisting petitioner or his father with defense expenses related to the Federal indictments and from extending loans to anybody, the purpose of which was to benefit petitioner or his father, unless such loans were fully secured (1985 FDIC Order to Cease and Desist). -- Florida Consent Order, February 5, 1985The Florida Banking Department also responded to the Federal indictments of petitioner and his father. The Florida Banking Department's response resulted in a Consent Order that became effective on February 5, 1985, and that superseded the 1984 Florida Memorandum (1985 Florida Consent Order). The Florida Banking Department had carried out an examination of SSB as of May 18, 1984, which, "despite certain improvements, revealed continued weakness, which if not corrected, * * * [would] jeopardize the safety and soundness of the bank." -- FDIC Report of Examination as of August 20, 1984FDIC's Report of Examination as of August 20, 1984 (1984 FDIC Report), was completed in February 1985. The report concluded that, as of August 20, 1984, SSB was insolvent, in that its liabilities exceeded its adjusted1992 Tax Ct. Memo LEXIS 426">438 assets, and that at least $ 11,000,000 in new capital was necessary to bring its capital to an acceptable level. Finally, SSB was given a rating of 5 in four of five categories and a rating of 4 in one category. The composite rating was again 5, the worst possible rating. The 1984 FDIC Report commented that the last three examinations disclosed an escalating trend of deterioration in SSB's overall condition and that, during that period, petitioner, his father, and his brother exercised a dominant and controlling influence over SSB's management, policies, and daily operations. The report heavily criticized SSB's directors and the Corona family for failing to remedy the loan problems brought to their attention by FDIC, to implement many of FDIC's recommendations from earlier examinations, and to comply fully with the banking laws. In the report, FDIC noted the suspensions of petitioner and his father from their positions with SSB and emphasized the need for the directors to install a qualified management team. In sum, the 1984 FDIC Report stated that SSB's survival hinged on a massive recapitalization, employment of acceptable management, drastic cost cutting measures, and a restructuring1992 Tax Ct. Memo LEXIS 426">439 of SSB's assets and liabilities. -- FDIC Order of Correction, September 11, 1985Based on the 1984 FDIC Report, FDIC again found that SSB had engaged in unsafe or unsound banking practices and was in an unsafe or unsound condition to continue operations as an insured bank, unduly jeopardizing FDIC's insurance risk. FDIC issued an Order of Correction, effective September 11, 1985, providing that, if SSB were to continue as an insured institution, SSB had to take certain corrective measures (1985 FDIC Order of Correction). -- FDIC Report of Examination as of October 1, 1985By letter dated April 22, 1986, the Atlanta Regional Office of FDIC forwarded to SSB a copy of its Report of Examination as of October 1, 1985 (1985 FDIC Report). In that letter, the Atlanta Regional Office notified SSB that it was recommending to FDIC's Washington, D.C., office that SSB be retained on the formal problem list, that the formal action to terminate SSB's insured status be continued, and that civil money penalties and an enforcement action be pursued based on SSB's noncompliance with various FDIC orders. The 1985 FDIC Report determined again that SSB was insolvent and gave SSB individual1992 Tax Ct. Memo LEXIS 426">440 ratings of 5 in all five categories for the first time and another overall rating of 5. It concluded that SSB's survival hinged on a massive recapitalization, employment of acceptable management, drastic cost cutting measures, and a restructuring of SSB's assets and liabilities. -- Appointment of Liquidator, May 23, 1986On May 23, 1986, the Florida Comptroller appointed FDIC as liquidator of SSB, to liquidate SSB's assets and wind up its affairs. The Florida Comptroller based his decision to appoint a liquidator on the 1985 FDIC Report completed in April 1986 and, in particular, on the findings in that report that the value of SSB's adjusted capital and reserves was negative $ 23,327,000 and that SSB had a composite rating of 5, the worst possible rating. Petitioner's 1984 ReturnOn his 1984 return, as originally filed, petitioner reported a long-term capital gain of $ 4,140,000. By amended return, petitioner reported a short-term capital loss of $ 2,625,000, resulting from the worthlessness of his SSB shares. OPINION Section 165(a) allows a deduction for losses sustained during the taxable year and not compensated for by insurance or otherwise. To be allowable1992 Tax Ct. Memo LEXIS 426">441 as a deduction under section 165(a), a loss must be evidenced by a closed and completed transaction, fixed by identifiable events, and actually sustained during the taxable year. Sec. 1.165-1(b), Income Tax Regs. If shares of stock in a corporation become wholly worthless during a taxable year, the loss resulting therefrom may be deducted under section 165(a), as an ordinary loss or as a capital loss, as appropriate. See sec. 165(g); sec. 1.165-5, Income Tax Regs.As stated previously, the only issue before us is whether petitioner's stock in SSB became worthless in 1984. Whether shares of stock have become worthless, and the taxable year in which such worthlessness has occurred, are questions of fact, and petitioner bears the burden of proof. Rule 142(a); Figgie International, Inc. v. Commissioner, 807 F.2d 59">807 F.2d 59, 807 F.2d 59">62 (6th Cir. 1986), affg. T.C. Memo. 1985-369; Clark v. Welch, 140 F.2d 271">140 F.2d 271 (1st Cir. 1944). To carry that burden, petitioner must show that, in 1984, his SSB stock ceased to have both liquidating value (an excess of assets over liabilities) and potential value (a reasonable expectation that the assets would exceed1992 Tax Ct. Memo LEXIS 426">442 the liabilities in the future). Austin Co., v. Commissioner, 71 T.C. 955">71 T.C. 955, 71 T.C. 955">969-970 (1976); Steadman v. Commissioner, 50 T.C. 369">50 T.C. 369, 50 T.C. 369">376 (1968), affd. 424 F.2d 1">424 F.2d 1 (6th Cir. 1970); Morton v. Commissioner, 38 B.T.A. 1270">38 B.T.A. 1270, 38 B.T.A. 1270">1278-1279 (1938), affd. 112 F.2d 320">112 F.2d 320 (7th Cir. 1940). Since respondent has conceded on brief that SSB was insolvent at 1984 year end, we will take it as a given that, in 1984, SSB lacked liquidating value. The parties disagree as to whether SSB had potential value during 1984. We explained the importance of potential value in 38 B.T.A. 1270">Morton v. Commissioner, supra at 1278-1279: The ultimate value of stock, and conversely its worthlessness, will depend not only in its current liquidating value, but also on what value it may acquire in the future through the foreseeable operations of the corporation. Both factors of value must be wiped out before we can definitely fix the loss. If the assets of the corporation exceed its liabilities, the stock has a liquidating value. If its assets are less than its liabilities but there is a reasonable hope and expectation that1992 Tax Ct. Memo LEXIS 426">443 the assets will exceed the liabilities of the corporation in the future, its stock, while having no liquidating value, has a potential value and can not be said to be worthless. The loss of potential value, if it exists, can be established ordinarily with satisfaction only by some "identifiable event" in the corporation's life which puts an end to such hope and expectation. We described "identifiable events" as events that "limit or destroy the potential value of stock", "such as the bankruptcy, cessation from doing business, or liquidation of the corporation, or the appointment of a receiver for it." 38 B.T.A. 1270">Id. at 1278; see also 38 B.T.A. 1270">Steadman v. Commissioner, supra at 1278. Simply put, petitioner has failed to show an identifiable event in the life of SSB occurring in 1984 that would put an end to the hope and expectation that the value of SSB's assets would exceed its liabilities in the future. Petitioner has shown neither the bankruptcy, cessation from doing business, liquidation of SSB, appointment of a receiver for SSB, nor any other event that clearly limited or destroyed in 1984 the potential value of his SSB shares. Of course, during 1984, SSB was under1992 Tax Ct. Memo LEXIS 426">444 intense scrutiny by FDIC and the Florida Banking Department. We cannot see, however, how an examination or the completed report of such an examination constitutes an identifiable event. Further, we cannot see how any of the various actions taken during 1984 by those two regulatory agencies constitutes an identifiable event within the meaning of 38 B.T.A. 1270">Morton v. Commissioner, supra at 1278. Although the 1984 Florida Memorandum and the 1984 FDIC Order of Correction were issued during 1984, and although SSB was subject during 1984 to the 1983 FDIC Temporary Order, those actions simply required SSB to take various corrective measures, and none of them constituted the respective agency's severest form of regulatory action. While FDIC, in the Consolidated FDIC Action initiated in late 1983 and early 1984, charged SSB with engaging in unsafe and unsound practices and committing violations of law and moved to remove the Coronas from corporate positions, the Consolidated FDIC Action did not in any event result in the issuance of an order until August 1985, when the 1985 FDIC Consolidated Order was issued. Furthermore, the 1984 FDIC Order of Correction, issued upon consideration1992 Tax Ct. Memo LEXIS 426">445 of the September 1983 examination and effective March 1984, threatened termination of FDIC insurance unless certain corrective measures were taken. While such termination certainly would have been serious, nothing in the record indicates that FDIC made good on its threat in 1984. Finally, the actions taken by FDIC in December 1984 after the Federal indictments were filed against petitioner and his father are not identifiable events that limited or destroyed the potential value of SSB stock. Those actions related to the removal of petitioner and his father as officers and directors of SSB and the prohibition against their future involvement with SSB; if anything, those actions may have had a positive effect on the value of petitioner's SSB shares. In sum, petitioner would have us hear a death knell in the regulatory concern and action taking place in 1984. That we do not hear. Both FDIC and the Florida Banking Department were, in 1984, providing prescriptions for recovery. Neither regulatory body seems to have given up hope for SSB's recovery until completion in April 1986 of FDIC's report of examination as of October 1, 1985. We conclude that there was no identifiable event, 1992 Tax Ct. Memo LEXIS 426">446 38 B.T.A. 1270">Morton v. Commissioner, supra, with regard to SSB in 1984. Compare Thompson v. Commissioner, 115 F.2d 661">115 F.2d 661 (2d Cir. 1940), affg. 40 B.T.A. 1380">40 B.T.A. 1380 (1939); Bartlett v. Commissioner, 114 F.2d 634">114 F.2d 634, 114 F.2d 634">639 (4th Cir. 1940); In re Hoffman, 16 F. Supp. 391, 392 (E.D. Pa. 1936), affd. Yocum v. Rothensies, 87 F.2d 200">87 F.2d 200 (3d Cir. 1936). Nevertheless, as we said in 38 B.T.A. 1270">Morton v. Commissioner, supra at 1279 (citing De Loss v. Commissioner, 28 F.2d 803">28 F.2d 803, 28 F.2d 803">804 (2d Cir. 1928)): There are, however, exceptional cases where the liabilities of a corporation are so greatly in excess of its assets and the nature of its assets and business is such that there is no reasonable hope and expectation that a continuation of the business will result in any profit to its stockholders. In such cases the stock, obviously, has no liquidating value, and since the limits of the corporation's future are fixed, the stock, likewise, can presently be said to have no potential value. Where both these factors are established, the occurrence in a later year of an "identifiable1992 Tax Ct. Memo LEXIS 426">447 event" in the corporation's life, such as liquidation or receivership, will not, therefore, determine the worthlessness of the stock, for already "its value had become finally extinct." * * * See also Steadman v. Commissioner, 50 T.C. 369">50 T.C. 377 (citing 38 B.T.A. 1270">Morton v. Commissioner, supra at 1279, and concluding, on the facts there at issue, that, after a given year, there was no reasonable expectation of future profit to the shareholders of the corporation and that a prudent businessman would have ascertained the stock to be worthless in that year). We reject petitioner's implied argument that this case is one of the exceptional cases described in 38 B.T.A. 1270">Morton v. Commissioner, supra at 1279, where the liabilities of the corporation are so greatly in excess of its assets that there is no reasonable hope and expectation of future profit through continued operation of the business. While the 1985 FDIC Report (October 1, 1985) found that SSB's capital and reserves had a value of negative $ 23,327,000, the 1984 FDIC Report (August 20, 1984) calculated only a negative $ 3,511,000. That latter figure is relatively small in light of petitioner's 1992 Tax Ct. Memo LEXIS 426">448 own contribution to capital of $ 2,625,000 during 1984. Also, such amounts of capital and reserves were determined after making substantial adjustments to unadjusted "book" capital and reserves, for adversely classified assets. On a book basis, SSB's capital and reserves totaled $ 6,144,000 and $ 1,377,000, both positive values, as of August 20, 1984, and October 1, 1985, respectively. Petitioner has demonstrated neither how severe the capital and reserve problem of SSB had grown by the end of 1984 nor that a prudent businessman would have discounted SSB's capital and reserves as severely as did FDIC, which, as a bank examiner and regulator, may well have been under different pressures to adversely classify assets than a prudent businessman would be in judging the probability of future profits from a continuation of SSB's business. FDIC undoubtedly was aware of the deteriorating capital position of SSB during 1984, yet it took no action during 1984 to terminate deposit insurance coverage. FDIC issued the 1984 FDIC Order of Correction and the 1985 FDIC Order of Correction, which threatened termination of insurance if certain corrective measures were not taken. We take FDIC's failure1992 Tax Ct. Memo LEXIS 426">449 to terminate deposit insurance during 1984, in the face of a deteriorating capital structure, which it was aware of, as an indication that, during 1984, FDIC had not eliminated the possibility of a recovery. If it had eliminated that possibility, FDIC would not have allowed its exposure to underwriting losses to increase as the capital structure of the bank further deteriorated. Likewise, during 1984, the Florida Banking Department did not act to close SSB, but, by issuing the 1984 Florida Memorandum, it acted only to require SSB to rehabilitate itself. Petitioner has not carried his burden of showing that, during 1984, SSB presented the exceptional case contemplated in Steadman v. Commissioner, 38 B.T.A. at 377. In sum, we hold that petitioner has failed to meet his burden of proving that his SSB stock became worthless in 1984. For the foregoing reasons, Decision will be entered for respondent. Footnotes1. The parties have so stipulated. We assume that petitioner has conceded any other adjustments, and the addition to tax, which were disputed by him in the petition. Of course, computation of the addition to tax may change if we redetermine the deficiency.↩1. At each examination of SSB, the FDIC examiners reviewed all of the bank's assets and, where appropriate, adversely classified an asset as: substandard, doubtful, or loss, with a loss classification being the most severe. SSB's assets included loans, securities, real estate, and fixed assets, with loans representing the bulk of the assets. In Sept. 1985, SSB, petitioner, his father Rafael Corona, and his brother, Ricardo Corona, petitioned the U.S. Court of Appeals for the Eleventh Circuit for review of FDIC's decision and order in the FDIC Consolidated Action. On Mar. 13, 1986, in Sunshine State Bank v. FDIC, 783 F.2d 1580">783 F.2d 1580 (11th Cir. 1986), the Eleventh Circuit affirmed FDIC's actions.2↩ For regulatory purposes SSB's book capital and reserves were adjusted by subtracting 100% of the book value of assets classified as "loss" and 50% of the book value of assets classified as "doubtful". No adjustment (subtraction) was made for assets classified as "substandard". In some cases, there were other adjustments to book capital and reserves.3. Petitioner later was convicted of having in 1977 and 1978 assisted a drug dealer in buying a controlling interest in SSB with laundered drug money under dishonest circumstances. See United States v. Corona, 885 F.2d 766">885 F.2d 766, 885 F.2d 766">773-774↩ (11th Cir. 1989).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620973/	J. S. RIPPEL & CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.J. S. Rippel & Co. v. CommissionerDocket No. 59009.United States Board of Tax Appeals36 B.T.A. 789; 1937 BTA LEXIS 656; November 2, 1937, Promulgated 1937 BTA LEXIS 656">656 1. Where the Board, after a hearing and decision on the merits, entered its decision in this proceeding on August 6, 1934, and no petition for review of such decision was filed, the Board is without authority to grant a motion for reopening and reconsideration filed October 14, 1937, even though it be assumed that an error in law was committed in the Board's decision. 2. Section 1005(a) of the Revenue Act of 1926 is applicable and the Board's decision has become final under the provisions of that act, and the Board, under the facts stated, is now without power to change its decision. John A. Conlin, Esq., for the petitioner. Paul A. Sebastian, Esq., for the respondent. BLACK36 B.T.A. 789">789 OPINION. BLACK: On June 29, 1934, the Board's report in this proceeding was promulgated and on August 6, 1934, the Board's decision pursuant to its report was entered to the effect that there is a deficiency in petitioner's Federal income tax for the year 1928 in the amount of $1,920.01. No petition for review to a United States Circuit Court of Appeals was ever filed in the proceeding. On October 14, 1937, petitioner filed a motion for reconsideration, alleging1937 BTA LEXIS 656">657 as grounds therefor, among other things, as follows: That said decision of the Board was rendered in error, because: (1) A memorandum decision in an issue of exact similar facts was made by this Board in Philip N. Lillienthal and reversed by the United States Circuit Court of Appeals for the Ninth Circuit on December 5, 1935 () (2) Also see decision by the Board in , in which Member Trammell, who wrote the opinion in the Rippel case, stated: "I now think that the Rippel case was in error, and should not be followed." (3) Further, the decision by the Supreme Court in John J. Watts supports the now contention that the Rippel & Co. decision by this Board was in error. The decision in the Rippel case by the Board was promulgated June 29, 1934, and Order entered August 6, 1934. Petitioner, Rippel & Co., did not appeal to the Circuit Court but paid the tax under protest, and, under date of January 7, 1935, lodged with the Bureau of Internal Revenue claim for refund, which has been examined by the Commissioner of Internal Revenue and rejected in view of the final decision by this Board. In fairness1937 BTA LEXIS 656">658 and in justice to petitioner it is urged that this Board reopen and reconsider its decision because of subsequent decisions in the higher courts holding that facts in issue similar as those in the Rippel case were non-taxable reorganizations. 36 B.T.A. 789">790 (See , granting petition to review) (See also ) If the Board had authority and jurisdiction to entertain petitioner's motion for reopening and reconsideration of its report promulgated June 29, 1934, and its decision entered August 6, 1934, it might be granted. The decision of the Board in the case of , appears to be in conflict with the opinion of the United States Circuit Court of Appeals for the Ninth Circuit in the case of , involving a similar transaction. However, the Board's decision in the J. S. Rippel & Co. case has now become final and the Board does not consider that it has any power or authority to reopen it. Section 1001(a) of the Revenue Act of 1926, as amended by the Revenue Act of 1932, reads1937 BTA LEXIS 656">659 as follows: The decision of the Board rendered after the enactment of this act * * * may be reviewed by a Circuit Court of Appeals, or the Court of Appeals of the District of Columbia, as hereinafter provided, if a petition for such review is filed by either the Commissioner or the taxpayer within three months after the decision is rendered. As has already been stated, the Board's decision in the J. S. Rippel & Co. case was entered more than three years ago and no petition for review thereof was filed with any United States Circuit Court of Appeals. Section 1005 of the Revenue Act of 1926 provides the date on which the Board's decision becomes final. It reads in part as follows: The decision of the Board shall become final - (1) Upon the expiration of the time allowed for filing a petition for review, if no such petition has been duly filed within such time * * . It seems plain that under the facts above stated, and the provisions of the foregoing statute, the Board's decision has become final and that we are now without any statutory authority to reopen it, notwithstanding it appears that an error of law may have been committed in the rendering of our decision. 1937 BTA LEXIS 656">660 It is well settled that the Board is a tribunal of limited authority and jurisdiction, and where the statute provides that our decisions shall, under certain circumstances, become final, we have no power to reopen and change them when such finality has taken place. The statute which prescribes when the Board's decision shall become final is somewhat similar to a statute of limitation. It is a statute of repose. It works for and against the Government, as it works for and against the taxpayer. There have been cases decided by the Board in favor of the taxpayer where no petition for review was filed and the Board's decision has become final, where a subsequent 36 B.T.A. 789">791 decision by the Supreme Court of the United States on the same point has shown that the Board's decision was wrong. The Commissioner is not permitted, however, in such cases where the Board's decision has become final, to reopen them. The same rule must naturally and properly apply to the taxpayer. We think the case of , cited by petitioner, is distinguishable on its facts. In that case both parties stipulated that an error had been1937 BTA LEXIS 656">661 made because of a mutual mistake, and joined in asking the Board to correct it. We have no such stipulation here. In the instant case, there was a hearing on the merits and the error in the Board's decision if any, is one of law and not one occasioned by a mutual mistake of fact between the parties. We do not see where the case of , also cited by petitioner, has any application. In the latter case no question whatever had arisen as to the Board's decision having become final. No such question was in the case. For the reasons above stated, an order will be entered, denying petitioner's motion for reopening and reconsideration.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620974/	PERRY SEGURA & ASSOCIATES, INC., PERRY AND EMMA L. SEGURA, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentPerry Segura & Associates, Inc. v. CommissionerDocket Nos. 4033-74 and 4034-74.United States Tax CourtT.C. Memo 1975-80; 1975 Tax Ct. Memo LEXIS 294; 34 T.C.M. 406; T.C.M. (RIA) 750080; March 26, 1975, Filed Theodore L. Jones, for the petitioners. Joseph T. Chalhoub and R. E. Glanville, for the respondent. DAWSONMEMORANDUM OPINION DAWSON, Judge: This matter is before the Court on respondent's motion to dismiss for lack of jurisdiction on the ground that the petitions in these cases were filed more than 90 days after the mailing of the notice of deficiency, as provided by section 6213(a). 1In notices of deficiencies mailed on March 8, 1974, respondent determined the following deficiencies in petitioners' Federal income taxes and additions to the tax: DocketAddition to tax NumberYearDeficiencySec. 6643(a)4033-741970 $111,920.14$5,596.011971 $129,432.71$6,471.644034-741970$108,804.95$5,440.251971$173,977.42$8,689.871975 Tax Ct. Memo LEXIS 294">296 The ninety day period for filing the petitions with this Court expired on June 6, 1974, which date was not a legal holiday in the District of Columbia. The petitions were received and filed by the Court on Monday, June 10, 1974, which was 94 days after the notices of deficiencies were mailed. When received, the petitions were in an official business envelope of the United States Post Office, Washington, D.C. 20013. This envelope was stamped "RECEIVED IN DAMAGED CONDITION - REWRAPPED IN THE POST OFFICE AT WASHINGTON, D.C. 20013." The original covering envelope with its postmark was destroyed or otherwise disposed of by the U.S. Postal Service. The only parts of the original mailing envelope which reached this Court were the address label prepared by a secretary of petitioners' counsel and the certified mail receipt (No. 953452), both of which were taped on the outside of the substituted envelope. On July 22, 1974, respondent filed a motion to dismiss both petitions for lack of jurisdiction alleging that they had not been timely filed. A hearing on respondent's motion was held in Washington, D.C. on September 11, 1974. The morning the motion was heard petitioners' counsel discovered1975 Tax Ct. Memo LEXIS 294">297 that the petitions had been received by the Court in an official business envelope of the U.S. Post Office with no postmark stamped thereon and that the original mailing envelope had been destroyed and was not a part of the Tax Court's files. Prior to the hearing, the petitioners' counsel filed an objection to the motion based upon facts supported by affidavits and relying upon the presence in the record of the original mailing envelope bearing a postmark of June 5, 1974. The affidavits show that this postmark had been placed on the cover of the original mailing envelope, containing the petitions herein, by a private postage meter of and by an employee of the law firm of which petitioners' counsel is a partner. At the hearing both parties were granted time to file seriatim briefs. According to affidavits filed by Michael A. McClelland, a clerk to petitioners' counsel, and Karen Benson, a secretary to such counsel, the petitions were placed in an envelope, a postmark was placed thereon by means of the firm's private postage meter, a certified mail sticker was affixed, and the envelope was then taken to the local post office where it was mailed at 6:30 p.m. These acts were done on1975 Tax Ct. Memo LEXIS 294">298 June 5, 1974, the 89th day after the mailing of the notices of deficiencies. Petitioners' counsel has the receipt for certified mail, but it is not postmarked. Two questions are presented for our decision. The first is whether petitioners may present extrinsic evidence to establish timely mailing where intervening acts of the U.S. Postal Service have destroyed the original postmarked envelope in which the petitions were mailed. The second question, which can be considered only if the first is answered affirmatively, is whether this Court has jurisdiction of these cases. The second question is one of fact to be determined from an examination of the record. . Section 6212(a) authorizes respondent, upon determination of a deficiency in Federal income tax, to send a notice of deficiency to the taxpayer. Section 6213, in turn, gives a taxpayer within the United States 90 days (not counting Saturday, Sunday, or a legal holiday in the District of Columbia as the last day) after the mailing of the statutory notice of deficiency to file a petition with this Court. We have previously held that we have no jurisdiction unless a1975 Tax Ct. Memo LEXIS 294">299 petition is filed within this period. ; , affd. (C.A. 9, 1964). Section 7502 provides that in certain cases timely mailing of a petition will be treated as timely filing. 2 Respondent contends that petitioners cannot avail themselves of this section since the envelope containing their petitions did not have a postmark when received by this Court. He cites , affd. without decision in open court, (C.A. 2, 1972); . 1975 Tax Ct. Memo LEXIS 294">300 At the hearing petitioners offered a United States Postal Service Standards card showing that zip-coded first class mail should be delivered on the third day after mailing when sent to an addressee located more than 600 miles from the point of mailing. In addition, they also presented a letter from the Postmaster, Baton Rouge, Louisiana, 70821, dated November 7, 1974, stating that a certified letter mailed at 6:30 p.m. on June 5, 1974, would be delivered in Washington, D.C. on Friday, June 7, except where the mail is damaged in transit. The Postmaster notes therein that the processing of the damaged envelope through the re-wrap operation in the Washington Post Office probably accounted for the delivery of the petitions on Monday, June 10, 1974. 31975 Tax Ct. Memo LEXIS 294">301 Respondent's regulations do not expressly cover a situation where a postmark is destroyed in the course of the mails. However, we are convinced that petitioners have presented sufficient evidence to satisfy the requirements of section 301.7502-1(c)(1) (iii)(b) which are (1) that the private postage meter postmark on the envelope or wrapper bear a date on or before the last date of the period prescribed for filing a petition with this Court and (2) that the petitions be received by this Court not later than a properly addressed and stamped envelope would be received had it been postmarked on the same date at the same point of origin by the U.S. Post Office. Furthermore, we note that section 7502(a)(1) requires only that the postmark be "stamped on the cover in which [the petitions were] mailed," and that the envelope be mailed within the statutory 90-day period. It does not require that the postmark survive a journey through the mail process. Cf. (C.A. 3, 1965). As the Court there noted: [To] hold otherwise would be to narrow the scope of section 7502(a) to a fortuitous application wholly dependent upon the care with1975 Tax Ct. Memo LEXIS 294">302 which postal employees affixed postmarks and thus unwarrantedly to defeat in part its remedial purposes. . The evidence presented by petitioners establishes that both petitions were deposited in the mail before the last day of the 90-day statutory period. Furthermore, we are convinced that any delay in their receipt by this Court was due to the time required for the Post Office rewrapping of the damaged original envelope in which the petitions were mailed. Admittedly, the risk of mailing is on the taxpayer. However, the risk to which the statute and regulations refer is the risk that the envelope containing the petition would not be postmarked before the 90th day, and not the risk that the postmarked envelope in which the document is mailed will be destroyed in transit. See section 301.7502-(1)(c)(1)(iii), Proced. and Admin. Regs., which reads in pertinent part: Accordingly the sender who relies upon the applicability of section 7502 assumes the risk that the postmark will bear a date on or before the last date, or the last day of the period, prescribed for filing the document, but see subparagraph1975 Tax Ct. Memo LEXIS 294">303 (2) of this paragraph with respect to the use of registered mail or certified mail to avoid this risk. [Emphasis supplied.] Additionally, section 301.7502-1(c)(2), Proced. and Admin. Regs., notes that: [The] risk that the document will not be postmarked on the day that it is deposited in the mail may be overcome by the use of registered mail or certified mail. [Emphasis supplied.] The underlined words have meaning and cannot be ignored. Moreover, the legislative history supports this interpretation. Both the House and Senate Reports note that section 7502 "applies in the case where documents (other than returns) are mailed to the proper office within the time prescribed by the internal revenue laws, as indicated by the postmark on the envelope, and are received by that office after such time has expired." [Emphasis supplied.] H. Rept. No. 1337, 83d Cong., 2d Sess., p. A434 (1954); S. Rept. No. 1622, 83d Cong., 2d Sess., p. 615 (1954). 4 See also the dissent of Judge Brown in (C.A. 5, 1957) at p. 177.1975 Tax Ct. Memo LEXIS 294">304 Our holding on the first issue here is in accord with our position in , where we said at page 597: We are not holding that under no circumstances can the taxpayer come within section 7502(c)(2) without producing a timely and properly postmarked sender's receipt for certified mail, but we think the evidence in support of compliance must be more convincing than it is in this case. The key question in the instant case is whether there was a postmark on the original envelope mailed by petitioners to the Court, rather than no postmark on the envelope substituted by the U.S. Postal Service. By contrast, in Rappaport and Higby5 no postmark appeared on the original mailing envelopes, and therefore both cases are clearly distinguishable. 1975 Tax Ct. Memo LEXIS 294">305 The affidavits here establish to our satisfaction that the original mailing envelope bore a timely postmark, albeit one affixed by a private postage meter, and that the envelope was timely mailed. In addition, other evidence presented establishes that the petitions were received by the Court within the due course of the mails, even making no allowance for the delay necessitated by the Post Office's rewrapping of the petitions. Moreover, unlike Rappaport and , it is clear here that intervening acts of the United States Postal Service destroyed the original postmark upon which petitioners might have otherwise relied under the authority of relevant regulations and statutory provisions. For the reasons stated herein, we conclude that petitioners may present extrinsic evidence to establish that their petitions were timely mailed. We also conclude, based upon all the extrinsic evidence offered by petitioners, that their petitions were mailed within the statutory period in an envelope bearing a timely postmark. We have jurisdiction over both petitions. Accordingly, respondent's motion to dismiss these cases for lack of jurisdiction will be denied. 1975 Tax Ct. Memo LEXIS 294">306 An appropriate order will be entered.Footnotes1. Unless otherwise stated, all section references are to the Internal Revenue Code of 1954, as in effect during the years in issue.↩. Fiscal year ending September 30. ↩2. This section reads in pertinent part: General Rule-- (1) Date of Delivery-- If any * * * document required to be filed, * * * within a prescribed period or on or before a prescribed date under authority of any provision of the internal revenue laws is, after such period or such date, delivered by United States mail to the agency, officer, or office with which such * * * document is required to be filed * * * the date of the United States postmark stamped on the cover in which such * * * document * * * is mailed shall be deemed to be the date of delivery * * . (2) Mailing requirements. -- This subsection shall apply only if -- (A) the postmark date falls within the prescribed period or on or before the prescribed date -- (i) for the filing * * of the * * * document. And (B) the * * * document * * * was, within the time prescribed in subparagraph (A), deposited in the mail in the United States in an envelope or other appropriate wrapper, postage prepaid, properly addressed to the agency * * * or office with which the * * * document is required to be filed * * *.↩3. It should be noted that the envelope was received by the Court at 8:24 a.m. on Monday, June 10, 1974. The Postmaster's letter also notes that certified mail can be postmarked after 4:30 p.m., when the windows at the Baton Rouge station close, if presented at the main office call window. However, it appears from the record that petitioners' counsel was not aware that this could be done. Finally, in a separate letter, the Postmaster indicated that he had no record of petitioners' counsel's law firm ever having used an improper meter date or being otherwise involved in other mailing irregularities. In this letter he also noted that correctly metered mail is not postmarked again by the post office.↩4. It should be noted that both reports also indicate that since it is possible to predate postmarks where postage meters are used, section 7502(b) provides that a postmark not made by the U.S. Post Office shall be deemed to be the date of delivery "only to the extent permitted by regulations" promulgated by the Secretary of the Treasury or his delegate (the Commissioner of Internal Revenue). We have noted above that our decision is consistent with the regulations as promulgated and adopted.↩5. In Rappaport, no postmark was affixed on the original mailing envelope as mailed and received by the Court; thus, we concluded that evidence showing that the envelope would have been postmarked within the 90-day period was inadmissible, and granted respondent's motion to dismiss for lack of jurisdiction. Similarly, in Higby the original mailing envelope, as received by the Court, also bore no postmark, CONTINUED and respondent's motion to dismiss was likewise granted. The situation here is more like that of Dyke Cullum,↩ Docket No. 4244-73, an unpublished memorandum sur order dated May 1, 1974. In that case we denied respondent's motion to dismiss for lack of jurisdiction and allowed petitioner an opportunity to present evidence that the postmark had been affixed to a large block of stamps which had been dislodged and lost in the course of the mails.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620975/	John Thomas Edge v. Commissioner.Edge v. CommissionerDocket No. 77975.United States Tax CourtT.C. Memo 1961-94; 1961 Tax Ct. Memo LEXIS 249; 20 T.C.M. 421; T.C.M. (RIA) 61094; March 31, 19611961 Tax Ct. Memo LEXIS 249">249 Held, expenses incurred by petitioner during 1957 in Chicago, Illinois, and the vicinity thereof, for travel, meals, and lodging are not deductible as "away from home" traveling expenses under section 62(2)(B) or 162(a)(2), I.R.C. 1954. Floyd Garlock, 34 T.C. 611">34 T.C. 611, followed. Held further, petitioner is not entitled to dependency exemptions under sections 151 and 152 for his mother and two minors, allegedly his illegitimate children. Russel C. Jones, Esq., 321 West Fourth St., Owensboro, Ky., for the petitioner. Arthur Clark, Jr., Esq., for the respondent. BRUCE 1961 Tax Ct. Memo LEXIS 249">250 Memorandum Findings of Fact and Opinion BRUCE, Judge: This proceeding involves a deficiency in Federal income tax for the year 1957 in the amount of $1,115.46. The issues are: (1) whether amounts incurred by petitioner during 1957 for meals, lodging, and travel constitute away-from-home traveling expenses within the meaning of sections 62(2)(B) or 162(a)(2), Internal Revenue Code of 1954; and (2) whether petitioner is entitled to dependency exemptions under sections 151 and 152 for his mother and for two minors, allegedly his illegitimate children. Of the itemized deductions claimed respondent has questioned only the away-from-home traveling expenses; the remaining itemized expenses being less1961 Tax Ct. Memo LEXIS 249">251 than $1,000 and less than 10 percent of the adjusted gross income, respondent allowed the standard deduction in lieu of the itemized deductions. Findings of Fact John Thomas Edge, hereinafter referred to as the petitioner, filed his Federal income tax return for the year 1957 with the district director of internal revenue for the district of Kentucky. The petitioner is an electrician, more particularly an electric lineman, and has been a member of the Owensboro, Kentucky, local of an electrical workers' union since 1950. Except for the months of March and April 1958, when he was employed by L. E. Myers Electric Co., Cloverport, Kentucky, petitioner was employed by the A & A Electric Company in Chicago, Illinois, or in the vicinity thereof, from January 1956 to at least December 1958. During 1957 this employment was primarily in the construction of high tension towers for electric lines. The headquarters of the A & A Electric Company is Cicero, Illinois. During the year 1957, the petitioner resided in rooming houses and hotels, apparently renting on a weekly basis and eating out at restaurants. He moved from one location to another partly because he wished to be closer to1961 Tax Ct. Memo LEXIS 249">252 his place of employment and partly because rides to and from the job site would be more readily available. During the years 1956 through 1958, petitioner's places of employment and residence were as follows: YearMonthsPlace of EmploymentType of EmploymentPlace of Residence1956Jan.-Mar.Distribution workTowne Hotel, Cicero, Ill.Apr.-Jul.79th & LawndaleDistribution work2564 S. Yale Ave., S. Chicago,Ill.Aug.-Oct.NorthDistribution work3948 W. 22d St., Chicago, Ill.Nov.-Dec.North Lake2546 S. Yale Ave., Chicago, Ill.1957Jan.-Feb.Burwin (Berwyn?), Ill.Painted street lights1931 S. Crawford Ave., Chicago,Ill.Mar.-Jun.From Lockport, Ill. toPublic Service Co.201 N. State St., Lockport, Ill.Bedford Park, Ill.Jul.-Aug.From Lumbard (Lom-Public Service Co.1514 Ferrisst., Franklin Park,bard?) Substation toIll.North Lake Substa-tion, West IllinoisSept.-Oct.Des Plaines, Ill. toPublic Service Co.Hotel on 41 Highway, DesWaukegan, Ill.Plaines, Ill.Nov.-Dec.97th & Harlem Ave.,1315 N. 23d St., Melrose Park,Chicago, Ill.Ill.1958Jan.-Feb.Des Plaines, Ill. toPublic Service Co.120 North 24th St. MelroseWaukegan, Ill.Park, Ill.Mar.-Apr.Cloverport, Ky.830 Sutherland Ave., Owens-boro, Ky.MayMontline, Ill.Public Service Co.2438 N. 22d St., Melrose Park,Ill.JuneBerwyn, Ill.Painted street lights2438 N. 22d St., Melrose Park,Ill.JulyNappersville (Naper-Public Service Co.Hotel, Naperville, Ill.ville?), Ill.AugustRainewood, Ill.Public Service Co.Hotel, Rainewood, Ill.Sept.Highway Dept.2438 N. 22d St., Melrose Park,Ill.Oct.-Dec.Blue Island to Good-Public Service Co.201 Mississippi St., Joliet, Ill.win's Grove, Ill.1961 Tax Ct. Memo LEXIS 249">253 The petitioner was unmarried when he went to Chicago. He married in 1958 and thereafter lived with his wife in Chicago. The petitioner's mother, Mamie Edge, and his father resided at 830 Sutherland Avenue, Owensboro, Kentucky, in 1957. Mamie Edge and her husband both drew social security benefits; Mamie's social security pension amounted to about $41 or $42 per month. The petitioner contributed some funds to his parents' support in 1957, part of which was used for the payment of the rent on their home. Since about 1950 petitioner has worked only about two years in Owensboro, Kentucky. He maintained his voting registration, his principal union affiliation, and his membership in the church and a rod and gun club in Owensboro, and kept some personal belongings at his parents' home. During 1957 petitioner visited his parents' home in Owensboro about twice a month. Louise Teasley, hereinafter referred to as Louise, has been married to Milton Teasley since about 1943. In September 1949 Milton Teasley was sentenced to serve a term in the penitentiary. Before serving that sentence he was required to serve another sentence in the county jail. His sentence in the penitentiary commenced1961 Tax Ct. Memo LEXIS 249">254 in May 1950 and continued for about 27 months, at which time he returned home, where he remained about 2 to 4 months before he was again sentenced to the penitentiary. This sentence was for a period of about 2 years, at the completion of which he returned home once more, apparently remaining several months before being sentenced to a 5-year term in the penitentiary. Louise gave birth to children, all with the surname of Teasley, on the following dates: July 16, 1944, December 12, 1945, June 15, 1948, August 3, 1949, September 3, 1951, October 17, 1952, March 6, 1954, June 25, 1955, June 4, 1957, and August 30, 1958. Mary Sherry Elaine Teasley was born on September 3, 1951. Thomas Allen Teasley (referred to as John on petitioner's tax return for 1957) was born on June 4, 1957. During 1957 petitioner sporadically gave sums of money ranging from $15 to $25, or even an occasional $50, to Louise for the support of Mary Sherry. During 1957 Louise received public assistance from the State in an unspecified amount. These public assistance payments started at $50 per month when Milton was first sent to the penitentiary and were increased with each additional child. Louise paid her household1961 Tax Ct. Memo LEXIS 249">255 expenses, including all expenses for the support of her children, from whatever funds she had available. Louise entered Our Lady of Mercy Hospital, Owensboro, Kentucky, on June 4, 1957, and on that date gave birth to Thomas Allen Teasley, who died 2 days later on June 6, 1957. The child's grave was opened and he was buried by the Owensboro Funeral Home. On June 3, 1957, Louise telephoned the petitioner in Chicago and told him she needed some money for the hospital. The petitioner wired her $75, $50 of which she paid on the hospital bill of $119.05 and $25 of which she paid on the funeral bill of $235. The total amount paid to the funeral home was $50, which amount was apparently furnished or paid by the petitioner. As of October 10, 1959, the balance due to the hospital was $69.05 and the balance due to the funeral home was $185, as shown by statements of account addressed to Louise. In his Federal income tax return for the year 1957 petitioner claimed itemized deductions as follows: ContributionsCatholic church & school$ 100.00TaxesCigarette tax 2 packs per dayat 5 per pack52.00 [53.00]MedicalCost of medicines &drugsOther medical & den-tal expense$274.50Total$274.50Enter 3% of line 11,p. 1250.35Allowable amount24.15Other DeductionsHard toe shoes, Carhart over-alls, special gloves, tools200.00Transportation-constructionelectrician worked in 4cities780.00Union dues253.90Total Deductions$1,410.051961 Tax Ct. Memo LEXIS 249">256 On the said return petitioner also claimed dependency exemptions for: Mamie Edge, "John-son (died 3 days after birth)," and "Mary Sherry-daughter." During the year 1957 petitioner's principal place of employment was the area around Chicago, Illinois, for an indefinite period of time. Opinion The first issue presented pertains to the deductibility of certain amounts allegedly incurred by petitioner in the Chicago area during 1957 as away-from-home traveling expenses within the meaning of sections 62(2)(B)1 and 162(a)(2), 2 Internal Revenue Code of 1954. 1961 Tax Ct. Memo LEXIS 249">257 Neither party introduced any specific evidence as to the relative geographical locations of petitioner's various places of employment and residence during the years 1956 through 1958. However, from the entire record, and the geographical location of such places, of which we take judicial notice, it appears that they are all, with the exception of Cloverport, Kentucky, where petitioner worked in March and April 1958, in Chicago proper or the vicinity thereof. More specifically, during 1957, the taxable year here in issue, such places were generally on the western or northwestern side of Chicago, within a radius of approximately 20 miles of Cicero, the home office of petitioner's employer. Petitioner's employment locations being thus localized, our holding in the case of Floyd Garlock, 34 T.C. 611">34 T.C. 611, is controlling here. In that case the taxpayer, a heavy-duty equipment mechanic who maintained a domicile and residence in Mohawk, New York, and was affiliated with a union local in Binghamton, New York, was employed at various construction project sites for the same employer from November 1950 until some time in 1954 in the vicinity of Passaic, New Jersey. The taxpayer there1961 Tax Ct. Memo LEXIS 249">258 presented essentially the same argument that the instant petitioner makes, to wit: that the work performed on each construction project constituted a separate and distinct temporary job. We held that the taxpayer's principal place of employment was the area around Passaic for an indefinite period of time and expenses for meals and lodging there incurred were not deductible as "away from home" traveling expenses. In arriving at this conclusion, we stated that "a mere geographical relocation from one construction site to another does not of itself automatically give rise to a new, separate and distinct job," especially where all the relocations were within a reasonably confined area and for the same employer and that "The substantial and actual duration of petitioner's employment * * * indicates its indefiniteness." In the instant case petitioner's allegedly separate and temporary jobs constituted a single job for the same employer, the substantial and actual duration of which indicates its indefiniteness. The area in and around Chicago, Illinois, was petitioner's principal place of employment during 1957 for a substantial, indefinite and indeterminate period of time. Accordingly, 1961 Tax Ct. Memo LEXIS 249">259 petitioner's expenses for meals and lodging there incurred are not deductible as "away from home" traveling expenses under sections 162(a)(2) and 62(2)(B). Similarly, travel expenses incurred in the Chicago area by petitioner in 1957 are not deductible as "away from home" traveling expenses. They constitute nothing more than commuting expenses which are not allowable as deductions. Frank H. Sullivan, 1 B.T.A. 93">1 B.T.A. 93. The second issue is whether petitioner is entitled to dependency exemptions under sections 151 3 and 152 4 for his mother and two minors, allegedly his illegitimate children by Louise Teasley. 1961 Tax Ct. Memo LEXIS 249">260 The statutory prerequisite for a dependency exemption is that the claimant provide over half of the support of the claimed dependent. Section 152. Petitioner has the burden of proving not only the amount of support he provided, but also the total support from all sources. See Bernard C. Rivers, 33 T.C. 935">33 T.C. 935, where we stated: "The burden is upon him [petitioner] to establish clearly his right to the dependency exemptions. * * * The right to the exemption is contingent upon the total amount of expenditure for the support * * . Cohan [Cohan v. Commissioner, 39 F.2d 540] does not authorize or require a conjecture by this Court as to that total amount." The evidence presented in this respect is unsatisfactory. Petitioner has not attempted to summarize either his alleged support or the total support provided for any of the three parties claimed as dependents. With respect to his mother petitioner testified that he gave her $20 per week for her support. Even if we accept the amount and the regularity of these payments, as to which there is no credible corroboration, petitioner still would not have established that he provided over half of her support in1961 Tax Ct. Memo LEXIS 249">261 1957. The record indicates that the amounts which he contributed were not solely for the support of his mother. They were, at least in part, utilized by both his parents for the payment of rent on the home in which they lived. While the amount of his mother's social security benefits is established in the approximate amount of $41 to $42 per month, the father also received social security benefits, the amount of which is not in evidence. Since neither the amount provided by the petitioner, nor the total amounts used by the parents for their support, either individually or collectively, has been established, the petitioner has failed to carry his burden of proving that he contributed more than half of his mother's support. The claimed dependency exemptions for Thomas Allen Teasley and Mary Sherry Elaine Teasley, allegedly petitioner's illegitimate children, must also be denied. While petitioner made some payments during 1957 to Louise for the support of Mary Sherry, there is no indication of the total amount which he provided or of the total support of Mary Sherry. Accordingly, petitioner has failed to meet his burden of proving that he provided over half of Mary Sherry's support1961 Tax Ct. Memo LEXIS 249">262 and the claimed dependency exemption for her must be denied. The third dependency exemption claimed was for Thomas Allen (John) Teasley, who was born June 4, 1957, and died two days thereafter. Petitioner apparently paid $50 of Thomas Allen's funeral expenses. On reply brief petitioner concedes that the funeral expenses were not incurred for the support of Thomas Allen. He also paid $50, or less than one-half of the total $119.05 hospital bill incurred by Louise in giving birth to Thomas Allen. We are unable, on the record presented, to determine what if any portion of the total hospital bill or of petitioner's payment represented support of the child, rather than medical expenses of Louise. Petitioner wired the money to Louise in response to her telephoned request before the child was born, that she needed money for the hospital. In view of the foregoing and the fact that petitioner paid less than one-half of the total bill, we hold that petitioner has failed to establish that he provided over one-half of the support of Thomas Allen and accordingly he is not entitled to a dependency exemption for such child. Decision will be entered for the respondent. Footnotes1. SEC. 62. ADJUSTED GROSS INCOME DEFINED. For purposes of this subtitle, the term "adjusted gross income" means, in the case of an individual, gross income minus the following deductions: * (2) Trade and business deductions of employees. - * (B) Expenses for travel away from home. - The deductions allowed by part VI (sec. 161 and following) which consist of expenses of travel, meals, and lodging while away from home, paid or incurred by the taxpayer in connection with the performance by him of services as an employee. * ↩2. SEC. 162. TRADE OR BUSINESS EXPENSES. (a) In General. - There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including - * (2) traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business. * ↩3. SEC. 151. ALLOWANCE OF DEDUCTIONS FOR PERSONAL EXEMPTIONS. (a) Allowance of Deductions. - In the case of an individual, the exemptions provided by this section shall be allowed as deductions in computing taxable income. * (e) Additional Exemption for Dependents. - (1) In general. - An exemption of $600 for each dependent (as defined in section 152) - (A) whose gross income for the calendar year in which the taxable year of the taxpayer begins is less than $600, or (B) who is a child of the taxpayer and who (i) has not attained the age of 19 at the close of the calendar year in which the taxable year of the taxpayer begins, or (ii) is a student. * (3) Child defined. - For purposes of paragraph (1)(B), the term "child" means an individual who (within the meaning of section 152) is a son, stepson, daughter, or stepdaughter of the taxpayer. * ↩4. SEC. 152. DEPENDENT DEFINED. (a) General Definition. - For purposes of this subtitle, the term "dependent" means any of the following individuals over half of whose support, for the calendar year in which the taxable year of the taxpayer begins, was received from the taxpayer (or is treated under subsection (c) as received from the taxpayer): (1) A son or daughter of the taxpayer, or a descendant of either, * (4) The father or mother of the taxpayer, or an ancestor of either, * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620976/	Herbert A. Dunn and Georgia E. Dunn, Petitioners v. Commissioner of Internal Revenue, RespondentDunn v. CommissionerDocket No. 114-76United States Tax Court70 T.C. 715; 1978 U.S. Tax Ct. LEXIS 72; August 21, 1978, Filed 1978 U.S. Tax Ct. LEXIS 72">72 Decision will be entered under Rule 155. 1. Petitioner-husband engaged in harness horse racing and breeding activities. Held, on the facts, he did not carry on a trade or business or engage in an activity for profit during the taxable years at issue. Sec. 183, I.R.C. 1954.2. All of petitioner-wife's shares in a corporation, which held a General Motors franchise, were redeemed in 1970 under an agreement which provided for a 12-year payout of the redemption price, payments being subject to certain restrictions incorporated in the agreement in order to meet the requirements imposed on the corporation by General Motors as conditions to retention of its franchise. Stock of other shareholders was attributed to her but she filed the required agreement. She did not remain as an officer, director, or employee of the corporation. Held, petitioner-wife did not retain a prohibited interest under sec. 302(c)(2)(A)(i), I.R.C. 1954, with the result that the attribution rules do not apply and the proceeds of the redemption are entitled to capital gain treatment under sec. 302(a), I.R.C. 1954. Robert M. Tyle, for the petitioners.Anthony M. Bruce, for the respondent. Tannenwald, Judge. TANNENWALD70 T.C. 715">715 Respondent determined deficiencies in petitioners' Federal income tax as follows:YearDeficiency1970$ 50,531.75197121,618.10The issues remaining for our decision are: (1) Whether 70 T.C. 715">716 petitioner Herbert Dunn was engaged in the trade or business of harness horse racing and breeding and (2) whether the redemption of petitioner Georgia Dunn's stock in Bresee Chevrolet, Inc., constituted a complete termination of her interest in the corporation under sections 302(b)(3)1 and 302(c)(2).1978 U.S. Tax Ct. LEXIS 72">77 GENERAL FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly. The stipulations of facts, together with the exhibits attached thereto, are incorporated herein by this reference.Herbert A. Dunn and Georgia E. Dunn (Herbert, Georgia, or petitioners) resided in Liverpool, N. Y., at the time of filing the petition herein. Petitioners filed joint Federal income tax returns for 1970 and 1971 with the North-Atlantic Service Center, Andover, Mass. Herbert was born in 1893 and Georgia was born in 1897.FINDINGS OF FACTTrade or Business IssueHerbert has been interested in horses since at least 1940. Prior to 1968, he owned various horses, which were stabled at his home and ridden by himself and his children for pleasure. He entered his horses in amateur exhibitions and horse shows to compete for ribbons.He later became interested in harness racing. In 1968, Herbert owned "Little Pumpkin" and "Crowning Glory." "Little Pumpkin" was entered in two races at Pompano Beach, Fla., and won a total of $ 104. The combined winnings of the first place winners in these two races was $ 800. On his 1968 Federal income tax returns, Herbert disclosed a net loss of1978 U.S. Tax Ct. LEXIS 72">78 $ 8,967.65 from the operations of his racing stable, including wagering. Petitioner took no deduction for this loss because, during 1968, Herbert considered himself an amateur and his racing activities as not being carried on for profit.In 1969, Herbert informed his lawyer that he contemplated retiring from the automobile business (see p. 721 infra) and that he wanted his harness horse racing and breeding to be his future 70 T.C. 715">717 business. Upon his lawyer's advice, he retained a certified public accountant to prepare the appropriate schedule for his income tax return.In 1969, Herbert continued to own "Crowning Glory" and he acquired "Miss Linda Sharp" and "Straight Shot." He did not enter any horses in races in 1969.In 1970, Herbert continued to own "Crowning Glory" and acquired "Henry Knauf." "Miss Linda Sharp" and "Straight Shot" were sold at losses of $ 1,680.23 and $ 2,182.28, respectively, which petitioners deducted as losses from the sale of section 1231 property. Prior to his sale, "Straight Shot" was entered in 11 races at Saratoga Springs, N. Y., winning a total of $ 734. The combined winnings of first place horses in these races was $ 4,200. "Straight Shot" 1978 U.S. Tax Ct. LEXIS 72">79 was also entered in a "New York Sire Race" at Buffalo, N. Y., where he finished fourth and won $ 627.35. The winner of this race won $ 3,921. None of Herbert's other horses were entered in races in 1970.In 1971, Herbert continued to own "Henry Knauf" and "Crowning Glory." For the first time, he took a deduction for depreciation with respect to "Crowning Glory." "Henry Knauf" was entered in two races at Vernon Downs, Vernon, N. Y., where he won $ 93.75 for fifth place in one race and nothing in the other. The winner in the former race won $ 937.50. "Crowning Glory" was not entered in any races in 1971.Herbert continued to own "Crowning Glory" throughout 1972. "Henry Knauf" was sold at a loss in that year. Prior to his sale, he was entered in four races at Pompano Beach, where he won a total of $ 219, and was entered in eight races at Saratoga Springs, where he won a total of $ 240. The combined first place winnings in all these races was $ 11,570. "Crowning Glory" was not entered in any races in 1972.Subsequent to 1972, Herbert began winding down his horse racing and breeding activities and did not enter any more races. In each of the years 1973 and 1974, he sold a foal. 1978 U.S. Tax Ct. LEXIS 72">80 He continued to own "Crowning Glory" until 1975.Herbert conducted his harness racing and breeding activities in both New York State and Florida. In 1970 and 1971, petitioners spent the winter in Florida.On their tax returns for 1969 through 1975, petitioners reported on Schedule C (Profit/or Loss from Business or Profession) all income from Herbert's breeding and harness 70 T.C. 715">718 racing activities and deducted expenses such as board and training, stud fees, association fees, drivers, and accounting fees.The financial aspects of Herbert's horse racing and breeding activities may be summarized as follows:YearGross receipts 1DeductionsProfit (loss)1968 2$ 5,032.35$ 14,000.00($ 8,967.65)19694,263.509,677.66(6,096.65)19701,230.3520,860.85(19,630.50)197193.0014,015.55(13,922.55)19721,796.0013,140.96(11,344.96)19731,400.004,219.21(2,819.21)19744,250.003,795.92504.08 19751,500.001,144.00356.00 1978 U.S. Tax Ct. LEXIS 72">81 Petitioners' reported taxable income for the years 1968 through 1974 was as follows:YearTaxable income1968$ 18,847.80196944,706.86197038,440.77197131,317.74197224,315.56197334,181.34197457,123.40On October 31, 1972, Herbert, but not Georgia, signed a letter electing, pursuant to section 183(e), to defer the determination of whether the presumption in section 183(d) applies until the close of calendar year 1976.ULTIMATE FINDING OF FACTHerbert did not carry on a trade or business or engage in an activity for profit during the taxable years 1970 and 1971.OPINIONThe question before us is whether Herbert's harness horse racing and breeding activities constitute a trade or business, as petitioners contend, or an activity not engaged in for profit, as respondent contends. Petitioners' entitlement to deductions for net operating losses and for ordinary losses incurred in the sale 70 T.C. 715">719 of horses is dependent upon our resolving this issue in their favor.Section 183(d)provides that, if for any 2 of 7 consecutive taxable years (in the case of an activity which consists in major part of the breeding, training, showing, or racing of horses) the gross1978 U.S. Tax Ct. LEXIS 72">82 income derived from such activity exceeds the deductions, the activity shall be presumed to be engaged in for profit unless the Commissioner establishes to the contrary. If the taxpayer so elects under section 183(e), the applicability of the presumption shall not be determined before the close of the sixth taxable year following the year in which the taxpayer first engages in the activity. For this purpose, a taxpayer is treated as not engaged in any activity in a year beginning before January 1, 1970. In the event of such an election, the presumption shall apply to each taxable year in the 7-year period beginning with the first year in which the taxpayer engages in the activity, subject to certain conditions.The Commissioner contends that Herbert's purported election is invalid because not signed by Georgia. See section 12.9, Income Tax Regs., adopted as temporary regulations under section 183(e) by T.D. 7308, 1974-1 C.B. 64, and not yet made permanent. Petitioners urge us to give the election effect because they were told by respondent's agent that only Herbert need sign the election and the temporary regulation on which respondent1978 U.S. Tax Ct. LEXIS 72">83 relies was not published until March 1974, 17 months after Herbert signed his purported election. We find it unnecessary to resolve this dispute because, even assuming arguendo that the election is valid (compare Forrester v. Commissioner, 49 T.C. 499">49 T.C. 499 (1968), with Corn Belt Hatcheries of Arkansas, Inc. v. Commissioner, 52 T.C. 636">52 T.C. 636 (1969)), we think respondent has established that Herbert's activities were not engaged in for profit.An activity not engaged in for profit under section 183 is the other side of the coin of a trade or business under section 162. 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 legislative history indicates that Congress intended to codify the distinction between a business and a hobby drawn by case law. H. Rept. 91-413 70 T.C. 715">720 (Part 1) 71 (1969), 1969-3 C.B. 200, 245; S. Rept. 91-552,103 (1969), 1969-3 C.B. 423, 489.The test of whether an individual is 1978 U.S. Tax Ct. LEXIS 72">84 carrying on a trade or business for purposes of section 162 depends upon his primary or dominant motive, i.e., is it to make a profit. Godfrey v. Commissioner, 335 F.2d 82">335 F.2d 82, 335 F.2d 82">84 (6th Cir. 1964), affg. T.C. Memo. 1963-1; Hirsch v. Commissioner, 315 F.2d 731">315 F.2d 731, 315 F.2d 731">736 (9th Cir. 1963), affg. T.C. Memo. 1961-256; Jasionowski v. Commissioner, 66 T.C. 312">66 T.C. 312, 66 T.C. 312">319 (1976). The taxpayer's expectation of profit need not be reasonable, but it must be a good faith expectation. Mercer v. Commissioner, 376 F.2d 708">376 F.2d 708, 376 F.2d 708">710-711 (9th Cir. 1967), revg. T.C. Memo. 1966-82; 315 F.2d 731">Hirsch v. Commissioner, supra;Benz v. Commissioner, 63 T.C. 375">63 T.C. 375, 63 T.C. 375">383 (1974).Whether Herbert had the requisite profit motive is a question of fact to be determined on the basis of the entire record. 66 T.C. 312">Jasionowski v. Commissioner, supra at 319. The regulations set forth the relevant factors, derived from prior case law, which are to be considered in determining1978 U.S. Tax Ct. LEXIS 72">85 the applicability of section 183. 66 T.C. 312">Jasionowski v. Commissioner, supra at 320; 63 T.C. 375">Benz v. Commissioner, supra.The regulations further provide that no one factor is conclusive and, thus, we do not reach our decision herein by merely counting the factors which support each party's position. Sec. 1.183-2(b), Income Tax Regs.Because of health constraints, Herbert was unable to testify and we must reach our decision on the basis of objective factors contained in the record. Analysis of these factors convinces us that Herbert had no bona fide expectation of profit. We recognize, as petitioners point out, that it takes time to develop a successful breeding and horse racing business. However, on the facts of the record herein, we are convinced that Herbert's activities were not potentially profitable. Compare Bessenyey v. Commissioner, 45 T.C. 261">45 T.C. 261, 45 T.C. 261">274-275 (1965), affd. 379 F.2d 252">379 F.2d 252 (2d Cir. 1967), and Sabelis v. Commissioner, 37 T.C. 1058">37 T.C. 1058, 37 T.C. 1058">1062 (1962). In 1969, Herbert did not enter his horses in any races and thus a loss was inevitable. 1978 U.S. Tax Ct. LEXIS 72">86 In 1970, only "Straight Shot" was entered in races. Yet, even if "Straight Shot" had won each of the 12 races with total prize money of $ 8,121, Herbert would still have sustained a loss of $ 12,872.85. In 1971, only "Henry Knauf" was entered in races and he won only $ 93.75. While the record does not indicate the total first-place prize money in the two races in which "Henry Knauf" was entered, assuming a total of $ 2,000 70 T.C. 715">721 (based upon evidence of first-place money in races in other years) and first-place finishes, Herbert's activities would still have resulted in a loss of $ 12,016.30. In 1972, "Henry Knauf" was entered in 12 races, with total first-place prize money of $ 11,570. If he had won every race (an unlikely prospect given the number of races), Herbert's loss of $ 11,344.96 would have been reduced to $ 233.96. Following 1972, Herbert decided to wind down his activities and entered no horses in races. In 1974 and 1975, he did earn a small profit, but, since he was essentially liquidating his operation during those years, we think this fact is entitled to little weight as evidence of a profit motive.We are further influenced by the fact that Herbert was 761978 U.S. Tax Ct. LEXIS 72">87 years old in 1969, an advanced age for embarking on any new business and particularly one that takes time to develop. Moreover, the fact that Herbert had always been interested in horses and had actively pursued this interest in other ways strongly indicates that his activities were a hobby, rather than a business. Sec. 1.183-2(b)(9), Income Tax Regs. See 63 T.C. 375">Benz v. Commissioner, supra at 385; 45 T.C. 261">Bessenyey v. Commissioner, supra at 274-275.We are unimpressed by the few outward manifestations of a business (hired trainers, an accountant to prepare the appropriate schedule for their tax return) upon which petitioners base their position. In short, we are convinced that Herbert's activities were not operated on a basis which supports the conclusion of good faith expectation of profitability and there is no evidence of a plan of development that would change this situation. See sec. 1.183-2(b)(6). Nor is there any other evidence that persuades us that Herbert's profit motive, while unreasonable, was nevertheless bona fide. Compare 376 F.2d 708">Mercer v. Commissioner, supra.Redemption IssueBresee Chevrolet1978 U.S. Tax Ct. LEXIS 72">88 Co., Inc. (Bresee or the company), is a car dealership franchised by General Motors (GM) and located in Syracuse, N. Y.Georgia acquired all of the stock of the company through inheritance from her parents and purchase from others in 1936. Until about 1951, Herbert was president of the company. Thereafter, her son William B. Dunn served as president. Herbert continued as an employee until he retired in 1973.Beginning in 1951, Georgia made gifts of stock to her children 70 T.C. 715">722 so that as of June 1, 1970, the stock of the company was owned as follows:RelationshipNumberStockholderto Georgiaof sharesGeorgia249Jane D. Harrisdaughter51Patricia Bowendaughter51William B. Dunnson 149On June 1, 1970, Bresee redeemed all of Georgia's remaining shares. GM had been pressing her for some time to dispose of her stock because they wanted her son, who was the president of the company, to own a majority of the stock. Georgia desired to dispose of her stock because she was advised that it created liquidity problems from an estate planning point of view and because she and her husband wanted additional income as they advanced in age, and Bresee, 1978 U.S. Tax Ct. LEXIS 72">89 with one exception, had not in the past paid dividends. She also wished to spend most of her time in Florida and did not want to have any business responsibilities.Georgia and the company were represented by separate counsel in negotiations regarding a stock redemption. The parties reached an agreement whereby Bresee would redeem Georgia's shares, which provided for payment of $ 335,154 as follows:a. The sum of ONE HUNDRED THOUSAND DOLLARS ($ 100,000.00) on June 1, 1970.b. The balance amounting to TWO HUNDRED THIRTY-FIVE THOUSAND ONE HUNDRED FIFTY-FOUR DOLLARS ($ 235,154.00) by the Purchaser executing and delivering a promissory note made payable to the Seller, in said amount of $ 235,154.00, bearing interest to be computed at the rate of Five Percent (5%) per annum, and made payable as follows:"The sum of FIFTY-FIVE THOUSAND ONE HUNDRED FIFTY-FOUR DOLLARS ($ 55,154.00) of principal, together with interest computed on said principal indebtedness of $ 235,154.00 from June 1, 1970 at the rate of 5% per annum, shall be due and payable on June 1, 1971.Thereafter commencing with June 1, 1972, and continuing for a period of ten (10) years, regular annual payments covering principal1978 U.S. Tax Ct. LEXIS 72">90 and interest computed at the above rate in the constant amount of $ 23,311.80 each shall be due and payable on the 1st day of June of each year until June 1, 1981. Each of said annual payments of $ 23,311.80 shall be first applied in payment of interest computed at the rate of 5% per annum on the respective unpaid principal balances, and the balance of each payment shall then be applied in the reduction of the principal indebtedness then remaining unpaid."70 T.C. 715">723 The agreement was subject to the approval of GM, and, in order to obtain that approval, the parties provided that Bresee would not be required to make any payment which would reduce its "owned net working capital" 2 below whatever amount was required by its franchise agreement or would prevent Bresee from retaining 50 percent of the previous year's net profits after taxes. If any payment of any installment would violate said provisions, the due date of such installment would be postponed until such time as it could be made without violating the provisions.1978 U.S. Tax Ct. LEXIS 72">91 The agreement further provided that Bresee would not take any action such as excessive purchases, declaring or paying dividends, increases in officers' salaries, or abnormal increases in indebtedness which would affect its ability to make timely payments to Georgia. Bresee further agreed that it would borrow against life insurance policies on Georgia's life owned by it in order to make the first two payments.On November 1, 1970, Bresee entered into a new Minimum Capital Standard Agreement with GM, whereby it agreed to increase its "minimum owned net working capital" from $ 329,569 to $ 732,266 by October 31, 1971, and to retain 75 percent of its net profits after taxes until such time as it had increased its working capital as required.GM approved the agreement. 3 Bresee made the first payment of $ 100,000 on June 1, 1970, with proceeds from a loan against life insurance. On June 1, 1971, Bresee's financial condition was such that it could not make its payments to Georgia without violating the restrictions imposed by GM. Accordingly, Georgia was paid only $ 45,260.34 in principal and no interest. The cash for the payment was raised by selling real estate. 4 The balance of1978 U.S. Tax Ct. LEXIS 72">92 the June 1, 1971, principal payment was paid on June 13, 1972, and the interest due on June 1, 1971 ($ 11,757.70), was paid on September 13, 1974.Payments of principal and interest were made as follows: 70 T.C. 715">724 Date duePrincipal dueDate paidJune 1, 1972$ 14,311.80June 18, 1973June 1, 197315,027.39May 29, 1974June 1, 197416,567.70Oct. 15, 1975June 1, 197517,396.08July 27, 1976Date dueInterest dueDate paidJune 1, 1972$ 11,757.70June 13, 1972June 1, 19739,000.00June 18, 1973June 1, 19748,284.41May 29, 1974June 1, 19756,744.10Oct. 15, 1975June 1, 19765,915.72July 27, 19761978 U.S. Tax Ct. LEXIS 72">93 Each time a payment was made, Bresee was in violation of its Minimum Capital Standard Agreement, although its net working capital was increasing each year. GM was not specifically informed of the payments, but did receive monthly balance sheets and profit and loss statements. GM never objected to the payments made by Bresee to Georgia.Bresee was the largest Chevrolet dealer between Buffalo and Albany.Following the redemption of her stock, Georgia was not an officer, director, or employee of Bresee. At the time of trial, she had not acquired any stock in Bresee. Georgia filed the agreement required by section 302(c)(2)(iii) with her 1970 tax return.OPINIONThis issue is whether amounts received by Georgia in redemption of her Bresee stock are ordinary income, as respondent contends, or capital gain, as petitioners contend.Section 302(a)provides that a distribution of property to a shareholder by a corporation in redemption of stock will be treated as a sale or exchange of the stock if the redemption falls into one of four categories enumerated in section 302(b). Under section 302(d), all redemptions which do not meet a specific statutory exception are treated as distributions1978 U.S. Tax Ct. LEXIS 72">94 under section 301 (i.e., a dividend to the extent the corporation has earnings and profits and the balance as a return of capital).Under section 302(b)(3), a shareholder is entitled to exchange treatment if all the stock owned by that shareholder is redeemed. Georgia is treated as the owner of her children's stock 70 T.C. 715">725 under the attribution rules of section 318 unless she meets the requirements of section 302(c)(2), which provides, in relevant part, that the attribution rules do not apply to a complete redemption of all the stock owned by a shareholder if "immediately after the distribution the distributee has no interest in the corporation (including an interest as officer, director, or employee) other than an interest as a creditor" and the agreement required by section 302(c)(2)(A)(iii) is filed. Thus, unless that subsection is applicable, all of her stock is not considered to have been redeemed.Georgia filed the required agreement and did not remain as an officer, director, or employee of Bresee. Thus, the focal point of the dispute herein is whether Georgia retained an interest "other than an interest as a creditor."At the outset, we think it important to establish1978 U.S. Tax Ct. LEXIS 72">95 certain guidelines for our analysis of the issue thus posed.First, we do not have a situation where the attribution rules clearly apply and the question is whether such application can be avoided by considerations of business purpose. United States v. Davis, 397 U.S. 301">397 U.S. 301 (1970). In this case, we are faced with the threshold question of whether Georgia falls within the creditor exclusion from the distributee category so that the attribution rules simply do not come into play. In this context, we do not feel compelled to apply the mandate of Davis that business considerations are irrelevant.Second, the determination of whether a taxpayer has "an interest other than as a creditor" concededly requires consideration of the plethora of cases in the debt-equity arena. Most of these cases involve situations where the taxpayer retained a stock interest and sought a dual status -- as a creditor as well as a shareholder -- a factor which is not present herein. Moreover, analysis of those cases has been described as "distinguishing the indistinguishable" (see W. Plumb, "The Federal Income Tax Significance of Corporate Debt: A Critical Analysis and a Proposal," 1978 U.S. Tax Ct. LEXIS 72">96 26 Tax L. Rev. 369, 640 (1971)), and, in any event, the relative weight to be given the various considerations which enter into the decisional process in that arena is not necessarily the same in every context. Such variable contextual application finds support in section 385, enacted by section 415(a) of the Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat. 487, which authorized the Secretary of the Treasury to prescribe regulations 70 T.C. 715">726 (which he has not yet even proposed) to determine whether an interest in a corporation should be treated as "stock or indebtedness" and in the underlying legislative history. See S. Rept. 91-552, pp. 138-139 (1969), 1969-3 C.B. 423, 511-512. Cf. Commissioner v. Brown, 380 U.S. 563">380 U.S. 563, 380 U.S. 563">578 (1965).Third, we note that there is not the slightest suggestion in the record that the transaction herein was not bona fide and that the interposition of conditions of payment relating to the requirements of GM was contrived so as to give colorable support to a transaction which otherwise would be suspect as a scheme for tax avoidance. See Lewis v. Commissioner, 47 T.C. 129">47 T.C. 129, 47 T.C. 129">135 (1966);1978 U.S. Tax Ct. LEXIS 72">97 Curry v. Commissioner, 43 T.C. 667">43 T.C. 667, 43 T.C. 667">695 (1965).With the foregoing guidelines in mind, we proceed to analyze the facts herein in light of section 1.302-4(d), Income Tax Regs., which provides:(d) For the purpose of section 302(c)(2)(A)(i), a person will be considered to be a creditor only if the rights of such person with respect to the corporation are not greater or broader in scope than necessary for the enforcement of his claim. Such claim must not in any sense be proprietary and must not be subordinate to the claims of general creditors. An obligation in the form of a debt may thus constitute a proprietary interest. For example, if under the terms of the instrument the corporation may discharge the principal amount of its obligation to a person by payments, the amount or certainty of which are dependent upon the earnings of the corporation, such a person is not a creditor of the corporation. Furthermore, if under the terms of the instrument the rate of purported interest is dependent upon earnings, the holder of such instrument may not, in some cases, be a creditor.Respondent, relying on a literal interpretation of his regulation, asserts that1978 U.S. Tax Ct. LEXIS 72">98 any indicia of a proprietary interest is fatal, that there are several such indicia in the instant case, and that consequently Georgia fails to meet the requirement that her claim "must not in any sense be proprietary." (Emphasis added.) Recognizing that in interpreting a regulation "the courts should if possible avoid a construction which will bring into question" its validity (see Steen v. Commissioner, 61 T.C. 298">61 T.C. 298, 61 T.C. 298">304 (1973), affd. per curiam 508 F.2d 268">508 F.2d 268 (5th Cir. 1975)), we are satisfied that a proper reading of section 1.302-4(d), Income Tax Regs., does not accord with respondent's literal interpretation. Cf. Estate of Lennard v. Commissioner, 61 T.C. 554">61 T.C. 554 (1974).Respondent argues that Georgia's claim was voluntarily subordinated to the claims of general creditors because some payments were deferred. He assumes that Bresee was paying all 70 T.C. 715">727 its creditors because it continued in business. While it is not clear from the record whether Bresee in fact paid all its creditors currently, even if such were the case, we think that the record herein does not support respondent's1978 U.S. Tax Ct. LEXIS 72">99 assertion regarding subordination, which, at a minimum, implies some voluntary act or failure to act on the part of the creditor. 51978 U.S. Tax Ct. LEXIS 72">100 The mere fact that Georgia may not have been paid while other creditors were is not sufficient in and of itself to constitute subordination. Moreover, we are satisfied that Georgia pressed for payment and expected payment. Additionally, since every payment made was in excess of that permitted by the GM restrictions, she was receiving more than she was entitled to under the terms of the agreement. 6 In short, we are unable to find subordination in the ordinary understanding of that term. Finally, we note that we have only recently held that subordination, if it exists, is only one of several factors to be taken into account. 61 T.C. 554">Estate of Lennard v. Commissioner, supra.Respondent attempts further to support his position that Georgia retained "an interest other than as a creditor" by arguing that Bresee did not have a good record of timely compliance with its obligations to make payments to her. See Piedmont Corp. v. Commissioner, 388 F.2d 886">388 F.2d 886, 388 F.2d 886">891 (4th Cir. 1968), revg. T.C. Memo. 1966-263; Baker Commodities, Inc. v. Commissioner, 48 T.C. 374">48 T.C. 374, 48 T.C. 374">397-398 (1967), affd. 415 F.2d 519">415 F.2d 519 (9th Cir. 1969). We think this argument is belied by the record. First, with the 1978 U.S. Tax Ct. LEXIS 72">101 exception of the June 1971 payment, interest payments were made regularly, albeit the 1975 and 1976 payments were a few months late. Moreover, although principal payments were running about a year behind, they were being made on a fairly regular basis. Cf. Bullock v. Commissioner, 26 T.C. 276">26 T.C. 276, 26 T.C. 276">295 (1956), affd. per curiam 253 F.2d 715">253 F.2d 715 (2d Cir. 1958). And, as we have previously pointed out, payments were made in excess of the amounts permitted by the agreement.70 T.C. 715">728 Finally, we deal with respondent's attempt to buttress his position on the basis of the restrictions imposed by virtue of the arrangements between Bresee and GM. In one breath, he points to the fact that there is some evidence: (1) That the parties did not expect the restrictions to be enforced; and (2) that payments were consistently made in excess of the amounts permitted by those restrictions. On this basis, he argues that we should give little, if any, weight to the restrictions. Perhaps if there had been a substantial stretchout of payments beyond the terms set forth in the agreement between Georgia and Bresee, respondent's position would be entitled1978 U.S. Tax Ct. LEXIS 72">102 to greater consideration. But the fact is that the agreed timetable was substantially complied with and respondent has not suggested that a 12-year payout is per se of such a length as to make Georgia's interest "other than an interest as a creditor." See Rev. Rul. 57-295, 1957-2 C.B. 227; cf. Lisle v. Commissioner, T.C. Memo. 1976-140.In the next breath, respondent seizes upon the fact that the incorporation of the restrictions imposed by GM into the agreement between Georgia and Bresee produced a situation where the payments to Georgia were dependent upon earnings and (at least in theory) could by postponed indefinitely. He goes on to argue that this caused Georgia to have a proprietary interest (cf. 43 T.C. 667">Curry v. Commissioner, supra;Duerr v. Commissioner, 30 T.C. 944">30 T.C. 944, 30 T.C. 944">947 (1958)) in contravention of the provision of section 1.302-4(d), Income Tax Regs., which states --For example, if under the terms of the instrument the corporation may discharge the principal amount of its obligation to a person by payments, the amount or certainty of which are dependent1978 U.S. Tax Ct. LEXIS 72">103 upon the earnings of the corporation, such a person is not a creditor of the corporation.We think respondent pushes his regulation beyond its intended meaning. Perhaps if the parties to an agreement inter sese voluntarily construct such an arrangement, it could be said to fall within the example as being "under the terms of the instrument." But, we think this portion of the regulation (which, after all, is only an example) should not be elevated into a rule of law which would automatically include restrictions derived from conditions which are in fact imposed, as is the case herein, by a third party in order to accomplish that person's legitimate business objectives, and where there is no evidence that it served 70 T.C. 715">729 an additional purpose of furthering the interests of the actual parties to the redemption agreement. 7 We are satisfied that the inclusion of restrictions on payment, at least where they are imposed by an independent third party, should be simply one factor out of several in determining whether a person retains an interest "other than an interest as a creditor" within the meaning of section 302(c)(2)(A)(i) and respondent's regulations thereunder. Cf. Albers v. Commissioner, 414 U.S. 982">414 U.S. 982 (1973)1978 U.S. Tax Ct. LEXIS 72">104 (denial of certiorari, Judge Powell dissenting, in a section 302(b)(1) case involving preferred stock issued at insistence of Federal Maritime Commission); Harlan v. United States, 409 F.2d 904">409 F.2d 904, 409 F.2d 904">909 (5th Cir. 1969) (restriction on payments of notes required by law); Commissioner v. Union Mutual Insurance Co. of Providence, 386 F.2d 974">386 F.2d 974, 386 F.2d 974">976-978 (1st Cir. 1967), affg. 46 T.C. 842">46 T.C. 842 (1966) (restrictions required by terms of corporate charter). 81978 U.S. Tax Ct. LEXIS 72">*105 It is clear from the record that Georgia wanted to terminate her interest in Bresee so that she could have income and more liquid assets and could spend more time in Florida without concern for business affairs in New York. The company wanted to redeem her interest because of pressure to do so from GM. Under the circumstances of this case, the redemption of Georgia's stock constituted a bona fide severance of her interest in Bresee within the intended purpose of section 302(c)(2). H. Rept. 1337, 83d Cong., 2d Sess. 35 (1954); S. Rept. 1622, 83d Cong., 2d Sess. 45 (1954). The factors relied upon by respondent, applied within the appropriate boundaries of interpretation of section 1.302-4(d), Income Tax Regs., do not mandate a contrary conclusion. Accordingly, Georgia is entitled to capital gain treatment with respect to the proceeds of the redemption. Sec. 302(a).Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years in issue.↩1. Gross receipts exceed the amounts received from harness racing, but the record does not contain the source of the excess.↩2. Figures for 1968 include income and losses from wagering.↩2. "Owned net working capital" was defined to mean the amount of net working capital which should be supplied by investment and earnings.↩3. There is no specific evidence that General Motors approved the redemption agreement, but such approval can clearly be inferred from the record.↩4. The stock redemption agreement provided that this payment would be made with proceeds from a loan against life insurance policies on Georgia's life. The record contains no explanation for Bresee's failure to make payment by the agreed means.↩5. Respondent does not argue that Georgia's claim was subordinated pursuant to the terms of the agreement. Subordination may be considered implicit in the fact that her right to payment is dependent on earnings because of the GM restrictions. Respondent's argument with respect to these restrictions is discussed at pp. 728-729 infra↩.6. We note that the stock redemption agreement provided that the 1970 and 1971 payments could be made without affecting or decreasing the "present 'Owned Net Working Capital.'" However, the parties stipulated that the June 1, 1971, payment would have violated the Minimum Capital Standard Agreement dated November 1, 1970↩. The change in the effect of the payment is apparently due to the fact that a new Minimum Capital Standard Agreement was executed subsequent to the redemption agreement.7. In this connection, we note that it can clearly be inferred from the record that, absent GM's insistence, Georgia and Bresee would not have included such restrictions in the agreement.↩8. Cf. also Lisle v. Commissioner, T.C. Memo. 1976-140 (restrictions required by local law did not result in interest other than as a creditor); Wilson & Fields v. Commissioner, T.C. Memo. 1962-200 (restrictions imposed by FHA regulations); Oak Motors, Inc. v. Commissioner, T.C. Memo. 1964-86↩ (terms arranged to comply with minimum net worth requirement of Ford Motor Co.).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620977/	Paul W. Adams, Petitioner v. Commissioner of Internal Revenue, Respondent; Paul W. Adams, Transferee, Petitioner v. Commissioner of Internal Revenue, RespondentAdams v. CommissionerDocket Nos. 6976-74, 6977-74, 6978-74, 6979-74, 6980-74, 6981-74United States Tax Court70 T.C. 446; 1978 U.S. Tax Ct. LEXIS 104; June 13, 1978, Filed 1978 U.S. Tax Ct. LEXIS 104">104 Subsequent to the filing of the opinion in the case of Adams v. Commissioner, 70 T.C. 373">70 T.C. 373 (1978), and upon its own motion, this Court directs that the parties therein submit briefs addressing the issue as to whether this Court has the statutory authority to determine a deficiency in tax under sec. 4941(b)(1), I.R.C. 1954. Sherin V. Reynolds, for the petitioner.Thomas P. Dougherty, Jr., for the respondent. Fay, Judge. FAY70 T.C. 446">446 SUPPLEMENTAL OPINIONOn May 30, 1978, our Findings of Fact and Opinion 1 were filed in this case (70 T.C. 373">70 T.C. 373 (1978)), which, in part, sustained respondent's determination that petitioner was subject to a 5-percent excise tax individually and as transferee of Automatic Accounting Co. under section 4941(a)(1)2 for certain acts of self-dealing which occurred between a private foundation and petitioner and Automatic. Pursuant to the opinion, decisions in docket Nos. 6977-74, 6978-74, and 6980-74 will be entered under Rule 155.1978 U.S. Tax Ct. LEXIS 104">108 Respondent further asserted a deficiency in tax under section 4941(b)(1) and requested the Court to determine petitioner's liability for such a tax. The above-noted opinion does not preclude entry of a decision for respondent on this point. However, although somewhat obscure, therein lies the present problem.70 T.C. 446">447 At the outset, we note that the jurisdication of this Court is limited to that conferred upon it by statute. Sec. 7442. With certain exceptions, 3 this jurisdiction generally consists of authority to redetermine the correct amount of a "deficiency" asserted by the Commissioner. Sec. 6214(a). The term "deficiency," as it relates to the present case, is defined in section 6211(a) to mean "the amount by which the tax imposed by * * * chapter * * * 42" exceeds that shown on the return. (Emphasis supplied.) Thus, according to section 6211, the chapter 42 tax must be "imposed" before a deficiency can exist.Section 4941(b)(1) provides that where1978 U.S. Tax Ct. LEXIS 104">109 an initial tax under section 4941(a)(1) is imposed on an act of self-dealing, and such act of self-dealing is not corrected within the correction period, then there is imposed an additional tax. 4 Pursuant to section 4941(e)(4), the correction period does not expire until the decision of this Court is final. 5 See secs. 6213(a), 6214(d), 7481, 7483, and 7459(c).1978 U.S. Tax Ct. LEXIS 104">110 Under this statutory scheme, certain procedural and perhaps substantive difficulties are presented by the entry of decisions under these circumstances. Specifically, a deficiency cannot exist for this Court's redetermination until the section 4941(b)(1) tax is imposed, but such tax is not imposed, assuming no correction occurs, until this Court's decision is final. The circuitous nature of this procedure raises a serious question of whether this Court has the statutory authority to enter a decision which determines a deficiency in section 4941(b)(1) tax.Accordingly, an order will be issued directing that the parties submit briefs setting forth their respective positions addressing the issue as to whether or not this Court, under the present 70 T.C. 446">448 statute, has the authority to determine a deficiency in section 4941(b)(1) tax. 61978 U.S. Tax Ct. LEXIS 104">111 An appropriate order will be issued. Footnotes1. Because the question raised herein is a legal one, recitation of the facts, which are set forth at length in our initial opinion, need not be repeated in detail.↩2. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended.↩3. See, e.g., secs. 7428, 7476, 7477, and 6512(b).↩4. SEC. 4941(b). Additional Taxes. --(1) On self-dealer. -- In any case in which an initial tax is imposed by subsection (a)(1) on an act of self-dealing by a disqualified person with a private foundation and the act is not corrected within the correction period, there is hereby imposed a tax equal to 200 percent of the amount involved. The tax imposed by this paragraph shall be paid by any disqualified person (other than a foundation manager acting only as such) who participated in the act of self-dealing.↩5. SEC. 4941(e)(4). Correction period. -- The term "correction period" means, with respect to any act of self-dealing, the period beginning with the date on which the act of self-dealing occurs and ending 90 days after the date of mailing of a notice of deficiency with respect to the tax imposed by subsection (b)(1) under section 6212, extended by --(A) any period in which a deficiency cannot be assessed under section 6213(a), and(B) any other period which the Secretary determines is reasonable and necessary to bring about correction of the act of self-dealing.↩6. It is expected that the parties' briefs will include: (1) A discussion of the definition of a "deficiency" contained in sec. 6211. This will necessarily involve the meaning of the word "imposed" used therein and in sec. 4941(b)(1). See Laing v. United States, 423 U.S. 161">423 U.S. 161 (1976). (2) The provisions of secs. 6214 and 7442 relating to the jurisdiction of this Court. See Bendheim v. Commissioner, 214 F.2d 26">214 F.2d 26 (2d Cir. 1954). (3) The weight to be given the congressional explanation of the scheme of enforcement of these provisions. See H. Rept. 91-413 (Part 1), 1969-3 C.B. 200, 214; S. Rept. 91-552 (1969), 1969-3 C.B. 423, 442. (4) The effect of the above, if any, on the imposition of the initial tax provided in sec. 4941(a)(1)↩ under the transitional rules set forth in sec. 53.4941(f)-1(b)(2), Foundation Excise Tax Regs.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620978/	NATIONAL OIL & GAS CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.National Oil & Gas Co. v. CommissionerDocket No. 2040.United States Board of Tax Appeals6 B.T.A. 399; 1927 BTA LEXIS 3517; March 4, 1927, Promulgated 1927 BTA LEXIS 3517">3517 During the taxable year the petitioner became entitled to a certain amount of oil as his share of that produced under a lease. He disposed of only a portion thereof during the taxable year. His books were kept and his returns were made upon the basis of cash receipts and disbursements. Held, that a reasonable allowance for depletion is to be based upon the amount of oil sold, the proceeds of which are included in the return. Appeal of R. M. Waggoner,5 B.T.A. 1191">5 B.T.A. 1191, followed. Harry C. Weeks, Esq., for the petitioner. Bruce A. Low, Esq., for the respondent. PHILLIPS 6 B.T.A. 399">399 Petitioner appeals from the determination by the Commissioner of a deficiency of $14,588.75, income and profits taxes for 1919. The proceeding involves the determination of two issues: (1) The proper allowance for depletion of oil based upon discovery value, and (2) whether allowance should be based upon the amount of oil sold or upon the amount of oil produced, the petitioner making his return upon a cash receipts and disbursements basis. The facts were stipulated. 6 B.T.A. 399">400 FINDINGS OF FACT. The taxpayer is a Texas corporation with its principal1927 BTA LEXIS 3517">3518 office at Wichita Falls. The deficiency asserted herein was calculated without any allowance for depletion upon oil produced. The petitioner owned until December 1, 1919, a three-eighths interest in an oil and gas lease of 2 1/2 acres of land in Block 74, Red River Valley Land Subdivision, Wichita County, Texas, upon which it was required to pay, under its contract, no development expenses whatever, and no operating expenses until the production of the property had declined to 50 barrels per day. One dollar and fifty-seven and one-half cents per barrel is a reasonable depletion unit to be used in the allowance of a deduction for depletion upon said property. The petitioner's share of the oil actually produced from said property in 1919 was $26,843.56 barrels. During 1919 the petitioner sold 23,729.97 barrels of such oil and received therefor $41,611.46, which was reported by it as gross income and accepted by the Commissioner. The proceeds from the remaining 3,113.59 barrels of oil produced from said property in 1919 were not accounted for as income by the petitioner in 1919. The records of the petitioner do not show that payment for said oil was received. The selling price1927 BTA LEXIS 3517">3519 for such oil was $6,056.35. It is not known whether this sum was misappropriated by someone connected with the petitioner or whether it was not paid to the petitioner in 1919. OPINION. PHILLIPS: In computing the net income of the petitioner no allowance was made for depletion. It is now agreed between the parties that $1.575 per barrel is a reasonable depletion unit to be used in the computation of the deduction. The parties also raise the question whether depletion allowance should be based upon the amount of oil produced, whether or not sold in the taxable year and included in the income of that year, or upon the amount of the oil sold. Petitioner keeps its books upon a cash receipts and disbursements basis. Its share of the oil produced during the year was 26,843.56 barrels. It returned as income the proceeds from the sale of only 23,729.97 barrels. It is not known what happened to the remaining oil, but the parties are agreed that payment therefor was not received by the petitioner in 1919 so as to constitute a part of its income upon a cash receipts and disbursements basis. In the 1927 BTA LEXIS 3517">3520 , it was held that, in such circumstances as we have here, allowance for depletion could be taken only upon the basis of the oil sold curing the year, 6 B.T.A. 399">*401 the proceeds of which were included as income; in other words, the depletion was to be taken upon the same basis as the income was returned. The decision in that appeal is decisive of the question here involved. The deficiency should therefore be computed by allowing a deduction for depletion based upon 23,729.97 barrels at $1.575 per barred. Decision will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620979/	Shelby Owens and Dorothy H. Owens, Husband and Wife v. Commissioner.Owens v. CommissionerDocket No. 58812.United States Tax CourtT.C. Memo 1958-103; 1958 Tax Ct. Memo LEXIS 129; 17 T.C.M. 519; T.C.M. (RIA) 58103; May 29, 1958Robert J. Hobby, Esq., and Wentworth P. Durant, Esq., 1520 Republic Bank Building, Dallas, Tex., for the petitioners. Carswell H. Cobb, Esq., for the respondent. TRAINMemorandum Findings of Fact and Opinion TRAIN, Judge: Respondent determined a deficiency in petitioners' income tax for the year 1953 in the amount of $4,684.88. Petitioners dispute only the disallowance of the deduction of $7,500 in attorney's fees. The sole issue for determination is whether the sum of $7,500, which was paid to an attorney in 1953, is an expense incurred for the production of income or for the management, conservation, or maintenance of property held for the production of income. Findings of Fact Some of the facts have been stipulated and1958 Tax Ct. Memo LEXIS 129">130 are hereby found as stipulated. Petitioners are husband and wife and are residents of Arlington, Texas. They filed a joint return for the calendar year 1953 with the district director of internal revenue at Dallas, Texas, on September 15, 1954. From 1922 to December 10, 1948, petitioner Shelby Owens (hereinafter called petitioner) was married to Margaret Stuckert Owens (hereinafter called Margaret). In 1946 they became estranged, and they separated during the year. At that time petitioner had various business interests but his chief business and source of income was a lumber business known as Stuckert-Owens Lumber Company, which was carried on as a partnership between petitioner and J. Lamar Stuckert, a nephew of Margaret. Each partner owned a 50 per cent interest in the business. During all of their married life, petitioner and Margaret were residents of Texas, a community property state, and all of the property and business interests which were owned by them at the time of the separation were owned in community. Due to the circumstances leading up to their separation, Margaret became very embittered and generally let it be known that she was going to get everything she could1958 Tax Ct. Memo LEXIS 129">131 from petitioner by virtue of the divorce proceedings. To this end she contacted J. Lamar Stuckert, her nephew and petitioner's partner, and attempted to negotiate a new partnership arrangement of the lumber business with him, contingent upon her being able to wrest this from petitioner in the divorce proceeding. J. Lamar Stuckert declined any such arrangement for reasons of his own and so advised petitioner. He told petitioner that he would dissolve their partnership, regardless of cost, if Margaret were to obtain any active interest in the business. J. E. Foster, with whom petitioner was similarly associated in another business, became alarmed at these events, forced a dissolution of their partnership, and bought out petitioner's interest. This left petitioner dependent on the Stuckert-Owens Lumber Company as his primary source of income. During 1946, Margaret retained Hal Lattimore, a Fort Worth attorney who was a lifelong friend of both parties, as her counsel and paid him $2,500 in cash in advance for representing her in the divorce proceedings. Petitioner was represented by his brother Richard, also a Fort Worth attorney, who customarily handled his legal affairs. Petitioner1958 Tax Ct. Memo LEXIS 129">132 did not plan to, and made no effort to, contest the divorce proceedings, but was anxious only to save his interest in Stuckert-Owens Lumber Company as his source of income. Richard told him that he did not believe he could handle any of the property settlement negotiations because of the family relationship and his personal acquaintance with Margaret. Richard, who had his place of business in the same building with Lattimore, Margaret's attorney, met with Lattimore often but did not discuss the property settlement with him. Margaret informed Lattimore of her desire to obtain petitioner's interest in the lumber company, $100,000 in cash, the home, and automobiles as her settlement. Petitioner consulted Lattimore, who was familiar with his business affairs, and told him that it was essential that he retain his full interest in the lumber business, if possible. He told Lattimore that he would pay the $100,000, his home and the property out at the lake, and the other things mentioned in the property settlement if he could keep the lumber business. He promised to pay Lattimore $7,500 and not to contest the divorce if Lattimore could get Margaret to agree to let him keep the lumber business. 1958 Tax Ct. Memo LEXIS 129">133 Lattimore agreed that it would be for the best interest of petitioner to keep the lumber business and, as Margaret's attorney, would recommend that she accept petitioner's offer. Lattimore informed Margaret of the conversation he had with petitioner and advised her to accept petitioner's offer. The property settlement was arranged whereby petitioner would retain his interest in the lumber company, as he had desired. Richard Owens reviewed the final settlement for petitioner and recommended that he accept it because it was in his best interests. On September 28, 1948, Shelby Owens executed the property settlement. Richard Owens delivered the settlement to Margaret's attorney, who then secured Margaret's acceptance of it as so constituted. It was agreed that the $7,500 which petitioner was to pay Lattimore for his efforts in securing the property settlement as petitioner desired would be incorporated in the divorce decree as the attorney's fees. The property settlement and the attorney's fees were incorporated in the divorce decree entered December 10, 1948. After the divorce decree and property settlement, Lattimore prepared a note for $7,500 as payment from petitioner, which1958 Tax Ct. Memo LEXIS 129">134 petitioner signed and returned to him. Petitioner did not pay Richard Owens any monies for his efforts on behalf of petitioner in the divorce proceedings or property settlement. He did, however, do some work for Richard. In 1953, a tax deficiency was assessed against Lattimore. This deficiency was satisfied by payment of the $7,500 note which was applied to the tax deficiency. Petitioner deducted the $7,500 attorney's fees in his 1953 tax return. Respondent disallowed this deduction. Opinion Petitioner contends that the $7,500 paid to Lattimore was deductible under section 23(a)(2) of the 1939 Code as an expense paid for the management, conservation, or maintenance of property held for the production of income. 1 Petitioner argues that the fee paid to Lattimore was to save his interest in the Stuckert-Owens Lumber Company which was his sole source of income. He asserts that the money was paid to Lattimore for his efforts on behalf of petitioner and not as Margaret's attorney. He further points out that the divorce was not contested and that his only efforts were to save his sole source of income. 1958 Tax Ct. Memo LEXIS 129">135 In , revd. (C.A. 6, 1957), this Court held, under facts similar to those before us here, that fees paid to an attorney for his efforts in securing a favorable property settlement incidental to a divorce were not deductible. Further citing , affd. (C.A. 9, 1953); , and , revd. (C.A. 8, 1952). Recently, in , affd. (C.A. 2, April 7, 1958), the Court adhered to this position, and we find nothing in the instant case which would lead us to a different conclusion. Decision will be entered for the respondent. Footnotes1. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: (a) Expenses. - * * *(2) Non-Trade or Non-Business Expenses. - In the case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620980/	GEORGE BOHARSKI AND MARGARET BOHARSKI, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent; GEORGE BOHARSKI, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBoharski v. CommissionerDocket Nos. 2408-85, 7375-86, 39622-86.United States Tax CourtT.C. Memo 1988-155; 1988 Tax Ct. Memo LEXIS 183; 55 T.C.M. 604; T.C.M. (RIA) 88155; April 14, 1988. George Boharski, pro se. Thomas E. Ritter, for respondent. SHIELDSMEMORANDUM FINDINGS OF FACT AND OPINION SHIELDS, Judge: In these consolidated cases, respondent determined deficiencies in and additions to petitioners' income taxes as follows: Additions to Tax, Secs. 1Docket No.YearDeficiency6651(a)(1)6653(a)6653(a)(1)6653(a)(2)6654(a)George and Margaret Boharski, petitioners2408-851980$ 2,341.00$ 385.00$ 156.00$ --$ --$ --19815,531.00----277.00----George Boharski, petitioner7375-8619827,500.001,875.00--375.00730.1939622-8619833,513.00632.25--175.65163.22The issues are: (1) whether petitioner 2 is entitled to deduct certain farm losses disallowed by respondent for 1980 and 1981; 1988 Tax Ct. Memo LEXIS 183">185 (2) whether petitioner is entitled to deduct employee business expenses disallowed by respondent for 1980 and 1981; (3) whether petitioner is entitled to a deduction for a charitable contribution to the Universal Life Church for 1981; (4) whether petitioners are liable for additions to tax under section 6651(a)(1) for failing to file a timely return in 1980, and petitioner for the same addition to tax for 1982 and 1983; (5) whether petitioners are liable for additions to tax under section 6653(a) for negligence for 1980 and under section 6653(a)(1) for 1981, and petitioner under section 6653(a)(1) for 1982 and 1983; and (6) whether petitioner is liable for additions to tax under section 6654(a) for 1982 and 1983. FINDING OF FACT Some of the facts have been stipulated and are so found. The stipulations and exhibits associated therewith are incorporated herein by reference. George and Margaret Boharski, husband and wife, resided in Kalispell, 1988 Tax Ct. Memo LEXIS 183">186 Montana, during 1980 through 1983 and at the time of filing their petitions in these cases. They filed an untimely joint income tax return for 1980 on March 26, 1982 and a timely joint return for 1981 on or before April 15, 1982. Neither petitioner filed an income tax return for 1982 or 1983. In 1977, petitioner purchased ten acres of land and constructed a house thereon where he and his family resided through 1983. The property was also improved with a barn, a chicken house and pig lots where petitioner raised a few cattle, chickens and pigs, some of which were sold and the balance consumed by petitioner and his family. On their returns for 1977 though 1981, petitioner reported gross receipts, expenses and net losses from the cattle, chicken and pig operation as follows: 19771978197919801981Gross Receipts$ 399 $ 1,236 $ 2,294 $ -- $ 959 Cost of items sold161 650 2,428 -- 360 $ 238 $ 586 $ (134)$ -- $ 599 Expenses and depreciation2,406 3,700 6,478 6,515 7,262 Loss claimed$ (2,168)$ (3,114)$ (6,612)$ (6,515)$ (6,663)1988 Tax Ct. Memo LEXIS 183">187 Respondent allowed the deductions claimed by petitioners for interest and taxes but disallowed the balances of $ 4,631 and $ 5,223 of the farm losses claimed by petitioners for the years 1980 and 1981, respectively. In 1980, petitioner worked full time on construction jobs as an electrician for Mathews McCracken Rutland Corp. in Missoula which is about 135 miles from his home in Kalispell. On the 1980 joint return, petitioner deducted $ 6,367 in employee business expenses for travel in connection with this employment. At trial petitioner testified that he computed his employee business expenses for 1980 by using an estimated daily average and was unable to produce any cancelled checks, receipts, log books, or other documentary evidence in support of the expenses. Respondent disallowed all of the employee business expenses claimed by petitioner for 1980. From February 2, 1981 until October 9, 1981, petitioner worked as an electrician for Electric Smith, Inc. at a location approximately ten miles from Troy, Montana which is about 120 miles from his home. For this period he claimed $ 7,798 in employee business expenses on the joint return for 1981. Again, he used an estimated1988 Tax Ct. Memo LEXIS 183">188 daily average to compute the claimed expenses and was unable to produce any supporting documents such as cancelled checks, receipts or log books. Respondent disallowed the deductions in their entirety. On the 1981 return, petitioner also claimed a deduction for a charitable contribution to the Universal Life Church of $ 12,500 which was limited by the limitation in section 170 to $ 10,792. The deduction was disallowed by respondent. During 1982, petitioner received taxable wages from Bechtel Power Corp. of $ 20,012 and from Kalispell Electric of $ 4,706. He also received nonemployee compensation from the International Brotherhood of Electrical Workers of $ 780 and unemployment compensation from the State of Montana of $ 2,429. During 1983, petitioner received taxable wages from Bechtel Power Corp. of $ 11,453, from Westinghouse Electric of $ 974, and from Intermountain Electric of $ 3,112. He also received, in 1983, unemployment compensation from the State of Montana in the amount of $ 3,626. OPINION Petitioner bears the burden of proving entitlement to deductions. Rule 142(a); Welch v. Helvering, 290 U.S. Ill (1933).(1) Farm LossesIn the deficiency1988 Tax Ct. Memo LEXIS 183">189 notice for 1980 and 1981, respondent disallowed all of the farm deductions claimed by petitioners except interest and taxes, 3 first, as having been incurred in activities not engaged in for profit and secondly, as not being substantiated in amount. Even if we were to able to find that the farm activities were engaged in for profit, which on this record we can not do, we would still be unable to hold for petitioners on this issue because the record contains no evidence tending to substantiate the deductions claimed for the farm. Consequently, petitioners have not carried their burden of proving entitlement to the farm deductions in excess of those allowed by respondent. Rule 142(a); Welch v. Helvering, supra.(2) Employee Business ExpensesAn employee is entitled to deduct ordinary and necessary expenses, including meals, if incurred in connection with his employment while away from home. Section 162. The petitioner has the burden of proof with respect to the amount of such deductions, Rule 142(a); Welch v. Helvering, supra. Under section1988 Tax Ct. Memo LEXIS 183">190 274(d), he is required to substantiate any travel expense with adequate records or by sufficient evidence corroborating his own testimony. In the record before us, petitioner has provided no substantiation as to the amount of such expenses, the number of days petitioner was away from home during the taxable years, and no cancelled checks, receipts, daily logs or other documentation in support of his estimates. Consequently, while we are satisfied that he incurred some travel expenses while away from home, his uncorroborated testimony as to his estimated average daily expenditures is not sufficient to satisfy the mandatory requirements of section 274(d). Stemkowski v. Commissioner,76 T.C. 252">76 T.C. 252 (1981), affd. in part, revd. and remanded in part on other grounds 690 F.2d 40">690 F.2d 40 (2d Cir. 1982). We, therefore, sustain respondent's determination with respect to this issue.3) Charitable ContributionOnce again petitioner has the burden of proving his entitlement to the deduction. Rule 142(a); Welch v. Helvering, supra; Davis v. Commissioner,81 T.C. 806">81 T.C. 806, 81 T.C. 806">815 (1983), affd. without published opinion 767 F.2d 931">767 F.2d 931 (9th Cir. 1985).1988 Tax Ct. Memo LEXIS 183">191 Petitioner, however, has failed to produce any substantiation for the claimed contribution and therefore, respondent's disallowance of the deduction is sustained.4) Additions to Tax for DelinquencyRespondent determined that both petitioners are liable for an addition to tax under section 6651(a)(1) for 1980 and that petitioner George Boharski is liable for such addition to tax for 1982 and 1983. The addition to tax under section 6651(a)(1) is properly imposed whenever a taxpayer fails to file a timely return unless the taxpayer can establish that such failure is due to reasonable cause and not to willful neglect. BJR Corp. v. Commissioner,67 T.C. 111">67 T.C. 111, 67 T.C. 111">131 (1976). With respect to the 1980 return, petitioner argues that reasonable cause for the late filing existed because a refund was due for a previous year and petitioner had reasonable cause to believe that no tax and apparently no return was due for 1980. The record, however, does not support this argument because there is no evidence in the record that would support a finding that any refund was due for a previous year. Furthermore, petitioner has failed to cite, and we know of no authority which1988 Tax Ct. Memo LEXIS 183">192 exempts a taxpayer from filing a return merely because a refund may be due for some previous year. For 1982 and 1983, petitioner claims he did not file income tax returns because of some vague Fifth Amendment argument that to do so would have tended to incriminate him in some undisclosed manner. It is well established that the refusal to file any return at all is not protected by the privilege against self-incrimination provided by the Fifth Amendment. United States v. Carlson,617 F.2d 518">617 F.2d 518, 617 F.2d 518">523 (9th Cir. 1980), cert. denied 449 U.S. 1010">449 U.S. 1010 (1980). We cannot find that petitioner's vague assertions with respect to alleged Constitutional violations constitute reasonable cause for his failure to file the 1982 and 1983 returns. We conclude therefore, that respondent's assertion of the additions to tax for 1980, 1982 and 1983 should and is hereby sustained.(5) Additions to Tax for NegligencePetitioner also has the burden of proving that respondent erroneously determined that he is liable under section 6653(a), 6653(a)(1) and 6653 (a)(2) for the additions to tax for negligence. Rule 142(a); Otis v. Commissioner,73 T.C. 671">73 T.C. 671, 73 T.C. 671">675 (1980),1988 Tax Ct. Memo LEXIS 183">193 affd. without published opinion 665 F.2d 1053">665 F.2d 1053 (9th Cir. 1981). Since petitioners have failed to produce any evidence to refute respondent's determination, respondent's determination is sustained.(6) Additions to tax for Failure to Make Estimated Tax PaymentsThe addition to tax under section 6654 for failure to make estimated tax payments is mandatory in the absence of one or more of the exceptions set forth in the section. Bagur v. Commissioner,66 T.C. 817">66 T.C. 817, 66 T.C. 817">824 (1976), remanded on another issue 603 F.2d 491">603 F.2d 491 (5th Cir. 1979); Estate of Ruben v. Commissioner,33 T.C. 1071">33 T.C. 1071 (1960). Since petitioner has offered no evidence on this issue, respondent's determination is sustained. Decisions will be entered for respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue unless otherwise indicated. All rule references are to the Tax Court Rules of Practice and Procedure. ↩. 50 percent of the interest due on the underpayment. ↩2. Margaret Boharski is a petitioner in docket No. 2408-85 solely by virtue of having filed joint returns with George Boharski for 1980 and 1981. Consequently, all references to petitioner in the singular are to George Boharski. ↩3. Interest and taxes included by petitioner in the farm losses were allowed by respondent as itemized deductions.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620981/	LUNG KUAN PAO and MARGARET LEE PAO, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent; TUNFAR, INCORPORATED, d/b/a THE GOLDEN BUDDHA RESTAURANT, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentLung Kuan Pao v. CommissionerDocket Nos. 18515-81, 18516-81.United States Tax CourtT.C. Memo 1984-224; 1984 Tax Ct. Memo LEXIS 447; 47 T.C.M. 1711; T.C.M. (RIA) 84224; April 26, 1984. Dennis C. O'Brien, for the petitioners. Stephen R. Klorfein, for the respondent. GOFFEMEMORANDUM FINDINGS OF FACT AND OPINION GOFFE, Judge: The Commissioner determined deficiencies in petitioners' Federal income tax and additions to tax as follows: AdditionsDocketTaxable YearsDeficiencyto TaxPetitionersNumbersEndingin taxSec. 6653(a) 1Lung Kuan Pao18515-81December 31, 1976$74,996.00$3,750.00and MargaretDecember 31, 197771,949.003,597.00Lee PaoDecember 31, 197862,719.003,136.00Tunfar,18516-81March 31, 197740,664.512,033.33IncorporatedMarch 31, 197863,066.673,153.33After concessions by the parties, the issues1984 Tax Ct. Memo LEXIS 447">448 for decision are whether: (1) petitioners Lung Kuan Pao and Margaret Lee Pao understated their income in the amounts of $137,889.13, $135,004.22 and $117,504.28 during taxable years 1976, 1977 and 1978, respectively; (2) petitioners Lung Kuan Pao and Margaret Lee Pao are liable for additions to tax pursuant to section 6653(a) for such years; (3) petitioner Tunfar, Incorporated, understated its income in the amounts of $115,396 and $156,806.26, during fiscal years ending March 31, 1977, and March 31, 1978, respectively; and (4) petitioner Tunfar, Incorporated, is liable for the additions to tax pursuant to section 6653(a) for such years. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and accompanying exhibits are so found and incorporated herein by reference. Petitioners Lung Kuan Pao and Margaret Lee Pao (hereafter sometimes referred to as "Mr. and Mrs. Pao") are married and filed joint Federal income tax returns with the Internal Revenue Service in Atlanta, Georgia, for taxable years 1976, 1977 and 1978. These1984 Tax Ct. Memo LEXIS 447">449 petitioners resided in Decatur, Georgia, when they filed their petition. Petitioner Tunfar, Incorporated (hereafter sometimes referred to as the "corporation"), is a corporation whose principal place of business is located in Decatur, Georgia, a suburb of Atlanta. During the years in issue, the corporation operated a Chinese restaurant, the Golden Buddha. The corporation filed Federal corporate income tax returns for the taxable years ending March 31, 1977 and March 31, 1978, with the Internal Revenue Service in Atlanta, Georgia. Petitioners Margaret Lee Pao and Lung Kuan Pao immigrated to the United States in 1972 and moved to Georgia in 1975. They formed Tunfar, Incorporated, in 1975. During the corporation's fiscal years ending March 31, 1976 and March 31, 1977, the Paos owned 60 percent of its stock and increased their ownership to 80 percent during the fiscal year ending March 31, 1978. The corporation opened the Golden Buddha in May 1975. Its operation of the restaurant was its only source of income during the years in issue. At all relevant times, the restaurant had a seating capacity of approximately 100 people and served moderately priced meals for lunch and1984 Tax Ct. Memo LEXIS 447">450 dinner. The restaurant did not serve alcoholic beverages during any of the years in issue. When the restaurant initially opened, it served food seven days a week. At some point, it reduced its business to six days a week. The restaurant eventually became so successful that it was not uncommon to have to wait up to 45 minutes to be seated for dinner, which was its busiest period. Throughout the years in issue, Mr. and Mrs. Pao worked long hours at the restaurant. Mrs. Pao was the cashier and hostess while her husband was the chief chef. Neither individual was employed elsewhere during the years in issue. Varying numbers of other employees worked at the restaurant as cooks, waiters, cashiers and busboys at all relevant times. The restaurant's records were maintained pursuant to the following procedures. An original meal ticket and one copy were initially prepared for each order; the original ticket was sent to the kitchen while the copy was ultimately given to the customer for bill paying purposes. The lunch tickets were prenumbered while the dinner tickets were unnumbered. Although the restaurant was supposed to retain both sets of tickets, approximately 10 percent of the1984 Tax Ct. Memo LEXIS 447">451 numbered lunch tickets were missing. No accurate estimate of the completeness of the retained dinner tickets could be made because they were unnumbered. After the close of business, the Paos would take that day's receipts and both sets of meal tickets to their home. The receipts (including charges) were added together and the customer meal tickets were totaled. These sums were then entered on daily summary sheets which were subsequently given to the restaurant's accounting service with other business records. This accounting firm prepared the corporation's tax returns for the years in issue from corporate bank statements, canceled checks and the restaurant's daily summary sheets. The accounting firm did not review the actual meal tickets or the cash register tapes when preparing the corporation's tax returns. At all relevant times, the restaurant's total receipts were comprised of an unusually high percentage of credit card receipts. During the years in issue, the following amounts were deposited to bank accounts in the name of petitioners Lung Kuan Pao or Margaret Lee Pao: 1976Type of AccountAmountSavings$ 29,333.66Checking40,980.24Savings25,743.55Checking56,367.19Checking34,844.33Total$187,268.971977Savings$ 11,351.60Checking611.58Savings29,251.07Checking18,886.07Checking48,147.03Total$108,247.351978Savings$ 23,523.12Checking63,820.94Checking14,736.00Total$102,080.061984 Tax Ct. Memo LEXIS 447">452 Most of the deposits to these accounts were small and irregular and in amounts less than $3,000 although several large deposits were made. The individual petitioners have no records specifically identifying the sources of these deposits. In response to pretrial interrogatories, the individual petitioners were unable to identify any of the sources of these deposits or the circumstances under which these funds were obtained. During 1976, the Paos transferred $30,880.91 between the above accounts. They also deposited most of their corporate salary checks, which totaled $17,198.84, to such accounts. Finally, the petitioners earned $1,100.06 of interest income on these accounts. During 1977, the Paos transferred $2,000 between their various bank accounts and made $2,606.13 of accommodation deposits to such accounts on behalf of a relative. They also received $2,411.61 of interest income from these accounts. The individual petitioners deposited most of their corporate salary checks, which collectively totaled $14,525.39, to these accounts. During 1978, the individual petitioners deposited $5,755 of rental income and reimbursement checks in the amounts of $1,885.57 and $2,4601984 Tax Ct. Memo LEXIS 447">453 to these accounts. They also received $1,475.21 of interest income from their bank accounts. Finally, these petitioners deposited most of their corporate salary checks, which collectively totaled $22,700, to these accounts. On December 6, 1977, petitioner Margaret Lee Pao purchased a parcel of real property known as 1916 Clairmont Road in Dekalb County, Georgia, in her maiden name (Margaret Lee) for $48,500. On March 15, 1978, she also purchased another parcel of real property known as 1902 Clairmont Road for $53,900 in her maiden name. Both parcels were purchased with cash or checks. Normally, when a person enters the United States, he must complete a written customs declaration which specifically asks if he is carrying more than $5,000 in currency or anything readily convertible into currency. If he is carrying funds in excess of this amount, he must also complete an additional form known as a currency monetary instrument pertaining to such funds. Data from these currency disclosure forms has been routinely entered into a single computer system since 1972 and can be located by the individual's name. Failure to disclose the importation of funds in excess of these currency1984 Tax Ct. Memo LEXIS 447">454 disclosure limits is a violation of the United States' civil and criminal codes. A search of the computerized currency monetary instrument records from 1972 to immediately prior to trial revealed no declarations for any of the following individuals (including various name derivations of each person): petitioner Lung Kuan Pao; petitioner Margaret Lee Pao; Moon Tsang Lee; Hsien Mu Pao (a.k.a. Ronnie Pao); Chang Ming Yu; Ben Yeon Lee; Chung Lung Yang; Guey Chien Chibe; Wen Jye Chuie; and Shu S. Lee. For all of the years in issue, the individual petitioners reported all of their restaurant salaries on their Federal income tax returns. On their 1977 tax return, they reported $2,411.61 of interest income from two banks. On their 1978 tax return, they reported $1,475.21 of interest income from two banks and a net rental income of $6.27 from two rental properties including a home at 1902 Clairmont Road. The Commissioner, utilizing the bank deposits and expenditures method of analysis, determined that the individual petitioners omitted $137,889.13, $135,004.22 and $117,504.28 of income in taxable years 1976, 1977 and 1978, respectively. The Commissioner also determined that the1984 Tax Ct. Memo LEXIS 447">455 most likely source of the unreported income was the restaurant; hence, he characterized the individual petitioners' receipt of the unreported income as corporate dividends to shareholders. The Commissioner, therefore, adjusted petitoners' dividend income to reflect section 116's partial dividends exclusion when recomputing their taxable income. Further, in arriving at such determinations, the Commissioner made allowances for all documented taxable and nontaxable sources of funds. Given that the Commissioner determined that the individual petitioners' unreported income arose from undisclosed corporate dividends, he also determined that the corporation omitted $115,396 and $156,806.26 in income during fiscal years ending March 31, 1977 and March 31, 1978, respectively. 2OPINION The first issue for decision is whether petitioners Lung Kuan Pao and Margaret Lee Pao understated their income during taxable years 1976, 1977 and 1978 by $137,889.13, $135,004.22 and $117,504.28, respectively. The petitioners object to the Commissioner's1984 Tax Ct. Memo LEXIS 447">456 utilization of the bank deposits and expenditures method of recomputing their income for such taxable years and contend that they correctly reported their taxable income for these years on their Federal income tax returns. The individual petitioners assert that the bank deposits and expenditures in question were not unreported corporate dividends but were accommodation deposits and purchases for relatives, friends, business associates and even some total strangers in accordance with their Oriental heritage. Specifically, these petitioners contend that numerous relatives, friends, corporate employees, and even some total strangers, who all immigrated to the United States with large amounts of cash and checks, gave their funds to petitioners for safekeeping as the Paos were already established in the country. Respondent contends that the substantial bank deposits and real property purchases by petitioners during the years in issue, adjusted for documented nontaxable and reported taxable sources, constitute unreported dividend income from the corporation. In Harper v. Commissioner,54 T.C. 1121">54 T.C. 1121, 54 T.C. 1121">1129 (1970), which involved the Commissioner's reconstruction of1984 Tax Ct. Memo LEXIS 447">457 a taxpayer's fraudulent understatement of income by the bank deposits and expenditures method, we held that: Where a taxpayer has made numerous deposits in bank accounts, the sources or nature of which are not accounted for or recorded in books and records maintained by him, determinations made by the Commissioner of income subject to tax on the basis of such deposits have been approved in many instances; and it has been repeatedly held that a presumption of correctness attaches to such determinations and that the taxpayer has the burden of overcoming such presumption. See sec. 446(b), I.R.C. 1954; Marcello v. Commissioner,380 F.2d 494">380 F.2d 494 (C.A. 5, 1967); Estate of Robert Lyons Hague,45 B.T.A. 104">45 B.T.A. 104, 45 B.T.A. 104">109, affd. 132 F.2d 775">132 F.2d 775, 132 F.2d 775">776 (C.A. 2, 1943), certiorari denied 318 U.S. 787">318 U.S. 787; Thomas B. Jones,29 T.C. 601">29 T.C. 601, 29 T.C. 601">613-614 (1957); Hoefle v. Commissioner,114 F.2d 713">114 F.2d 713, 114 F.2d 713">714 (C.A. 6, 1940); Boyett v. Commissioner,204 F.2d 205">204 F.2d 205, 204 F.2d 205">208 (C.A. 5, 1953); Goe v. Commissioner,198 F.2d 851">198 F.2d 851, 198 F.2d 851">853 (C.A. 3, 1952); Doll v. Glenn,231 F.2d 186">231 F.2d 186, 231 F.2d 186">188 (C.A. 6, 1956); O'Dwyer v. Commissioner,266 F.2d 575">266 F.2d 575, 266 F.2d 575">5881984 Tax Ct. Memo LEXIS 447">458 (C.A. 4, 1959), affirming 28 T.C. 698">28 T.C. 698 (1957), certiorari denied 361 U.S. 862">361 U.S. 862. Use of the bank-deposits method is proper even when the taxpayer keeps books and records which support his return as filed. Campbell v. Guetersloh,287 F.2d 878">287 F.2d 878 (C.A. 5, 1961). Respondent is not bound to accept a taxpayer's return or his books at face value. Holland v. United States,348 U.S. 121">348 U.S. 121 (1954). Our holding in Harper is clearly applicable to the instant proceeding. The individual petitioners made numerous and substantial bank deposits and real property purchases during the years in issue which were not completely and specifically reflected in their books and records. These petitioners have not contended nor shown the Commissioner's determinations to be "arbitrary and excessive"; hence, the traditional presumption of correctness attaches to the Commissioner's determinations and petitioners bear the burden of proving that such determinations were, in fact, erroneous. Helvering v. Taylor,293 U.S. 507">293 U.S. 507, 293 U.S. 507">515 (1935); Welch v. Helvering,290 U.S. 111">290 U.S. 111, 290 U.S. 111">115 (1933); Rule 142(a), Tax Court Rules of Practice1984 Tax Ct. Memo LEXIS 447">459 and Procedure. With respect to this issue, petitioners have failed to carry their burden of proof. Petitioners have failed to corroborate with credible evidence their claims of engaging in numerous and substantial accommodation deposits on behalf of family members, business associates and total strangers. Most of the bank deposits involved small sums of money which were made on an irregular although frequent basis. This pattern of deposits contradicts petitioners' claim that several individuals gave them large sums of money to make accommodation deposits on their behalf. Further, there is no record of any of these individuals declaring any funds to customs officials upon their entry into the United States during the mid and late 1970's, which is especially damaging given that some of these individuals testified that they did, in fact, declare sums in excess of $5,000 to customs officials.Finally, petitioners' explanation of these substantial bank deposits was, at best, contradictory and incomplete. We view the individual petitioners' detailed testimony of the pattern and source of the alleged accommodation deposits with suspicion given that they were unable to recall such facts1984 Tax Ct. Memo LEXIS 447">460 in pretrial interrogatories. Further, a large percentage of the bank deposits were made in 1976. Petitioners, however, did not present any evidence other than their own self-serving testimony of any specific individual who allegedly brought funds into the country and gave them to Mr. and Mrs. Pao during that year. Vague and general allegations of making accommodation deposits during the years in issue, without any supporting records or credible corroborating evidence, are insufficient to carry one's burden of proof. Petitioners' claims of making accommodation purchases of real property in petitioner Margaret Lee Pao's maiden name on behalf of a mysterious individual known as Shu Lee are also unconvincing. Mr. Lee's failure to appear at trial to corroborate petitioners' contentions warrants the inference that his testimony would not have been supportive of their position. Wichita Term. El. Co. v. Commissioner,162 F.2d 513">162 F.2d 513, 162 F.2d 513">515 (10th Cir. 1947). Further, petitioners actually reported rental income and claimed depreciation deductions on their 1978 Federal income tax return with respect to one of the parcels of real property that they allegedly merely held nominal1984 Tax Ct. Memo LEXIS 447">461 title to. This is inconsistent with the traditional role of nominee title holders and we cannot accept petitioner Margaret Lee Pao's unsubstantiated claim that her tax attorney advised her to do so. Accordingly, the Commissioner's determinations with respect to the individual petitioners are sustained. The next issue presented is the Commissioner's determinations that the individual petitioners' underpayments of tax were due to negligence or intentional disregard of the rules and regulations. Sec. 6653(a). These determinations are presumptively correct, 290 U.S. 111">Welch v. Helvering,supra, and petitioners bear the burden of proving such determinations to be incorrect. Gallagher v. Commissioner,75 T.C. 313">75 T.C. 313, 75 T.C. 313">318 (1980); Vaira v. Commissioner,52 T.C. 986">52 T.C. 986, 52 T.C. 986">1004 (1969), affd. on this issue 444 F.2d 770">444 F.2d 770, 444 F.2d 770">777 (3d Cir. 1971); Rule 142(a), Tax Court Rules of Practice and Procedure. Petitioners did not offer any evidence directly pertaining to this issue; they unsuccessfully attempted to prove that the bank deposits and expenditures in issue constituted nontaxable accommodation deposits and purchases on behalf of third parties. 1984 Tax Ct. Memo LEXIS 447">462 Accordingly, we hold that the individual petitioners have also failed to carry their burden of proof with respect to these additions to tax and uphold the Commissioner's determinations. The next issue is whether petitioner Tunfar, Incorporated, d/b/a the Golden Buddha, understated its taxable income in the amounts of $115,396 and $156,806.26 for fiscal years ending March 31, 1977 and March 31, 1978. The Commissioner's determinations are presumptively correct, and petitioners have the burden of proving them to be erroneous. 290 U.S. 111">Welch v. Helvering,supra;Rule 142(a), Tax Court Rules of Practice and Procedure.The restaurant was extremely successful. It was not uncommon to have to wait up to 45 minutes to get seated at dinner. During the years in issue, an analysis of the restaurant's resported receipts demonstrated an unusually high percentage of charge purchases which would indicate the likelihood of unreported cash receipts. Further, the restaurant utilized prenumbered meal tickets only during lunch; the dinner meal tickets were unnumbered which prevented any determination of whether the retained dinner meal tickets represented substantially all of the dinner1984 Tax Ct. Memo LEXIS 447">463 orders. Dinner was the restaurant's busiest period. No explanation was offered as to why the dinner meal tickets were unnumbered while the lunch tickets were numbered. The major stockholders of the corporation worked long hours at the restaurant for relatively small amounts of reported income. They were also in positions which would assist them in diverting unreported dividends to themselves as petitioner Margaret Lee Pao worked as the cashier and the day's receipts were totaled in the privacy of the individual petitioners' home after work. At approximately the same time that the corporation is alleged to have underreported its income, its primary shareholders made close to $400,000 of bank deposits or purchases with funds that cannot be traced to nontaxable or reported taxable sources or otherwise satisfactorily explained.Finally, the accounting service which prepared the corporation's records and tax returns relied solely on materials furnished to them by petitioners Margaret Lee Pao and Lung Kuan Pao and did not independently verify the accuracy of any of the submitted data. Against this background, the corporate petitioner contends that its Federal income tax returns correctly1984 Tax Ct. Memo LEXIS 447">464 reported its income for the years in issue. In support thereof, it presented an accountant who independently analyzed its books and records and concluded that the corporation's tax returns in issue were correct. Although some of his statistical comparisons concerning wages, cost of goods sold and gross receipts disclosed no significant fluctuations (which factor he, in turn, claimed would indicate a complete reporting of income), these results could also demonstrate a consistent pattern of omitting income. Further, many of his statistical comparisons were flawed by his failure to review canceled checks for items purchased and to integrate cash purchases into his calculations. His analyses were also incomplete due to his failure to review the original cash register tapes. Finally, many of his calculations assumed that the unnumbered dinner meal tickets he reviewed constituted a complete accounting of the total dinner receipts, yet this has not been satisfactorily proven. Petitioner's remaining disinterested witnesses could only offer their general observations that the corporation appeared to be reporting all of its income and we found them unconvincing. Accordingly, petitioner1984 Tax Ct. Memo LEXIS 447">465 Tunfar, Incorporated, failed to carry its burden of proof and the Commissioner's determinations of the amounts of unreported income are upheld. The final issue is the Commissioner's determination that the petitioner Tunfar, Incorporated's underpayment of tax was due to negligence or intentional disregard of the rules and regulations. Sec. 6653(a). The Commissioner's determinations are presumptively correct, Welch v. Helvering,290 U.S. 111">290 U.S. 111, 290 U.S. 111">115 (1933), and petitioner has the burden of proving them to be erroneous. Rule 142(a), Tax Court Rules of Practice and Procedure.The petitioner did not offer any evidence directly pertaining to this issue; it merely unsuccessfully attempted to prove that it reported all of its income. Accordingly, we hold that this petitioner failed to carry its burden of proof with respect to these additions to tax and uphold the Commissioner's determinations. Decisions will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect for the taxable years in issue.↩2. The differences of unreported income between the individual and corporate petitioners are due to their utilization of different taxable years.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620982/	SANDRA M. LUKASIEWICZ, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentLukasiewicz v. CommissionerDocket No. 11852-87United States Tax CourtT.C. Memo 1989-68; 1989 Tax Ct. Memo LEXIS 68; 56 T.C.M. 1251; T.C.M. (RIA) 89068; February 14, 1989. Mark L. Laughlin, for the petitioner. Robert Archambault, for the respondent. GERBERMEMORANDUM FINDINGS OF FACT AND OPINION GERBER, Judge: In a statutory notice of deficiency dated March 30, 1987, respondent determined deficiencies and additions to the 1983 and 1984 joint income taxes of petitioner, Sandra M. Lukasiewicz, and her husband, Marvin G. Lukasiewicz, as follows: Additions to TaxSectionSectionYearDeficiency6653 (a) (1) 166611983$ 102,584$ 5,129 $ 25,646198459,2652,963 14,816On May 7, 1987, petitioner filed her petition in this Court contesting the deficiencies and additions. 21989 Tax Ct. Memo LEXIS 68">70 After concessions by the parties, the issues presented for our consideration in this case are: (1) Whether petitioner should be relieved of joint and several liability for the tax deficiencies pursuant to section 6013(e); and, if not, (2) whether petitioner is entitled to compute her 1983 and 1984 taxes under the "income averaging" method provided in sections 1301 to 1305. FINDINGS OF FACT The parties' stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference. Petitioner, a retired registered nurse, resided with her husband, Marvin G. Lukasiewicz, in Farwell, Nebraska, when the petition was filed in this case. Petitioner and Mr. Lukasiewicz have been married, without separation, since 1957. Since at least 1976, petitioner and her husband have been co-owners of a precious metals dealership that buys and sells coins, gold and silver. The business has been primarily conducted out of petitioner's home. Mr. Lukasiewicz has been the predominant force behind the business. Petitioner has also been involved in the business, albeit to a lesser extent. She has performed some secretarial-type tasks and she has accompanied her husband1989 Tax Ct. Memo LEXIS 68">71 to various coin and precious metals shows where he bought and sold coins, silver and gold. For the years at issue, 1983 and 1984, petitioner and her husband reported gross receipts from the business on their Federal income tax returns of $ 837,894 and $ 701,857.82, respectively. The business has obtained a competitive advantage over other precious metals businesses by offering "privacy" to its clients involved in purchase and sale transactions. The names of the clients would not be disclosed to others, including the Internal Revenue Service. As it turned out, the Internal Revenue Service received information that in 1979 Mr. Lukasiewicz, under the name "Marvin Luke," received and cashed a number of checks representing receipts from his business. 3 Upon this information, the Service decided to examine Mr. Lukasiewicz's 1979 income tax return. Revenue Agent Richard Troester of the Internal Revenue Service was assigned to this task. Troester mailed a "form letter," dated January 17, 1983, to Mr. Lukasiewicz informing him that his 1979 income tax return was selected for examination and that an appointment date for the examination was scheduled for February 3, 1983. He was asked1989 Tax Ct. Memo LEXIS 68">72 to bring all documents to support his income and business expenses as reported on the return. By letter dated January 22, 1983, Mr. Lukasiewicz advised Revenue Agent Troester that they could not meet together because he and his wife were having health problems and because his "tax lady" was too busy to attend the scheduled meeting. Mr. Lukasiewicz further wrote that his tax lady "would like to know what the discrepancy is." (Emphasis added.) Troester inferred that the "tax lady" was the preparer of the 1979 return. However, Troester later discovered that no income tax return was filed by either petitioner or her husband for 1979. Therefore, on January 31, 1983, Troester sent a second letter to both Mr. and Mrs. Lukasiewicz advising them that the records of the Internal Revenue Service indicated that they had not filed a 1979 income tax return. He requested that they provide him with a copy of their 1979 return, if one was filed, or an explanation as to why they did not file a return. He further advised them that1989 Tax Ct. Memo LEXIS 68">73 he wanted to meet with them prior to April 15, 1983. As the investigation progressed, the Internal Revenue Service widened its scope to include the years 1976 through 1982. It had become apparent that petitioner and her husband had failed to file income tax returns for those years, although they had substantial amounts of gross income from their precious metals business. Being concerned about the investigation, petitioner and her husband decided to seek the assistance of an attorney. On March 13, 1983, they met with attorney Patrick Shaughnessey in St. Paul, Nebraska. Mr. Shaughnessey referred them to Attorney Robert J. Murray. On March 15, 1983, they met with Mr. Murray in Omaha, Nebraska, regarding the pending tax investigation. Petitioner was also present at a May 17, 1983, meeting with her husband, Mr. Murray and Virgil J. Goracke, an accountant assisting in the investigation. That meeting involved the strategy to be taken at an upcoming meeting with the Internal Revenue Service. Throughout the investigation, Revenue Agent Troester attempted to meet with petitioner and her husband to examine their business records relative to the income and expenses of the business1989 Tax Ct. Memo LEXIS 68">74 for the years 1976 through 1982. Finally, by letter dated August 8, 1983, Troester advised them that he had determined from third-party sources that they had substantial amounts of gross income for the taxable years 1976 to 1982. He requested that they meet with him on August 17, 1983, to explain why returns for those years were not filed and to provide records pertaining to their sales, cost of sales and expenses. Troester's attempts were unsuccessful. Petitioner and her husband refused to meet with Troester, and they failed to furnish their business records during the investigation. With the use of third-party sources, Troester completed his examination for the years 1976 through 1982. On February 5, 1984, respondent mailed a statutory notice of deficiency to Mr. Lukasiewicz which reflected that substantial unreported income had been derived from the precious metals business in those years. The notice determined tax deficiencies totaling $ 1,147,799 and additions totaling $ 414,595. In response to the notice of deficiency, petitioner's husband filed a petition in this Court contesting the deficiencies (docket No. 12766-84). Shortly before the trial in that case, which1989 Tax Ct. Memo LEXIS 68">75 was subsequently settled before trial, some business records sought by Troester during the investigation were provided to him. Those records were incomplete at best. Petitioner's husband did not keep sufficient and adequate records regarding the precious metals business. He did not maintain any inventory records, sales journals, cash receipts journals, sales invoices or other records regarding sales of coins, gold and silver. With respect to the years at issue here, 1983 and 1984, petitioner and her husband timely filed their joint Federal income tax returns. They signed the 1983 and 1984 returns on April 14, 1984, and March 21, 1985, respectively. They reported gross receipts from their business, cost of goods sold in the business, expenses, business net profit (loss), total taxable income and total tax as follows: 19831984Gross receipts$ 837,894.00$ 701,857.82 Cost of sales820,682.00693,266.22 Expenses16,246.0011,045.63 Net profit (loss)966.00(2,454.03)Taxable income 49,001.00(820.00)Tax484.00-0- At the time petitioner signed1989 Tax Ct. Memo LEXIS 68">76 the 1983 and 1984 joint returns, she knew that neither she nor her husband had filed income tax returns for the years 1976 through 1982 and that the Internal Revenue Service had commenced an extensive investigation regarding those years. Petitioner also knew the investigation involved the amount of income, expenses and cost of goods sold in her and her husband's precious metals business. In addition, petitioner knew her husband did not maintain adequate business records and that the Internal Revenue Service was claiming that her husband was liable for substantial amounts of taxes for the years 1976 through 1982 as a result of unreported income from the business. By letter dated December 31, 1985, Revenue Agent Troester advised petitioner and her husband that their 1983 and 1984 joint income tax returns were selected for examination. He requested that they meet with him on January 13, 1986, and produce, among other items, "All books and records used to determine gross receipts, cost of sales and expenses" with respect to their precious metals business for 1983 and 1984. In response to the letter, petitioner and her husband furnished some of the records that were requested. No1989 Tax Ct. Memo LEXIS 68">77 meeting, however, took place. By letter dated April 4, 1986, Troester advised petitioner and her husband that the records they furnished were incomplete and inadequate. He requested that they meet with him and produce complete inventory, sales and expense records. Petitioner and her husband, by their attorney, informed Troester that the records previously provided were all that were available for 1983 and 1984. They again declined to meet with him. Troester found no difference in the type of business records maintained and produced by petitioner's husband for 1983 and 1984 with those that were maintained and produced for the years 1976 through 1982. That is, petitioner's husband maintained and provided incomplete records for purchases and business expenses and no records pertaining to inventory and income. In an attempt to determine the accuracy of the 1983 and 1984 returns, Troester contacted third parties and examined what little information was provided by petitioner and her husband. Troester determined that the expenses and costs of goods sold reported on the returns were greater than what could be verified and, therefore, overstated. Therefore, respondent determined1989 Tax Ct. Memo LEXIS 68">78 additional taxes for petitioner and her husband for 1983 and 1984 in the approximate amounts of $ 102,000 and $ 60,000, respectively. Petitioner's husband has admitted that the cost of goods sold and Schedule C business expenses claimed in the metals trading business were overstated on their 1983 and 1984 joint income tax returns. OPINION With one exception, 5 petitioner does not dispute the correctness of the deficiencies and additions to tax for 1983 and 1984. However, petitioner contends that she should be relieved of the joint and several liability imposed by section 6013(d)(3) for the deficiencies because she is an "innocent spouse" under section 6013(e). To obtain relief under section 6013(e), as amended by the Tax Reform Act of 1984, 6 the person claiming innocent spouse status must prove: (1) That a joint return has been made for the taxable year(s) at issue; (2) that on such return there is a substantial understatement of tax attributable to grossly erroneous items of the other spouse;1989 Tax Ct. Memo LEXIS 68">79 (3) that the spouse claiming relief did not know and had no reason to know of the substantial understatement when signing the return; and (4) that, after considering all the facts and circumstances, it would be inequitable to hold the spouse seeking relief liable for the deficiency in income tax attributable to the substantial understatement. See section 6013(e)(1); , affd. . Each of these requirements must be satisfied to obtain innocent spouse relief. The dispute between the parties is whether petitioner has satisfied the "knowledge" and "equity" requirements enumerated in section 6013(e)(1)(C) and (D), respectively. To satisfy the requirements of section 6013(e)(1)(C), petitioner must establish that in signing the 1983 and 1984 joint returns, she did not know and had no reason to know that there was a substantial understatement1989 Tax Ct. Memo LEXIS 68">80 of tax. Thus, it is not enough for petitioner to show that she lacked actual knowledge of the understatement. She must also show that she had no reason to know of the understatement. ; . This issue is essentially factual. In order to prove that petitioner had no reason to know of the understatement, she must convince us that a reasonably prudent person with her knowledge of the surrounding circumstances would not and should not have known of the omissions, keeping in mind her level of intelligence, education and experience. . We stated in , that "the standard to be applied is whether a reasonable person under the circumstances of the taxpayer at the time of signing the return could be expected to know" of the understatement. Applying this standard to the facts of the present case, we conclude that petitioner has failed to meet the test and is, therefore, not entitled to the relief afforded by section 6013(e). Petitioner1989 Tax Ct. Memo LEXIS 68">81 testified that she did not participate in the preparation of the 1983 and 1984 returns, review their contents or make any inquiries regarding the returns. She, therefore, concludes that she had no actual knowledge of the understatements of tax caused by her husband's gross overstatements of the business' expenses and costs of goods sold. This may be so. However, any claim that petitioner had no reason to know of the understatements stretches credulity. The facts of this case show that petitioner is an intelligent, mature and educated person who assisted her husband in running their precious metals trading business out of their home. It was the gross overstatement of the expenses and cost of goods of this business which created the understatements of tax at issue. At the time petitioner signed the 1983 and 1984 returns, she knew that her husband did not maintain complete and accurate business records. She also knew that the Internal Revenue Service had commenced a broad investigation involving their last 7 taxable years -- for which she knew that tax returns had not been filed -- and which focused upon the income derived from, expenses incurred and cost of goods sold in1989 Tax Ct. Memo LEXIS 68">82 the business. In addition, petitioner knew that as a result of the investigation, the Internal Revenue Service was claiming that a large amount of taxes was owed for those years. Hence, petitioner had reason to doubt the quality or accuracy of what her husband claimed on the 1983 and 1984 returns and, further, to doubt the sufficiency of the underlying documents and records. Petitioner was on notice that the amounts claimed on their returns may not have reflected reality. A spouse, such as petitioner, may in fact have no actual knowledge of irregularities in the return which she signs, but we cannot ignore matters which would have put her on notice that there may be irregularities. Accordingly, we hold that petitioner has not met her burden of showing that there were no facts within her knowledge, or as to which she was reasonably chargeable with knowledge or notice, from which a prudent taxpayer would have known of the substantial understatements of tax in the 1983 and 1984 joint returns. Petitioner thus fails to qualify as an innocent spouse for those years. It is, therefore, unnecessary for us to consider the contentions of1989 Tax Ct. Memo LEXIS 68">83 the parties with respect to the "equity" requirement of section 6013(e)(1)(D). We next address whether petitioner may utilize the income averaging method of calculating her 1983 and 1984 tax liabilities that is contained in sections 1301 to 1305. 7Without getting involved with the intricacies of the income averaging provisions, sections 1301 through 1305 generally provide income averaging for an eligible individual whose taxable income for the year in which averaging is elected (the computation year) exceeds 120 percent of his average taxable income in the 4 preceding years (base period years).8 In short, in order for petitioner's tax liability to be computed under the income averaging method, the correct taxable income for the base periods for both 1983 and 1984 must first be determined. Thus, the question of whether petitioner is entitled to average her income for 1983 and 1984 turns on whether she adequately established her correct taxable income for each of the base period years. .1989 Tax Ct. Memo LEXIS 68">84 For 1983, those years would be 1979, 1980, 1981 and 1982. For 1984, those years would be 1981, 1982 and 1983. We conclude that petitioner has not met her burden. Petitioner claims in her briefs that the figure to be used as her taxable income for each of the years 1979 through 1982 is $ 0. She argues that since respondent was unable to attribute any taxable income to petitioner for those base period years, she should be able to claim that she had no taxable income for those years. Petitioner is incorrectly attempting to place the burden of establishing her taxable income upon respondent. That burden is squarely upon petitioner. She must establish her correct taxable income with precise data necessary for the computation and that does not consist of merely the taxable income that the Internal Revenue Service can uncover. In this regard, petitioner presented no documentary evidence or testimony to establish1989 Tax Ct. Memo LEXIS 68">85 that she, in fact, had no taxable income. In fact, petitioner testified that she had an undisclosed amount of dividend income during those years. Furthermore, it also could have been argued that since petitioner was a co-owner of the precious metals business during the years at issue, a portion of the income from that business was attributable to her. Accordingly, we find that petitioner is not entitled to elect the income averaging method of calculating her 1983 and 1984 tax liability. To reflect the foregoing and the concessions of the parties, Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the years at issue. All rule references are to the Tax Court Rules of Practice and Procedure.↩*. Plus 50 percent of the interest due on the deficiencies pursuant to section 6653 (a) (2) ↩2. Petitioner's husband filed a separate petition with this Court (docket No. 11526-87) regarding respondent's determinations for the years at issue here. On May 2, 1988, we dismissed that case for Mr. Lukasiewicz's failure to prosecute.↩3. It was only after the investigation had progressed did it become evident that Marvin Lukasiewicz was using the name "Marvin Luke" for business purposes.↩4. Includes income from sources in addition to the precious metals business.↩5. Respondent had disallowed a Schedule A contribution deduction of $ 780 for the taxable year 1983. Respondent now concedes that petitioner is entitled to that deduction.↩6. The Tax Reform Act of 1984, Pub. L. 98-369, sec. 424(a), 98 Stat. 801-802, amended sec. 6013(e) retroactively to all years to which the Internal Revenue Code of 1954 applies. A transitional rule is applicable for returns filed before 1985.↩7. The Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2744, repealed the income averaging rules for tax years beginning after December 31, 1986.↩8. For computation years beginning after Dec. 31, 1983, the reference to 120 percent is changed to 140 percent and the reference to the average taxable income in the 4 preceding years is changed to the 3 preceding years.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620983/	D. H. Willey v. Commissioner.D. H. Willey v. CommissionerDocket No. 18503.United States Tax Court1950 Tax Ct. Memo LEXIS 22; 9 T.C.M. 1109; T.C.M. (RIA) 50299; December 7, 19501950 Tax Ct. Memo LEXIS 22">22 1. Respondent did not err in holding that money received by petitioner during the taxable year for sale of timber was ordinary income and not a capital gain. 2. Where petitioner failed properly to allege error in respondent's treatment of an item for the taxable year, and there has been no motion to conform the pleadings to the proof, the respondent must be sustained. L. F. Ratterman, C.P.A., 3529 Burch Ave., Cincinnati, O., for the petitioner. R. W. Harbert, Jr., Esq., for the respondent. 1950 Tax Ct. Memo LEXIS 22">23 RICEMemorandum Findings of Fact and Opinion This proceeding involves a deficiency in income tax of $4,211.18 for the taxable year 1944. The issue to be decided is whether money received for the sale of timber in 1943 was capital gain or ordinary income. Petitioner also contends that the Commissioner allowed an item to be treated as income for 1944 which should have been treated as income for 1945. Findings of Fact Petitioner is an individual who filed his income tax return for the taxable year with the collector of internal revenue for the first district of Ohio. During 1943 and 1944, petitioner was president of the D. H. Willey Lumber Company, located in Cincinnati, Ohio. Petitioner, who is on the cash basis, owned about 5000 acres of standing timber in Alabama. In 1944 he received $8,212.40 for standing timber sold in 1943 under an oral contract to one P. M. Karr. This sum of $8,212.40 was not included in petitioner's income tax return for 1944. Mr. Karr had a small sawmill near the timber land. He selected the timber he wanted and used it for a high priority order which he had during the war emergency. He was not an employee of petitioner during the time in question, 1950 Tax Ct. Memo LEXIS 22">24 but merely watched over the land for petitioner who had known Karr for about 25 years. Opinion RICE, Judge: The issue which we must decide arises as a result of a prior proceeding before this Court in which we held that the present petitioner had erroneously included $8,212.40 in his income tax return for the taxable year 1943. 1 This amount is properly includible in the 1944 income tax return and the only contention is whether it represents ordinary income under section 22(a) of the Internal Revenue Code, or gain from the sale of capital assets under section 117. Respondent argues that it is ordinary income since it constitutes receipt of income from the sale of property held primarily for sale to customers in the ordinary course of trade or business. Property so held is excluded from the definition of "capital assets" in section 117(a). Under the evidence in this case we are unable to hold that such property was a capital asset. In order that a taxpayer who sells timber might be entitled1950 Tax Ct. Memo LEXIS 22">25 to the benefits of the capital gains provision of the law, many factors must be considered. Cf. U.S. v. Robinson, 129 Fed. (2d) 297; Commissioner v. Boeing, 106 Fed. (2d) 305; Carroll v. Commissioner, 70 Fed. (2d) 806; Camp Manufacturing Company, 3 T.C. 467">3 T.C. 467. We are unable to conclude from the facts presented in this case whether the Commissioner erred in disallowing the capital gain treatment. Since petitioner failed to meet his burden of proof, respondent's determination will be sustained. During the course of the trial, petitioner introduced evidence which intended to show that $7,226.05 for sale of timber in 1944 to P. M. Karr was received in 1945 and, therefore, should not have been included in the 1944 income tax return. However, since the petitioner failed to plead this properly as an error, and we find no motion by petitioner to amend his pleadings to conform to his proof, we must uphold the respondent on this question. Decision will be entered for the respondent. Footnotes1. D. H. Willey, et al., docket nos. 10864, 11911, 11912 and 12597, memorandum findings of fact and opinion, entered July 29, 1948 [7 TCM 454↩,].	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620985/	THE W. K. HENDERSON IRON WORKS & SUPPLY CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.W. K. Henderson Iron Works & Supply Co. v. CommissionerDocket Nos. 518, 3555, 10501.United States Board of Tax Appeals6 B.T.A. 92; 1927 BTA LEXIS 3598; February 9, 1927, Promulgated 1927 BTA LEXIS 3598">3598 In the absence of evidence showing that additional compensation was paid or accrued during 1918, the respondent's disallowance of the deduction on account thereof is sustained. There being no evidence as to the reasonableness of such additional amounts as compensation for 1919, no deduction is allowable in the latter year. Yandell Boatner, Esq., for the petitioner. Thomas P. Dudley, Jr., Esq., for the respondent. MILLIKEN 6 B.T.A. 92">92 These proceedings result from the determination by respondent of deficiencies in income and excess-profits taxes for the years 1918 to 1921, inclusive. The deficiency in tax for the year 1918 is less than $10,000. For the year 1919, the deficiency is $2,954.63, and for the two years 1920 and 1921, there is a deficiency of $10,810.02. The three appeals, filed for the four years in question, were consolidated at date of hearing. Petitioner alleged errors in the computation of the deficiencies in question, raising the issues that a reasonable rate of depreciation had not been allowed; that certain expense items had been disallowed, and that invested capital had been improperly decreased for certain of the years in question. 1927 BTA LEXIS 3598">3599 These three assignments of error were specifically waived and withdrawn by petitioner at the hearing, leaving only one issue involved in these proceedings, and that relates to the disallowance by the respondent of deductions for additional salaries for the years 1918 and 1919. FINDINGS OF FACT. Petitioner is a Louisiana corporation with its principal office in Shreveport. Its business is the manufacture and sale of machinery and supplies; its books of account were maintained and its income and profits-tax return was filed on the calendar year basis. During the year 1918 the total sales of the petitioner approximated $750,000, its physical properties were assessed at over $1,000,000 for city, county and State tax purposes, and the weekly pay roll during the year was approximately $7,500. During 1918 the principal officers of the petitioner were a president, vice president and general manager. The president, W. K. Henderson, died in September, 1918, and upon the death of the father, his son W. K. Henderson, Jr., became president of the petitioner for the period September, 1918, to December 31, 1918. His services to the petitioner consisted largely in arranging for necessary1927 BTA LEXIS 3598">3600 finances to secure the efficient operation of the business. W. S. Duncan, 6 B.T.A. 92">93 the vice president and general manager, was in charge of production during the year 1918. A salary of $6,666.68 was paid W. K. Henderson, Sr., during the year 1918, as president of petitioner for the period January 1, 1918, to the date of his death. W. K. Henderson, Jr., was paid a salary of $3,333.33 during the year 1918 for services performed during the period September to December 31, 1918. W. S. Duncan was paid during the year 1918 a salary of $7,149.96 for services rendered during the year 1918. Some time during the latter part of 1918 or the first part of 1919, W. K. Henderson, jr., and W. S. Duncan discussed the matter of the adequacy of the salaries they were receiving from the petitioner for the services they had performed and were performing. During the course of their conversation Henderson agreed with Duncan that their salaries were inadequate and they both decided that they should each receive an additional salary of $10,000 for the year 1918 for services rendered during the year 1918. During 1919, $20,000 was credited as additional compensation to W. K. Henderson, Jr., and W. 1927 BTA LEXIS 3598">3601 S. Duncan. In his individual income-tax return for 1918, W. K. Henderson, Jr., included the additional $10,000 thus credited to him and paid the tax due thereon. No directors' meetings were held nor were minutes recorded, with respect to the additional compensation which W. K. Henderson, Jr., and W. S. Duncan agreed upon for services rendered during the year 1918. OPINION. MILLIKEN: Section 234(a)(1) of the Revenue Act of 1918 provides that, in computing the net income of the corporation, there shall be allowed as deductions all of the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for services actually rendered. We were not informed whether the petitioner maintained its books of account upon the cash receipts and disbursements basis of upon the accrual basis. If upon the former, the additional salaries sought to be deducted from income, for the year 1918, must have been actually paid. The additional salaries were not paid during the year 1918. If the books of account were maintained upon the accrual basis for the year 1918, a liability must1927 BTA LEXIS 3598">3602 have been incurred in that year to pay the additional salaries in question, in order that the salaries could be claimed and allowed as a deduction in computing net income. The president of the petitioner testified that he was unable to state whether the agreement concerning the additional salaries for the year 1918 was entered into in the year 1918 or the year 1919, and consequently no liability to pay additional salaries having been 6 B.T.A. 92">94 proven for the year 1918, no deduction from income can be allowed therefor. Petitioner avers that if the additional salary deductions are not allowed for the year 1918, the same certainly consitutes a deductible item from income for the year 1919 when the salaries were actually paid. It may be that such additional salaries paid in 1919, when added to the regular salaries paid in 1919, constitute a reasonable compensation for personal services actually rendered in that year, but we have no evidence before us concerning the salaries paid, services performed, or the volume or character of business done during the year 1919, and we are, accordingly, without the necessary facts to determine the issue for that year. Judgment will be entered1927 BTA LEXIS 3598">*3603 for the respondent on 15 days' notice, under Rule 50.ARUNDELL and PHILLIPS dissent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620986/	MICHAEL JOHN KENDEL AND LIDDI KENDEL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentKendel v. CommissionerDocket No. 2389-82.United States Tax CourtT.C. Memo 1985-527; 1985 Tax Ct. Memo LEXIS 103; 50 T.C.M. 1279; T.C.M. (RIA) 85527; October 9, 1985. Michael John Kendel, pro se. Charles O. Cobb, for the respondent. BUCKLEYMEMORANDUM OPINION BUCKLEY, Special Trial Judge: This case was assigned to the undersigned pursuant to the provisions of section 7456(d)(3) of the Code 1 and General Order No. 8, 81 T. 1985 Tax Ct. Memo LEXIS 103">104 C. XXIII (1983). Respondent determined deficiencies in petitioners' income tax for 1977 in the amount of $1,985, for 1978 in the amount of $8,576, and for 1979 in the amount of $4,713. 2Petitioners, husband and wife, resided at 5809 Flambeau Road, Rancho Palos Verdes, California, at the time the petition was filed. Tax returns for 1977, 1978 and 1979 were timely filed at the Fresno, California, office of the Internal Revenue Service. Following an agreement between the parties, the issue remaining is whether petitioners may claim educational expenses for 1977 and 1978 in the amounts of $5,757.34 and $725.64, respectively, for a flight instruction course. 31985 Tax Ct. Memo LEXIS 103">105 Some of the facts have been stipulated to by the parties and are so found. The stipulation of facts, with attached exhibits, is hereby incorporated by reference. Petitioner Michael John Kendel has worked for United Airlines as a Flight Officer since 1964. Before December 2, 1977, he was a Flight Engineer (Second Officer). On December 2, 1977, he was promoted to Co-Pilot (First Officer). Petitioner took a flight instruction course in the operation of the Lear 25, a two-engine jet aircraft, between January 17 and March 8, 1977. The deduction itself is not questioned as a proper educational expense; rather, it is the amount of the deduction which presents the issue. Total cost of the flight instruction course was $5,757.34. Petitioners paid $5,031.70 in 1977 and $725.64 in 1978. The Veterans Administration reimbursed petitioner $4,433.47 of the amount expended in 1977 pursuant to 38 U.S.C. section 1677 (1976) (repealed in 1981). Under 38 U.S.C. section 3101(a), which excludes benefits payable to veterans, petitioners did not include the reimbursement in income. The amounts not reimbursed, $598.23 in 1977 and $725.64 in 1978, 1985 Tax Ct. Memo LEXIS 103">106 are agreed to be properly deductible. Petitioners deducted $5,031.70 in 1977 and $725.64 in 1978 on Schedule A as an "educational expense." The legislative history of the pertinent veterans' provisions does not show that Congress intended a veteran to have both an exemption and a tax deduction when reimbursed flight training expenses qualify as deductible business-related education. Manocchio v. Commissioner,78 T.C. 989">78 T.C. 989, 78 T.C. 989">997 (1982), affd. 710 F.2d 1400">710 F.2d 1400 (9th Cir. 1983). Indeed, section 265 was intended to prevent taxpayers from "reaping a double tax benefit by using expenses attributable to tax-exempt income to offset other sources of taxable income." Manocchio v. Commissioner,supra,78 T.C. 989">78 T.C. 997. The Court recognizes the position taken by the Eleventh Circuit in Baker v. United States,748 F.2d 1465">748 F.2d 1465 (11th Cir. 1984). However, as petitioners are within the Ninth Circuit, we are constrained to follow the Manocchio decision. Golsen v. Commissioner,54 T.C. 742">54 T.C. 742, 54 T.C. 742">756-757 (1970). Petitioners followed Rev. Rul. 62-213, 1962-2 C.B. 59, which held "expenses for education, paid or1985 Tax Ct. Memo LEXIS 103">107 incurred by veterans, which are properly deductible for Federal income tax purposes, are not required to be reduced by the nontaxable payments received during the taxable year from the Veterans' Administration." Before petitioner filed his petition on February 1, 1982, but after the tax years in question, respondent issued Rev. Rul. 80-173, 1980-2 C.B. 60, which "distinguished and clarified" Rev. Rul. 62-213. This later ruling held: Provided it is determined that a deduction is allowable to the taxpayer under section 162 of the Code and section 1.162-5 of the regulations, the taxpayer may not deduct * * * under section 162 of the Code, * * * the amount of the reimbursement to the taxpayer by the Veterans' Administration under 38 U.S.C. section 1677. Whether [the remaining expense] is deductible will depend on all the facts and circumstances in each case. The holding applies only to reimbursement payments made under 38 U.S.C. section 1677. For treatment of subsistence and educational allowance payments made under 38 U.S.C. section 1681 (1976), which are not reimbursement payments determined1985 Tax Ct. Memo LEXIS 103">108 by reference to amounts actually expended for tuition and fees, but rather are in the nature of a living stipend determined without regard to amounts expended, see Rev. Rul. 62-213, 1962-2 C.B. 59. Rev. Rul. 80-173, 1980-2 C.B. 60, 61. 4Rev. Rul. 80-173 does not specify that it is to be prospective only in application, thus it is automatically deemed to have retroactive effect. Manocchio,supra,78 T.C. 989">78 T.C. 1000. The Commissioner has discretion under section 7805(b) to decide whether regulations and revenue rulings will be applied retroactively and he will not ordinarily be estopped from correcting a mistake1985 Tax Ct. Memo LEXIS 103">109 of law. Manocchio,supra,78 T.C. 989">78 T.C. 1000-1001. The Commissioner's discretion will be upheld unless unconscionable injury or undue hardship is suffered by the taxpayer due to his reliance on the Internal Revenue Service's position or if there is an unfair disparity of treatment of similarly situated taxpayers. Mannochio,supra, and cases cited therein. As in Manocchio, petitioners here present a story of reliance on respondent. We believe that petitioners did rely on Rev. Rul. 62-213. However, petitioners have shown no exceptional injury caused by such reliance, and thus the retroactivity of Rev. Rul. 80-173 will be enforced. See also Becker v. Commissioner,85 T.C. 291">85 T.C. 291 (1985). The Manocchio result controls here for the following reasons. First, it is likely that petitioner would still have taken the course, even if he had known the deduction was not available due to the tax-free 90-percent reimbursement, the tax deduction for the remaining 10 percent and the improvement in skills required in petitioner's business. Secondly, requiring petitioner to pay the tax owing is not a sufficient injury1985 Tax Ct. Memo LEXIS 103">110 to militate against the Commissioner's discretion. Nor do we find an unfair discrimination by respondent, as only the inclusion of benefits pertaining to flight training, which are determined by reference to the cost of the training were changed. For other benefits which are allocable to both a class of nonexempt income and a class of exempt income, "a reasonable proportion hereof determined in the light of all the facts and circumstances in each case shall be allocated to each." Rev. Rul. 83-3, supra. As the taxpayer incurred educational expenses for which tax exempt income was received, permitting him to also deduct the entire educational expense would lead to a double benefit not allowed under section 265. Under the allocation method, the taxpayer may deduct the nonreimbursed amount. The rationale of section 265, disallowing deductions allocable to income exempt from tax, is a rational basis to treat the two reimbursements differently for tax purposes. We conclude that respondent correctly disallowed the deduction claimed for reimbursed flight training expenses. To give effect to concessions made in the stipulation of the parties, Decision will be entered1985 Tax Ct. Memo LEXIS 103">111 under Rule 155.Footnotes1. Section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. This case was originally filed under section 7463. Petitioner made an oral motion to remove the case from the small case category, which was unopposed by respondent. Petitioner's motion was granted.↩3. Petitioners had claimed net operating loss deductions from 1975 and 1976 in the amount of $60,244 for 1977, $49,144 in 1978, and $5,288 in 1979. Pursuant to the agreement, petitioners may claim a net operating loss carryover from 1976 in the taxable year of 1977 for the amount of $9,901.51. The remaining deductions of net operating loss carryforwards are disallowed.↩4. A third revenue ruling has now been issued, specifically revoking Rev. Rul. 62-213. Rev. Rul. 83-3, 1983-1 C.B. 72. That ruling holds that "the amount of the itemized deductions for tuition, books and other expenses connected with further education must be decreased to the extent the expense is allocable to the amounts received for such expenses from the Veterans' Administration * * *." Rev. Rul. 83-3, supra↩ at 73. A formula is then given for the allocation.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620987/	George C. Westervelt, Petitioner, v. Commissioner of Internal Revenue, RespondentWestervelt v. CommissionerDocket No. 7706United States Tax Court8 T.C. 1248; 1947 U.S. Tax Ct. LEXIS 167; June 26, 1947, Promulgated 1947 U.S. Tax Ct. LEXIS 167">167 Decision will be entered for the respondent. 1. During a portion of the taxable year 1941 petitioner was engaged in constructing a shipyard in Houston, Texas. His family resided in Florida in the family home throughout 1941, except between school terms, when they visited Houston and various places in Texas and rented a house in Santa Fe, New Mexico. After finishing at the shipyard in November petitioner resided in New York. At the end of the school term in 1942 his family joined him and they have continued to reside in New York. Held, petitioner is not entitled to report any part of his income on a community property basis.2. Petitioner made several trips during 1941 collecting data and information regarding thoroughbred cattle procedures and grasses for pasture lands and investigating land and other items in connection with the cattle business. He deducted his traveling expenses on the trips as ordinary and necessary expenses of a cattle business. Held, petitioner has failed to establish that he was engaged in carrying on the cattle business in the taxable year or that the expenditures were ordinary and necessary expenses of a trade or business in which he was 1947 U.S. Tax Ct. LEXIS 167">168 engaged. John Dwight Sullivan, Esq., for the petitioner.William F. Evans, Esq., for the respondent. Arnold, Judge. ARNOLD 8 T.C. 1248">1248 This proceeding involves an income tax deficiency for 1941 of $ 14,731.24. Two issues are presented: (1) Whether petitioner's salary and certain dividends were community income, and (2) whether traveling expenses in the amount of $ 769.80 were expenses of a trade or business.FINDINGS OF FACT.The petitioner filed his income tax return for the taxable year with the collector of internal revenue for the second district of New York. 8 T.C. 1248">1249 The address given upon his return, 27 William Street, New York, N. Y., was the office address of his employer. Petitioner's wife filed her income tax return with the collector of internal revenue for the district of Florida. The address given on her return was 1014 Hardee Road, Coral Gables, Florida.For the period 1934 to 1940, inclusive, the petitioner, a retired captain of the United States Navy, lived with his family, his wife and two daughters, at an established residence and domicile in Florida. He and his wife owned their home at the address given on her tax return in Coral Gables. His source1947 U.S. Tax Ct. LEXIS 167">169 of income was his retired pay and such amounts as he might make from some small investments or speculation. Up until October 1940 his time and attention were devoted almost exclusively to an attempt to develop a land area in Florida into a farming and cattle-raising area through a family corporation in which he was the majority stockholder.By the latter part of 1940 petitioner was convinced that this country's entry into the war was only a matter of time. He was 61 years of age and had been retired from the Navy for 13 years. In October 1940 he went to New York for consultation in connection with the manufacture of 3-inch guns and projectiles therefor. While in New York he also discussed associating himself with Admiral Frederick R. Harris, a naval engineer.At or about this time and while petitioner was in New York, he received orders from the Navy Department to report at Okalaka, Florida, on December 6, 1940, for a physical examination. If physically qualified he was ordered to report to Atlanta, Georgia, for active duty. Petitioner failed to qualify for active duty and returned the next day to New York.Following his return petitioner consummated an arrangement with Admiral1947 U.S. Tax Ct. LEXIS 167">170 Harris whereby he became associated with the latter in all of his activities, corporate and individual, except one. Under the arrangement petitioner was to participate to the extent of 20 per cent in the profits derived by the Harris organizations and in addition was to have a drawing account. The Harris organizations included the Frederick R. Harris Engineering Corporation, Construction Management, and Frederick R. Harris, Inc. The Harris organizations had their headquarters in New York and New Jersey, but they operated anywhere in the world that work was offered. Petitioner's arrangement provided that he should take specific charge of the shipbuilding, ship repair, and management activities of the Harris organizations.Petitioner's first assignment was in connection with the proposed construction of a shipyard at Houston, Texas, for the Todd Shipbuilding Corporation, which was then negotiating for a contract with the U.S. Maritime Commission. In anticipation of the Todd interests 8 T.C. 1248">1250 securing the contract, petitioner, as the representative of the Harris organizations, went ahead with the preliminary plans so that construction of the shipyard and the building of ships1947 U.S. Tax Ct. LEXIS 167">171 could start as soon as the contract was secured.In the latter part of December 1940 petitioner returned to Florida to spend the Christmas holidays with his family. He left Florida three or four days after Christmas for Houston on a preliminary survey of the proposed shipyard.During November and December 1940 and January 1941, petitioner wrote his mother and brother, who resided in Texas, and a friend in Texas, about his personal plans. Statements therein were to the effect that he was leaving Florida; that the girls would have to finish the school year and then the family would join him wherever he was; that he had no plans for disposing of his Florida property, as market conditions were unfavorable; that if the war lasted as long as he thought it would "we shall probably wash up here"; that maybe "we can work out some way of living in Texas"; that he would like living in Texas and believed his family would too; and that he hoped the family would like Texas as it "is quite likely we may live there permanently."Petitioner arrived in Houston on or about January 2, 1941, and made his temporary headquarters at the Rice Hotel, awaiting execution of the contract between Todd Shipbuilding1947 U.S. Tax Ct. LEXIS 167">172 Corporation and the Maritime Commission. With the execution of the contract on January 11, 1941, the Todd organization created a separate corporation, Houston Shipbuilding Co., which was financed by the Todd Shipbuilding Corporation. Petitioner was made vice president and general manager of the new corporation. He occupied this position as the representative of the Harris organizations and for the purpose of carrying out their contract with the Todd interests, which was to design, build, organize, and manage the Houston shipyard. Petitioner received a salary of $ 12,000 at first and later a salary of $ 18,000. This salary, while paid to petitioner by Houston Shipbuilding Co., was a part of the earnings of the Harris organizations and it was taken into account in determining the profits in which petitioner shared. Petitioner remained at the Rice Hotel while the shipyard was being constructed, except for a period of about two weeks in the summer, when his wife and family were in Houston. After a two-day stay at the Rice Hotel, petitioner and his family moved to another hotel because the Rice management objected to the presence of the family dog.When petitioner left Florida for1947 U.S. Tax Ct. LEXIS 167">173 Houston late in December 1940 his family continued to reside in their home at Coral Gables. He took none of his personal property to Texas except his wearing apparel and things of that kind. His personal automobile was stored in Florida. 8 T.C. 1248">1251 His daughters were attending a private school and their tuition was paid to the end of the school year. His family remained in Florida until the end of the school term in or about May 1941. When the school term ended the home in Coral Gables was closed, and petitioner's family went to Houston. After about two weeks in Houston with petitioner, the family went to Santa Fe, New Mexico, where they rented a house for about six weeks. From Santa Fe the family went to Fort Davis, Texas, for a visit, then to San Antonio, Texas, for a visit with petitioner's mother. After the visit in San Antonio petitioner's family visited ten days or two weeks with him in Houston. They then returned to Florida, reopened their home in Coral Gables, and the girls reentered school. Petitioner's family remained in their Coral Gables home until the end of the school year in May 1942, when they closed their home in Coral Gables, stored the furniture, and joined1947 U.S. Tax Ct. LEXIS 167">174 petitioner in New York. Petitioner's household furniture remained in storage in Florida until the latter part of 1945. The family home in Coral Gables was sold in July 1945.Petitioner's stay in Houston was terminated on or about November 15, 1941. By that time the plans for the shipyard had been completed. The first 6 ways were practically completed, ships had been laid on at least 5 of the ways, an organization of 15,000 people had been built up, and other management had been put in charge. The incidents of World War II and the demands on the Harris organizations by the Navy Department and others had increased to such an extent that petitioner returned to New York to handle the shipbuilding repair and the management activities of the widespread Harris organizations.The construction job which petitioner supervised at Houston was an exceedingly high pressure job. It took all the hours a day that he had to put in on it. The shipyard plant was built under wartime conditions so that ships could be turned out as quickly as possible. The demands of the job would have prevented petitioner from giving much time to his family if he had brought them to Houston. Conditions in Houston1947 U.S. Tax Ct. LEXIS 167">175 were so uncertain and indefinite that petitioner deemed it inadvisable to break up his Florida home and take his daughters out of school.In 1940 petitioner voted in the State of Florida. He did not vote during the taxable year in Florida or elsewhere. In 1942 he voted in New York City.On his income tax return for the taxable year petitioner reported as community income, received as a resident of Texas from February 20 to November 15, inclusive, two-thirds of his retirement pay, or $ 3,000; salary payments from the Houston Shipbuilding Co. of $ 12,750; and payments from the Harris organizations of $ 35,300, or a total of $ 51,050. One-half thereof, or $ 25,525, was reported by 8 T.C. 1248">1252 petitioner, together with sums received before arriving and after leaving Texas, as his individual income, and the other half was reported by his wife on her return for the taxable year. During the same period petitioner received corporate dividends aggregating $ 285. One-half thereof was reported by petitioner on his 1941 income tax return and the other half was reported on the income tax return of his wife as her share of community income. Other corporate dividends received by petitioner 1947 U.S. Tax Ct. LEXIS 167">176 during 1941 were reported as his individual income.During 1941 petitioner's domicile was in the State of Florida. His intention to abandon his Florida domicile and establish a permanent home elsewhere did not crystallize until after the taxable year.On his return for the taxable year petitioner deducted $ 769.80 as travel expenses. The deduction was explained in a schedule attached to his return as follows: "One phase of business activity was connected with investigation of land, and of matters connected with cattle, with the intention of going into the cattle business at a favorable time. Foundation laid for this through purchase of cattle from Hudgins Farm, Hungerford, Texas. Actual activity still in primary stages of investigation and examination, and collection of information and data, although cattle for foundation herd have been contracted for."The schedule showed the following amounts as business expenses:Jan. 7-14Trip from N. Y. C. to Florida, to Texas, to N. Y. C.$ 163.00Apr. 19-20Houston, Corpus Christi, Kingsville, Brownsville157.00May 1-5Trip to North Florida from Houston and return129.60July 4-7Round trip Houston and Santa Fe, New Mexico182.55Aug. 24-26Houston to Brownsville, and return56.40Sept. 26-28Round trip Houston, Austin, San Antonio81.25Total769.801947 U.S. Tax Ct. LEXIS 167">177 Petitioner was individually interested in getting into the cattle business. In the taxable year he had only a few cattle in Florida and Texas. His foundation herd was acquired in Texas subsequent to the taxable year. His trips in 1941 were partly in connection with his cattle buying in Texas, partly for collecting data and information regarding certain thoroughbred cattle procedures, growing grasses for improved pastures, and investigating land and other items in connection with the cattle business, and partly in making arrangements for carrying on the cattle business in Texas and in Florida. His trips were usually made in a hired automobile, but his January trip was by train and his July trip was by airplane. On his April trip petitioner bought some bulls from the King ranch near Kingsville, Texas. At the time he made his airplane trip to Santa Fe, New Mexico, petitioner's family was living in Santa Fe.8 T.C. 1248">1253 Petitioner was not engaged in the cattle business during the taxable year.OPINION.The principal issue is whether certain compensation and dividends received by petitioner while in Texas constituted community income. Petitioner's right to report this income as income1947 U.S. Tax Ct. LEXIS 167">178 of the marital community depends in the first instance upon whether he abandoned his Florida domicile and established a new domicile in Texas. As proof that he effected a change in his domicile, petitioner offered his own testimony and certain letters which he contends show his intention to change his domicile. Respondent contends that petitioner's domicile remained in Florida during the taxable year and that petitioner is not entitled to return the income in question as community income under the laws of Texas."Residence in fact, coupled with the purpose to make the place of residence one's home, are the essential elements of domicile." Texas v. Florida, 306 U.S. 398">306 U.S. 398, 306 U.S. 398">424, 83 L. Ed. 817">83 L. Ed. 817, 59 S. Ct. 563">59 S. Ct. 563. A change of domicile requires an abandonment of the old and an acquisition of a new domicile, coupled with the intention of making the last acquired residence a permanent home. Lee Rosenberg, 10 B.T.A. 601">10 B.T.A. 601; affd., 37 F.2d 808">37 F.2d 808, and authorities cited. The courts regard abandonment or change of domicile as a very serious matter and an intention to make a change requires proof by very satisfactory evidence. Samuel W. Weis, 30 B.T.A. 478">30 B.T.A. 478, 30 B.T.A. 478">487,1947 U.S. Tax Ct. LEXIS 167">179 and cases there cited. Residence alone is neither conclusive nor sufficient evidence of a change in domicile, Mitchell v. United States, 88 U.S. 350">88 U.S. 350, 21 Wall. 350; 1, 22 L. Ed. 584">22 L. Ed. 584Weis case, supra.1947 U.S. Tax Ct. LEXIS 167">180 Both parties agree and we have found as a fact that petitioner's established residence and domicile in 1940 was in Florida. Petitioner has shown that he left Florida with the possibility in mind that he might give up his Florida home at some time in the future. He has shown that he resided in Texas for about nine months while constructing the shipyard at Houston. His letters to friends and relatives show that he was considering the possibility of settling his family permanently in Texas. But the letters, his own testimony, and his conduct show that he never established a home in Texas. His family never actually resided with him in a home in Texas. They 8 T.C. 1248">1254 visited him after school was out in the summer of 1941 for two weeks or so, and then rented a house in Santa Fe, New Mexico. They visited him again on the way back to their Florida home, prior to the girls' reentry into school in the fall term of 1941. His family did not again return to Texas. By the middle of November 1941 his duties with the Harris organizations required him to be in New York. It was to New York that he moved his family at the end of the school year in May 1942. The most that can be said for 1947 U.S. Tax Ct. LEXIS 167">181 petitioner's residence in Texas is that it was transitory. Whatever consideration he had given to making Texas his permanent home was put aside and forgotten before any positive steps were taken to abandon his Florida home and establish a new home in Texas. His home in Texas was primarily a hotel room. He lived practically out of a suitcase. By his own admissions conditions were too unsettled and uncertain in Houston to break up his Florida home and settle his family in Texas. We agree with respondent that petitioner's domicile in 1941 was in Florida.Furthermore, it is doubtful whether petitioner could qualify as a resident under the laws of Texas. Article 2958 of the Texas Revised Civil Statutes, which relates to residence, provides in part as follows:The "residence" of a single man is where he usually sleeps at night; that of a married man is where his wife resides, or if he be permanently separated from his wife, his residence is where he sleeps at night; * * In Fidelity Deposit Co. of Maryland v. First National Bank of Teague, 113 S.W.2d 622">113 S.W.2d 622, the Texas court, speaking with reference to article 2958, and particularly with reference1947 U.S. Tax Ct. LEXIS 167">182 to that portion thereof which provides that the residence of a married man is where his wife resides, stated: "While said article is primarily an election statute, the rules for determining residence prescribed therein have been applied in other civil cases."The remaining issue is whether $ 769.80 expended by petitioner was for ordinary and necessary expenses of a trade or business deductible under section 23 (a) (1) (A) of the Internal Revenue Code. We can not agree with petitioner that he was engaged in carrying on a cattle business during the taxable year. His testimony shows that the expenses claimed as deductible were traveling expenses. The trips were preparatory to entering the cattle business. Petitioner was collecting data, investigating lands and methods used in the cattle business and grasses for pasture land, seeking a foundation herd, and acquiring bulls for his foundation herd, which he acquired subsequent to the taxable year. Petitioner's testimony is general in character. He produced no books of account of the cattle business, no receipts, no canceled checks or stubs, and no breakdown showing railroad and airplane fares, car hire, hotel bills, or other items1947 U.S. Tax Ct. LEXIS 167">183 making up the $ 769.80 total. Except for the April trip, petitioner made no effort to identify 8 T.C. 1248">1255 any trip with a business purpose. We can not assume that his trip to Santa Fe in July was for the purpose of inspecting Hereford cattle. If that was the purpose of the trip, he should have so testified. Every opportunity was afforded him on cross-examination to give in detail the business purposes of the several trips. It may well be that some of the expenditures were capital in nature, but the evidence here will not justify this classification. It is sufficient for our purposes to hold, as we do, that the expenditures were not ordinary and necessary expenses of a trade or business carried on by the taxpayer.Decision will be entered for the respondent. Footnotes1. "The court's opinion in this case sets forth the following principles regarding domicile (p. 353):"A domicile once acquired is presumed to continue until it is shown to have been changed. Where a change of domicile is alleged the burden of proving it rests upon the person making the allegation. To constitute the new domicile two things are indispensable: First, residence in the new locality; and, second, the intention to remain there. The change cannot be made except facto et animo↩. Both are alike necessary. Either without the other is insufficient. Mere absence from a fixed home, however long continued, cannot work the change. There must be the animus to change the prior domicile for another. Until the new one is acquired, the old one remains. These principles are axiomatic in the law upon the subject."	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620988/	PATRICIA GAIL CREWS, TRUSTEE, TRANSFEREE, THE O'NAN FAMILY TRUST, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCrews v. CommissionerDocket No. 5262-86United States Tax CourtT.C. Memo 1988-462; 1988 Tax Ct. Memo LEXIS 496; 56 T.C.M. 306; T.C.M. (RIA) 88462; September 26, 1988Joel L. Wertheim, for the petitioner. Magda Abdo-Gomez, for the respondent. WELLSMEMORANDUM FINDINGS OF FACT AND OPINION WELLS, Judge: By notice of liability dated December 10, 1985, respondent determined that petitioner was liable as transferee1988 Tax Ct. Memo LEXIS 496">497 for the tax liability of Roy I. and Madeline P. O'Nan, who had been assessed a deficiency of $ 177,795.34 for taxable year 1969, and an addition to tax for fraud of $ 88,897.67 under section 6653(b). 1 Respondent determined that petitioner was liable only to the extent of $ 131,400, the value of the transferred property when transferred. The issues for decision are the existence and extent of transferee liability. PRELIMINARY MATTER Respondent's notice of liability names Patricia Gail Crews in her capacity as trustee of "The O'Nan Family Trust," an entity which will be discussed later in this opinion. Yet, in her opening statement at trial, counsel for respondent stated "we are here against Ms. Patricia Gail Crews and not against a trust." As an initial matter, we must decide who is before the Court, Ms. Crews, individually, or the trust. As stated, the notice of liability issued in this case names Ms. Crews in her fiduciary capacity. The petition1988 Tax Ct. Memo LEXIS 496">498 filed by Ms. Crews is similarly captioned and verified by Ms. Crews as trustee. Based upon those facts, we hold that Ms. Crews in her individual capacity is simply not before this Court. We are, rather, confined to deciding the liability of Ms. Crews in her fiduciary capacity. In Shea v. Commissioner,31 B.T.A. 513">31 B.T.A. 513, 31 B.T.A. 513">514 (1934), the taxpayer's case was dismissed for lack of jurisdiction, because respondent had issued a notice of deficiency to "Mrs. Mary M. Shea, Trustee" and Mrs. Shea's petition denied her status as a fiduciary. The Board explained, "The law, * * * recognizes as separate entities a fiduciary of a trust and the same person acting in his individual capacity." Thus, Mrs. Shea's personal liability could not be adjudicated, because the statutory notice named her in a fiduciary capacity. In Estate of Eversole v. Commissioner,39 T.C. 1113">39 T.C. 1113, 39 T.C. 1113">1118 (1963), this Court had jurisdiction over a fiduciary in her individual capacity, but only because the statutory notice named her twice, once as a fiduciary and again as an individual. In the instant1988 Tax Ct. Memo LEXIS 496">499 case, respondent failed to take this precaution. See also Estate of Dupuy v. Commissioner,48 T.C. 918">48 T.C. 918, 48 T.C. 918">920 (1967) (separate statutory notices sent to individuals/fiduciaries); Estate of Meyer v. Commissioner,58 T.C. 69">58 T.C. 69, 58 T.C. 69">72 (1972). Furthermore, section 6213(a) proscribes the assessment of tax until after (1) a statutory notice has been mailed to the taxpayer and (2) the expiration of 90 (or 150) days thereafter or, if a petition is filed with this Court, the conclusion of litigation. We simply have no jurisdiction to decide whether Ms. Crews is liable as a transferee in her individual capacity, as she has never been issued the requisite statutory notice. Only the trust, through Ms. Crews as trustee, has received such notice. Finally, Rule 41(a) states in pertinent part, "No amendment shall be allowed after expiration of the time for filing the petition, however, which would involve conferring jurisdiction on the Court over a matter which otherwise would not1988 Tax Ct. Memo LEXIS 496">500 come within its jurisdiction under the petition as then on file." Respondent's request that we impose personal liability upon Ms. Crews amounts to a request that the notice of liability, the petition, and the answer be amended to substitute Ms. Crews, individually, as the taxpayer. Such an amendment is proscribed by Rule 41(a). Respondent argues that Ms. Crews, individually, is the true transferee, citing Fla. Stat. Ann. section 689.07 (West 1969), which states in relevant part, Every deed or conveyance of real estate * * * in which the word "trustee" or "as trustee" are added to the name of the grantee, and in which no beneficiaries are named nor the nature and purposes of the trust, if any, are set forth, shall grant * * * a fee simple estate with full power and authority in and to the grantee in such deed to sell, convey and grant and encumber * * * the real estate conveyed, unless a contrary intention shall appear in the deed of conveyance * * * The statute, at first blush, appears to support respondent, as the deed at issue fails to either name the trust beneficiaries whom Ms. 1988 Tax Ct. Memo LEXIS 496">501 Crews represents or set forth any other information about the trust. The statute excepts from its scope deeds which are accompanied by a recorded declaration of trust, but no recordation occurred here. Were we to accept respondent's position, we would be required to set aside the determination of liability against the trust, because only a transferee can suffer "transferee" liability. We decline, however, respondent's offer of self-sacrifice before this Court. The statute cited in support of respondent's argument, Fla. Stat. Ann. section 689.07 (West 1969), is not automatically applied to every conveyance in which a deed fails to specify trust beneficiaries or terms. Rather, the statute is intended to benefit creditors who have extended credit to trustees in reliance upon the trustees' purported outright ownership of property held in trust. Arundell Debenture Corporation v. Le Blond,139 Fla. 668">139 Fla. 668, 190 So. 765">190 So. 765, 190 So. 765">767 (1939). The statute allows those creditors to treat trust property as property held outright by the trustees. In the instant case, we hold that the statute does not apply, because it would truly be anomalous to use a statute designed for the protection1988 Tax Ct. Memo LEXIS 496">502 of creditors to frustrate the efforts of respondent, who is, as will be explained, a defrauded creditor. Further, the parties have stipulated to a transfer to "Patricia Gail Crews, trustee." Rule 91(e) prevents respondent from contradicting stipulated facts under the circumstances present herein. For the foregoing reasons, we find that Ms. Crews received the transferred property in her capacity as trustee of The O'Nan Family Trust. FINDINGS OF FACT Petitioner resided at Miami Lakes, Florida, when she filed her petition. Petitioner is the daughter of Roy I. and Madeline P. O'Nan (the "O'Nans"). On January 18, 1978, respondent issued a notice of deficiency to the O'Nans. The notice determined a deficiency of $ 648,265 for taxable year 1969, and an addition to tax for fraud of $ 324,132 under section 6653(b). The O'Nans filed a petition with this Court, and their case was tried from December 9, 1980, through December 11, 1980. We filed our opinion in that matter on January 28, 1982, in the case entitled Mandina v. Commissioner,T.C. Memo. 1982-34, affd. 758 F.2d 1399">758 F.2d 1399 (11th Cir. 1984).1988 Tax Ct. Memo LEXIS 496">503 On February 25, 1983, we entered our decision pursuant to that opinion, finding the O'Nans liable for a deficiency of $ 177,795.34, and an addition to tax for fraud of $ 88,897.67 under section 6653(b). The O'Nans filed an appeal, which was dismissed voluntarily. Approximately six months before our opinion was filed, the O'Nans created a family trust and transferred their residence and its furnishings to petitioner in her capacity as trustee. The transfer of the residence, located at 81 S. Royal Poinciana Boulevard, Miami Springs, Florida, and its contents occurred on August 24, 1981. On that date, the O'Nans and petitioner executed "The O'Nan Family Trust Agreement" (the "trust agreement"), and the O'Nans executed a warranty deed for the residence and a bill of sale transferring its contents. The parties, by stipulation, have valued all of the transferred property at $ 130,000 on the date of transfer. That amount does not reflect $ 1,600 of mortgage debt against the property. The trust assumed such debt on the transfer. The trust agreement gives the O'Nans the benefit of the trust property for their lives. Upon the death of both O'Nans, the trust property is to be distributed1988 Tax Ct. Memo LEXIS 496">504 to the O'Nans' children, James M. O'Nan, Roy J. O'Nan, Donna C. Fitts, and petitioner. The O'Nans received no direct consideration for the transfer in trust, but the $ 1,600 mortgage debt has been paid in full with funds pooled by the O'Nans' children, including petitioner. Further, the O'Nans' children, including petitioner, have pooled funds to pay certain expenses associated with the residence, specifically, real property taxes and premiums for casualty insurance. Those taxes total approximately $ 1,800 per year, while the insurance premium is $ 350 per year. The O'Nans purchased the residence in 1960 and have lived there since that time. In the year of transfer, 1981, they received wages of $ 2,477.97 and social security benefits of $ 8,616. After the transfer, their only assets were a checking account with an average balance in 1981 of $ 150 and a $ 5,000 life insurance policy with a $ 200 cash surrender value. Their liabilities after the transfer, in addition to the tax liability accrued for 1969, consisted of an $ 1,800 loan from Gulf Life and judgments totalling $ 3,000 in favor of Diners Club, Inc., American Express, Visa, and Master Charge. The O'Nans tax liability,1988 Tax Ct. Memo LEXIS 496">505 now assessed, remains outstanding. Respondent has made various efforts to collect the tax assessed against the O'Nans. Respondent has filed notices of lien for the deficiency and addition to tax which are dated August 19, 1983, and December 21, 1983, respectively. A notice dated June 20, 1983, requests payment of the $ 177,795.34 deficiency, as well as interest of $ 214,772.79. Mr. O'Nan has testified that it is not possible to recover the assessed liability from the O'Nans. Respondent filed a notice of lien dated July 24, 1985, against "The O'Nan Family Trust," naming petitioner in her capacity as trustee of the trust and "nominee" of the O'Nans. This notice purports to secure an unpaid balance of $ 392,568.13. On December 10, 1985, respondent issued the notice of liability which is the subject of the instant proceeding. OPINION Section 6901 states that the liabilities of transferees of property "shall * * be assessed, paid, and collected in the same manner * * * as in the case of taxes with respect to which the liabilities were incurred * * ." While section 6901 provides1988 Tax Ct. Memo LEXIS 496">506 the mechanism for enforcing transferee liability, the "existence and extent of [transferee] liability" are issues to be determined according to State law. Commissioner v. Stern,357 U.S. 39">357 U.S. 39, 357 U.S. 39">45 (1958). Further, the burden of proving transferee liability (but not the underlying tax liability) rests with respondent. Section 6902(a); Rule 142(d). As petitioner and the O'Nans resided in Florida at all relevant times and the transferred property is situated in that state, Florida law determines the validity of the property transfer to petitioner. Thomson v. Kyle,39 Fla. 582">39 Fla. 582, 23 So. 12">23 So. 12 (1897). Fla. Stat. Ann. section 726.01 (West 1988) states in pertinent part, Every * * * conveyance, * * * of lands, * * * and of goods and chattels, * * * contrived or devised of fraud, covin, collusion or guile, to the end, purpose or intent to delay, hinder or defraud creditors or others of their just and lawful actions, * * * shall be from henceforth as against the person or persons, * * * so intended to be delayed, hindered or defrauded, deemed, held, adjudged and taken to be utterly void, * * . 21988 Tax Ct. Memo LEXIS 496">507 Florida courts construing the foregoing statute have held that a conveyance will be presumed fraudulent if the transferor retains possession of the transferred property. Jones v. Wear,111 Fla. 69">111 Fla. 69, 149 So. 345">149 So. 345, 149 So. 345">348 (1933). A prima facie case of fraudulent conveyance is also presented when the transferee is a close relative of the transferor. Gyorak v. Davis,183 So. 2d 701">183 So. 2d 701, 183 So. 2d 701">703 (Fla. Dist. Ct. App. 1966). Both of those factors taint the transfer at issue. Yet, respondent has gone beyond presently merely a prima facie case. Florida law deems a transfer fraudulent when sufficient indicia or "badges" of fraud surround the transaction. In the instant case respondent has demonstrated that the conveyance to petitioner embraces almost every badge of fraud cited by the Florida courts. In Wieczoreck v. H & H Builders, Inc.,450 So. 2d 867">450 So. 2d 867, 450 So. 2d 867">873-874 (Fla. Dist. Ct. App. 1984), the court itemized those "badges" of fraud, as follows: The factors which are recognized in these cases as indicia of fraud are numerous. Generally, the most important1988 Tax Ct. Memo LEXIS 496">508 * * are the insolvency or indebtedness of the transferor; lack of consideration, or in some cases grossly inadequate consideration, for the conveyance; retention by the debtor of possession of the property; or a relationship between the transferor and the transferee; the reservation of benefit to the transferee; the pendency or threat of litigation; secrecy or concealment; and the transfer of the debtor's entire estate. In United States v. Fernon,640 F.2d 609">640 F.2d 609 (5th Cir. 1981), a son received real property from his parents while they were liable for tax deficiencies. After the son conveyed the property to himself and his wife as tenants by the entireties, the government brought suit against the son and his wife, alleging the initial transfer to be fraudulent. The trial court entered judgment against the defendants for the value of the transferred property as of the date of transfer. The appellate court affirmed the trial court's judgment, applying Florida law and citing the following factors: 1) lack of consideration for the transfer, 2) the relationship between the transferors and the transferee, and 3) the insolvency or "substantial indebtedness" of the transferors.1988 Tax Ct. Memo LEXIS 496">509 640 F.2d 609">640 F.2d at 613. Almost every factor cited in Fernon and Wieczoreck is present in this case. First, the O'Nans were insolvent when they transferred property to petitioner. The accrued tax liability for 1969, as well as other debts owed by the O'Nans, greatly exceeded their modest resources. Although the O'Nans' tax liability for 1969 was not finally adjudicated until 1983, for the purpose of determining the solvency, the liability accrued at the end of the taxable year. Kreps v. Commissioner,42 T.C. 660">42 T.C. 660, 42 T.C. 660">670 (1964), affd. 351 F.2d 1">351 F.2d 1 (2d Cir. 1965). Further, under Florida law, "substantial indebtedness" of a transferor can substitute for insolvency as a badge of fraud. Wieczoreck,450 So. 2d 867">450 So. 2d at 873. The accrued liability to respondent clearly qualified as substantial indebtedness. Second, even if petitioner's assumption of the $ 1,600 mortgage against the residence is characterized as consideration, it was "grossly inadequate consideration" for the transfer of a residence and furnishings stipulated to have been worth $ 130,000 when transferred. Third, the O'Nans retained possession following the transfer. 1988 Tax Ct. Memo LEXIS 496">510 Fourth, the transferee is a trust whose trustee is the transferors' daughter and whose beneficiaries are the transferors and their children. Finally, the transfer occurred during the pendency of the O'Nans' litigation before this Court, in fact just months prior to the date we filed our opinion finding the O'Nans liable. In sum, the transfer at issue could not more closely resemble a fraudulent conveyance. Petitioner argues that the transfer should be respected because the O'Nans did not intend to defraud respondent. Petitioner asserts that the O'Nans placed the property in trust to facilitate its distribution after their deaths and to ensure that costs, e.g., taxes, would be paid during their remaining lives. We find the O'Nans' subjective intent irrelevant to our conclusion. In Stelle v. Dennis,104 Fla. 384">104 Fla. 384, 140 So. 194">140 So. 194, 140 So. 194">195 (1932), the court stated, "when the legal effect of a conveyance is to defraud creditors, no matter what the actual intention may have been, it is fraud in law." The objective facts of the instant case reveal that the transfer rendered the O'Nans1988 Tax Ct. Memo LEXIS 496">511 incapable of meeting their obligation to respondent. Even if the O'Nans' subjective intent were determinative or relevant, we reject as unworthy of belief the testimony of petitioner and of the O'Nans' to the effect that the O'Nans placed the property in trust to further their retirement security and as an alternative means of testamentary disposition. The circumstances surrounding the transfer, particularly the litigation in this Court, clearly indicate that the principal purpose of the transfer was to place the property beyond respondent's reach. We find that any other motives, if they did indeed exist, were incidental to that purpose. Petitioner also argues that Fla. Stat. Ann. section 726.01 (West 1988) insulates a transfer for "good consideration" to a transferee without knowledge of the fraudulent purpose of the transferor. We agree with that interpretation of the statute. The parties have stipulated, however, that the O'Nans transferred property worth $ 130,000 in return for $ 1,600 of debt relief. By no stretch of our imagination can it be said that petitioner supplied "good1988 Tax Ct. Memo LEXIS 496">512 consideration." Thus, even if we were to accept petitioner's claim that she received the property while ignorant of the O'Nans' tax proceedings, our conclusion would remain unchanged. Based upon the foregoing we find that the O'Nans' transfer of their residence and its furnishings to petitioner was fraudulent under Florida law. Petitioner is therefore liable as transferee of the O'Nans. Having determined that petitioner is liable as transferee of the O'Nans, we next decide the extent of liability. Respondent's notice of liability states that petitioner's liability is limited to $ 137,400, the value of the transferred assets when transferred. Since the parties subsequently, at trial, stipulated that the assets were in fact worth $ 130,000 when transferred, we tentatively set petitioner's liability at $ 130,000. United States v. Fernon,640 F.2d 609">640 F.2d at 614 n.11; cf. Lowy v. Commissioner,35 T.C. 393">35 T.C. 393, 35 T.C. 393">395-396 (1960). In Stokes v. Commissioner,22 T.C. 415">22 T.C. 415, 22 T.C. 415">428 (1954), we held that the amount of mortgage debt against transferred property1988 Tax Ct. Memo LEXIS 496">513 reduces the amount of the fraudulent transfer. Thus, we reduce the liability by the amount of the mortgage assumed by petitioner and hold petitioner liable as transferee of the O'Nans in the amount of $ 128,400. Finally, Florida law gives respondent the right to statutory interest on petitioner's liability. In Lowy v. Commissioner,35 T.C. 393">35 T.C. 395, we recognized that when the underlying tax liability is greater than the value of the transferred assets, State law may permit "interest * * on the amount of the transferred assets, measured from a point of time that would not be earlier than the date of transfer." Here, Florida law grants prejudgment interest whenever "a verdict has the effect of fixing damages as of a prior date." Argonaut Insurance Co. v. May Plumbing Co.,474 So. 2d 212">474 So. 2d 212 (Fla. 1985) (citing Bergen Brunswig Corp. v. Stat Department of Health and Rehabilitative Services,415 So. 2d 765">415 So. 2d 765, 415 So. 2d 765">767 (Fla. Dist. Ct. App. 1982)). Florida law liberally grants prejudgment interest, and damages need not be readily ascertainable1988 Tax Ct. Memo LEXIS 496">514 prior to trial in order to earn interest. Cf. Taylor v. New Hampshire Insurance Co. of Manchester,489 So. 2d 207">489 So. 2d 207 (Fla. Dist. Ct. App. 1986) (prejudgment interest awarded in action for recovery pursuant to fire insurance policy). Our decision in this case fixes petitioner's liability as of the date of transfer. Cf. 42 T.C. 660">Kreps v. Commissioner, supra at 670 ("transferee is retroactively liable for transferor's taxes in the year of transfer and prior years, * * to the extent of the assets received from the transferor, even though the transferor's tax liability was unknown at the time of transfer." Emphasis supplied.).3 Respondent is thus entitled to 6-percent interest on $ 128,400 from the date of transfer, August 24, 1981, to June 30, 1982, and 12-percent interest on $ 128,400 from July 1, 1982, until the date of the notice of liability, December 10, 1985. 41988 Tax Ct. Memo LEXIS 496">*515 To reflect the foregoing, Decision will be entered for the respondent in the amount as decided above.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect for the taxable year is issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. ↩2. In 1987, Florida adopted the Uniform Fraudulent Transfer Act. 1987 Fla. Laws, c.87-89, sec. 1. Yet, the quoted language governs transactions in the year of the subject transfer, 1981. ↩3. We imposed liability for prejudgment interest from the date of transfer in two other Florida cases: Borg v. Commissioner,T.C. Memo. 1987-596, and Stone v. Commissioner,T.C. Memo. 1985-405↩. 4. Fla. Stat. Ann. sec. 687.01 (West 1988) sets the current rate of statutory interest at 12 percent. Prior to July 1, 1982, a 6-percent rate was in effect. 1982 Fla. Laws, c. 82-42, sec. 1. Prejudgment interest awarded under Stat law stops accruing upon the date of statutory notice. Thereafter, interest is a matter of Federal law under the Internal Revenue Code. Estate of Stein v. Commissioner,37 T.C. 945">37 T.C. 945, 37 T.C. 945">959-961↩ (1962).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620989/	BAILEY DENTAL CO. OF IOWA, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Bailey Dental Co. v. CommissionerDocket No. 3950.United States Board of Tax Appeals11 B.T.A. 860; 1928 BTA LEXIS 3706; April 27, 1928, Promulgated 1928 BTA LEXIS 3706">3706 1. Salaries not authorized by corporate action not deductible as ordinary and necessary expense. 2. Proof insufficient to establish right to relief under sections 327 and 328 of the Revenue Act of 1918. G. D. Shepherd for the petitioner. Philip M. Clark, Esq., for the respondent. LANSDON 11 B.T.A. 860">860 The respondent asserts a deficiency in income and profits tax for the year 1919 in the amount of $1,044.41. The petitioner contends that certain amounts distributed to its officers as dividends should be regarded as salaries incurred and paid within the taxable year, and that, if this contention is disallowed, it is entitled to have its tax liability for such year computed under the provisions of section 328 of the Revenue Act of 1918. 11 B.T.A. 860">861 FINDINGS OF FACT. The petitioner is an Iowa corporation with its principal office at Omaha, Nebr. During the taxable year it was engaged in the practice of dentistry at Council Bluffs and Sioux City, Iowa, and at Omaha, Nebr. In the taxable year R. W. Bailey and D. J. Shepherd each owned 50 per cent of the stock of the petitioner, and both were officers of the corporation. Each of the officers1928 BTA LEXIS 3706">3707 devoted about one-fourth of his time to the affairs of the petitioner. They visited the several offices regularly, planned policy and work, had general supervision and direction of all operations, hired by trained dentists and laboratory workers, and assumed personal responsibility for all expenses. Neither was paid any salary for services rendered. Within the time prescribed by law, the petitioner filed an income-tax return for the year 1919 as a personal service corporation, and set forth therein, that the amount of $1,500 had been paid to each of the two officers as their respective shares of the earnings of the corporation for such year. Upon audit the respondent disallowed personal service classification, held that the amounts paid the officers were dividends, determined net income for the year in the amount of $6,372.89, and asserted the deficiency in income and profits tax here in controversy. OPINION. LANSDON: The petitioner herein does not now seek personal service classification, but contends that the amounts distributed to its two officers in the taxable year as dividends should be regarded as salaries and deducted from its gross income for such year as ordinary1928 BTA LEXIS 3706">3708 and necessary business expenses, or that, if this contention is disallowed, its tax liability should be computed under the provisions of section 328 of the Revenue Act of 1918. The record supports the petitioner's contention that two of its officers rendered some services to it during the year in question, and that it paid no salaries to them. Each of the two officers received $1,500 in dividends. There is no evidence that the salaries claimed were authorized prior to or in the taxable year either by formal or informal corporate action. There was no accrual of such salaries on the books of the petitioner. We are of the opinion, therefore, that no liability for the payment thereof was incurred. When ; ; affirmed by the Court of ; . 11 B.T.A. 860">862 In support of its alternative contention for special assessment, the petitioner relies on section 327 of the Revenue Act of 1918. The language of such section pertinent to this controversy is as follows: 1928 BTA LEXIS 3706">3709 (d) Where upon application by the corporation the Commissioner finds and so declares of record that the tax if determined without benefit of this section, would, owing to abnormal conditions affecting the capital or income of the corporation, work upon the corporation an exceptional hardship evidenced by gross disproportion between the tax computed without benefit of this section and the tax computed by reference to the representative corporations specified in section 328. The only abnormality alleged by the petitioner is that disallowance of the deduction herein claimed as ordinary and necessary expenses incurred in earning this income which the respondent seeks to tax increases its net taxable income in the amounts disallowed and so increases its excess profits tax, and that it is, therefore, subject to an exceptional hardship as compared to other similar corporations which have been allowed to deduct all expenses incurred in producing income. The evidence is clear that the officers rendered some service to the petitioner in the taxable year, but, in the absence of any proof as to the reasonable value of such services, we can not say that the disallowance of the amounts in1928 BTA LEXIS 3706">3710 controversy as expenses resulted in an abnormality in income, or that the computation of the profits tax under section 301 works upon petitioner an exceptional hardship. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620991/	Samuel W. Meisel and Rose M. Meisel v. Commissioner.Meisel v. CommissionerDocket No. 411-66.United States Tax CourtT.C. Memo 1969-31; 1969 Tax Ct. Memo LEXIS 264; 28 T.C.M. 141; T.C.M. (RIA) 69031; February 13, 1969, Filed Herbert W. Mintz, for the petitioners. Paul H. Frankel, for the respondent. TANNENWALDMemorandum Findings of Fact and Opinion TANNENWALD, Judge: Respondent determined a deficiency of $42,417.18 in the petitioners' 1960 income tax. Certain issues have been conceded by the parties. The principal question remaining is whether a certain transfer of stock represented a bona fide sale on the installment basis. If that question is answered in the affirmative, there is a further issue as to whether certain payments to the transferor were loans or the proceeds from the disposition of installment obligations. Irrespective of the answer to the principal question, there is an additional issue as to whether certain payments with respect to these "loans" constituted deductible interest. Findings1969 Tax Ct. Memo LEXIS 264">265 of Fact Some of the facts are stipulated and are found accordingly. Petitioners (hereinafter referred to individually as Samuel or Rose) are husband and wife who had their legal residence in New York, New York, at the time of filing the petition herein. They filed a cash basis joint Federal income tax return for the taxable year 1960 with the district 142 director of internal revenue, Manhattan, New York. Eleanor M. Howard (hereinafter Eleanor) is the petitioners' daughter. Samuel has been a stockbroker since 1952 and has managed financial matters on behalf of Rose and Eleanor. Samuel arranged the intrafamily transactions in question; Rose and Eleanor participated only to the extent of signing papers at Samuel's request. S.W. Meisel Realty Corporation (hereinafter Realty) was a real estate corporation whose only significant asset was real property at Empire Boulevard and Bedford Avenue, Brooklyn, New York. It had owned this property since prior to 1952. Since the early 1950's, Eleanor owned an adjoining parcel of land at Bedford Avenue and Sullivan Place. At least until January 6, 1960, Rose owned Realty's one share of stock, constituting all of its issued and outstanding1969 Tax Ct. Memo LEXIS 264">266 stock, which she acquired in December 1945 for $5,000. On February 16, 1959, Realty adopted a plan of liquidation pursuant to section 337, Internal Revenue Code of 1954. On February 19, 1959, Realty and Eleanor entered into contracts for the sale of their adjoining properties to one Emanuel Lurio. Under this contract, the purchase price for the Realty property was $140,625, of which $100,000 was to be in the form of a 15-year purchase money mortgage. Because of difficulties in obtaining a zoning variance, these contracts were terminated in October 1959. At that time and until it was satisfied by a payment by Eleanor in December 1960, an architect's fee of $4,000 was unpaid and constituted a potential lien on the properties. On October 28, 1959, subsequent to the termination of the Lurio contracts, Realty entered into a Land Purchase Option Agreement with Esso Standard Oil Company (hereinafter Esso), which gave Esso an option to purchase Realty's property for $200,000, with a credit of the $1,500 paid for the option. Esso exercised this option on December 31, 1959 and paid Realty an additional $19,000 toward the purchase price. On January 6, 1960, Rose1969 Tax Ct. Memo LEXIS 264">267 transferred her Realty stock to Eleanor for $168,000. Eleanor agreed to pay $5,000 in 1960, and executed a series of ten $16,300 notes, bearing interest at 4 1/2 percent per annum, with one note due on each anniversary of the stock transfer for ten years. All notes maturing by the date of trial, together with the purported interest thereon, were paid. The closing of the sale of Realty's property to Esso was held on January 28, 1960. One hundred seventy-nine thousand, ninety-eight dollars and seventy four cents was paid in cash which, together with prior payments plus credits for taxes, water, and sewer aggregating $20,901.26, constituted the total purchase price of $200,000. Realty was dissolved on January 29, 1960 and $170,518 was distributed to Eleanor on that date. Eleanor made seven purported loans in varying amounts from $9,500 to $57,500 to Rose between February 1 and August 1, 1960, which totaled $171,500 and bore interest at the rate of 6 percent per annum. By January 12, 1968, these purported loans, together with the purported interest thereon, had been paid. Ultimate Findings of Fact The transfer of Realty stock from Rose to Eleanor was not a bona fide sale. 1969 Tax Ct. Memo LEXIS 264">268 The purported loans from Eleanor to Rose did not constitute a bona fide indebtedness, with the result that the purported payments for the use of the proceeds thereof were not interest. Opinion The principal issue to be resolved herein is whether the transfer of the Realty stock by Rose to Eleanor on January 6, 1960 was a bona fide sale. As our findings of fact reflect, we conclude that it was not. We see no need to detail the analysis of the evidence which underlies our conclusion. The various transactions were constructed with an obviously meticulous attention to detail. The elements which point in this direction are: (a) the variations among the amount distributed in liquidation of Realty ($170,518), the amount which Eleanor agreed to pay on the transfer of Realty stock ($168,000), and the amounts transferred by Eleanor to Rose ($171,500); (b) the differences in interest rate, 4 1/2 percent on the notes from Eleanor to Rose and 6 percent on the notes from Rose to Eleanor; and (c) the differences in times of payment by Eleanor to Rose and vice versa. Against these elements are the equally obvious elements 143 that the amounts are substantially the same, that an amount slightly1969 Tax Ct. Memo LEXIS 264">269 in excess of the proceeds of liquidation was funnelled into Rose's hands within approximately six months after Eleanor received the proceeds of liquidation, and that neither Eleanor nor Rose had any real knowledge of what was involved in the transactions between them. We were totally unimpressed by Samuel's efforts to construct a plausible explanation for the intra-family shuffling of funds. To be suse, there was some evidence of past borrowings by members of the family, but there was no evidence that Eleanor ever loaned significant, if any, amounts to Rose. The claim that the transfer of the Realty stock was designed to achieve a desired ownership of both parcels of property by Eleanor, principally because of prolonged absences from New York by Samuel and Rose, has a decidedly hollow ring; the family had owned both parcels and Samuel testified that he and his wife had been away from New York for six months of each year for 12 years prior to 1960. Likewise, the claim that the potential $4,000 lien was a substantial obstacle to a closing of the Esso sale, even if it has any bearing on the issue before us, is belied by the fact that the sale closed almost a year before the item was1969 Tax Ct. Memo LEXIS 264">270 paid. Moreover, we find it hard to believe that an item of $4,000 could possibly have caused Realty to allow the Esso deal to be cancelled, when we compare the much more favorable terms of that deal ($200,000, all cash) with that of the Lurio contract ($140,625, of which $100,000 was to be a mortgage). Finally, Samuel's claim that there was a substantial possibility that the Esso sale would not close is inconsistent with his claim that he was attempting, by the transactions between Eleanor and Rose, to establish a nest egg for his daughter. If that possibility was real, it made no sense to impose on Eleanor an obligation of $16,300 per year when the property appeared to have a potential rental income of only slightly in excess of this amount. We find nothing in the record before us which breathed life into petitioners' carefully conceived plan to minimize taxes. It had a stillbirth. Since we have determined that the transfer of the Realty stock from Rose to Eleanor was without substance, we need not consider whether the purported loans from Eleanor to Rose represented advance repayments of installment obligations. We do hold, however, and we have so found, that such purported loans1969 Tax Ct. Memo LEXIS 264">*271 did not constitute bona fide indebtedness, with the result that the so-called interest payments are not an allowable deduction. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620992/	William C. Byers and Bernice B. Byers v. Commissioner.Byers v. CommissionerDocket No. 46409.United States Tax CourtT.C. Memo 1955-45; 1955 Tax Ct. Memo LEXIS 293; 14 T.C.M. 153; T.C.M. (RIA) 55045; February 24, 19551955 Tax Ct. Memo LEXIS 293">293 1. Petitioner, William C. Byers, was president and majority stockholder of a corporation. The corporation gave him a certificate of indebtedness in return for advances which he had previously made to its predecessor proprietorship. This debt became worthless in 1950. Petitioners claimed a deduction for the entire amount of the debt on their return for that year. Held, this was a nonbusiness bad debt and petitioners' relief is limited to the provisions of section 23(k)(4) of the Code. 2. Petitioners claimed a deduction for unreimbursed expenses incurred in moving to another locality to accept new employment. Held, such expenses are nondeductible personal expenses. 3. Petitioners claimed various miscellaneous deductions from gross income. Held, on the facts, that such expenses are not allowable as deductions from either gross income or adjusted gross income. Harry H. Meisner, Esq., Box 367, Anchorage, Alaska, for the petitioners. Walter T. Hart, Esq., for the respondent. RICEMemorandum Findings of Fact and Opinion This proceeding involtes deficiencies in income taxes determined against petitioners for the years 1949 and 1950 in the amounts of $276.56 and $3,559.24, respectively. The issues to be decided are: (1) whether a $12,200 loss sustained by petitioner in 1950 was a business or a nonbusiness bad debt; (2) whether unreimbursed expenses incurred in moving to another locality to accept new employment are deductible expenses; and (3) whether certain miscellaneous expenses are deductible by petitioners for the year 1949. Findings of Fact William C. Byers and Bernice B. Byers are husband and wife residing in Cincinnati, Ohio. They filed joint income tax returns for the years 1949 and 1950 with the collector of internal revenue at Detroit, Michigan. On January 2, 1946, William C. Byers (hereinafter referred to as petitioner) purchased a gasoline and oil wholesale distribution business located in Indianapolis, Indiana. He operated1955 Tax Ct. Memo LEXIS 293">295 it as a sole proprietorship under the trade name of Triangle Oil Company until November 1946, when it was incorporated under the laws of the State of Indiana. Petitioner was president and the majority stockholder of the corporation (hereinafter sometimes referred to as Triangle). The only other stockholders were petitioner's son and his wife, the latter also acting as secretary and treasurer of the corporation. Due to the poor financial condition of the business, petitioner advanced approximately $12,000 to $14,000 to it from the time he purchased it until it was incorporated. Upon incorporation, Triangle gave a certificate of indebtedness to petitioner, pursuant to which the corporation promised to pay him the sum of $12,200 at some unspecified future date. The certificate stated that interest at the rate of 3 per cent per annum was to be paid annually. The certificate was signed by petitioner and his wife in their capacities as officers of the corporation. It was secured by a chattel mortgage upon the personal property of the corporation. Petitioner subsequently allowed the lien of such mortgage to be subordinated to an instrument of security favoring one of Triangle's creditors. 1955 Tax Ct. Memo LEXIS 293">296 This subordination was insisted upon by the creditor in exchange for the extension of a line of credit to Triangle. Petitioner devoted all of his time and attention to the business of the proprietorship and its successor corporation, Triangle, until July 1, 1947. On that date, he accepted a position as general sales manager for a concern in Cincinnati, Ohio. Thereafter, because of petitioner's absence from Indianapolis, his wife managed the affairs of the business, and petitioner's activities in connection with Triangle were restricted to weekends, which he spent in Indianapolis, and almost daily conferences with his wife by long distance telephone. In March or April of 1948, an arrangement was made with one Glen D. Holmes whereby he was to assist in the management of the business. In January of 1949, petitioner moved to New York City, accepting a position with the Packard Motor Company there. Petitioner lived in New York City until July 15, 1950, and his contact with the operation of Triangle was thereby still further reduced. During the period January through March of 1949, he made 2 or 3 trips by air to Indianapolis, and thereafter he had weekly long distance telephone conversations1955 Tax Ct. Memo LEXIS 293">297 with Holmes about the affairs of Triangle and received a monthly statement from him. Petitioner's wife resided in Cincinnati, Ohio, during the early part of 1949, and traveled to Indianapolis 2 or 3 times a week to confer with Holmes about the affairs of Triangle. She moved to New York City later in 1949. About May or June of 1950, Triangle was compelled to wind up operations as a result of involuntary receivership proceedings filed against it by its creditors in the Superior Court of Marion County, Indiana, Cause No. B-76948. Petitioner filed a claim for $13,697.87 in the receivership proceeding, said amount including the $12,200 evidenced by the certificate of indebtedness previously issued to him. The receiver disallowed the entire amount of this claim and the order of disallowance was sustained by the Superior Court of Marion County, Indiana, on April 6, 1954. Petitioners claimed a deduction on their joint return for the calendar year 1950 for a "bad debt loss to Triangle Oil Company" in the amount of $12,200. Said deduction has been disallowed by respondent. Petitioners reported gross income for 1949 and 1950 in the amounts of $12,937.40 and $26,755.88, respectively. All of1955 Tax Ct. Memo LEXIS 293">298 such income was earned by petitioner as an employee of various corporations, and no part of it was received as a result of his stock holdings in Triangle or because of his interests in or personal efforts on behalf of that company. Petitioner was reimbursed by the Packard Motor Company for part of the expenses incurred by him in connection with his move to New York City in January 1949. On their joint return for 1949, petitioners claimed a deduction from gross income of $1,498.92 as business expenses. Said amount was deducted from the total wages received by petitioner during 1949 as "business expenses not re-imbursed" to arrive at adjusted gross income. Schedule #1 attached to their 1949 return shows the details of the claimed $1,498.92 deduction from salary income as follows: Traveling and Automobile ExpensesExplanationAmountBusiness expenses incurred for Triangle Oil Co.(Taxpayer is president of company - expenses not reimbursed)Repairs, gas and oil$ 42.26Out of town business trips290.19$ 332.45Business expenses incurred for Packard Motor Company, Inc.Moving expenses from Detroit to New York$1,731.96Less: Re-imbursed by company715.221,016.74Rent on typewriter1.24Business envelopes9.26Depreciation on auto - 4 year life - cost $1,950.0050% used for business - seven months of 1949139.23$1,498.921955 Tax Ct. Memo LEXIS 293">299 In addition to the $1,498.92 deduction from gross income on their 1949 return, petitioners also claimed the $1,000.00 standard deduction from adjusted gross income in their computation of net income. Respondent disallowed $1,208.73 of the $1,498.92 deduction from compensation claimed by petitioners, allowing only the $290.19 claimed for "Out of town business trips." He determined that the $1,016.74 attributed to moving expenses was a nondeductible personal expense. He further determined that the following expenses, while allowable as itemized deductions from adjusted gross income, could not now be allowed because petitioners had taken a $1,000 standard deduction in lieu of such itemized deductions: Repairs, gas and oil$ 42.26Rent on typewriter1.24Business envelopes9.26Depreciation on auto139.23$191.99Opinion RICE, Judge: We must decide whether petitioner's failure to recover $12,200 on a certificate of indebtedness issued to him by a corporation of which he was the president and majority stockholder resulted in a business or a nonbusiness bad debt under section 23(k) of the Internal Revenue Code of 1939. 1 This issue has been before the Court1955 Tax Ct. Memo LEXIS 293">300 many times. Estate of William P. Palmer, Jr., 17 T.C. 702">17 T.C. 702 (1951); Jan G. J. Boissevain, 17 T.C. 325">17 T.C. 325 (1951); A. Kingsley Ferguson, 16 T.C. 1248">16 T.C. 1248 (1951). It is clear, from the facts of this case, that petitioners' relief is limited to the provisions applicable to nonbusiness bad debts. 1955 Tax Ct. Memo LEXIS 293">301 Petitioner was not in the business of lending money or organizing and financing corporations. He was not engaged in any business to which this loss can be attributed, for the business of the corporation cannot be treated as that of its stockholder or officer. Burnet v. Clark, 287 U.S. 410">287 U.S. 410 (1932). Consequently, this debt upon which petitioner failed to recover must be considered as a nonbusiness bad debt. Petitioners' reliance on cases allowing the deduction of losses under section 23(e) is inapposite since the item in issue is clearly a debt. Sections 23(e) and 23(k) are mutually exclusive and petitioners must, therefore, be restricted to the latter section which pertains to losses on debts. Spring City Co. v. Commissioner, 292 U.S. 182">292 U.S. 182 (1934). We turn next to the various deductions from gross income, aggregating $1,498.92, which were claimed by petitioners on their joint return for 1949. On brief, petitioners discard the itemization on their return. They now contend that all or most of the $1,498.92 was expended by them for unreimbursed travel expenses in connection with their employment as officers of Triangle. However, petitioners have failed to submit1955 Tax Ct. Memo LEXIS 293">302 any bills or records to substantiate the claimed expenses and we are convinced, on the basis of the record before us, that the amounts in question were expended in the manner originally itemized by petitioners on the Schedule attached to their return. In their itemized list, petitioners claimed that $290.19 was expended for "Out of town business trips" on behalf of Triangle and respondent has allowed this item. We are unable to see how any of the other items can be considered as unreimbursed travel expenses of an employee, deductible from gross income pursuant to section 22(n) of the Code. The largest item in issue, amounting to $1,016.74, was claimed as a deduction for petitioner's unreimbursed moving expenses to New York City. This must be disallowed since the expenses of moving to another locality to accept new employment are nondeductible personal expenses. York v. Commissioner, 160 Fed. (2d) 385 (C.A.D.C., 1947). As for the $42.26 attributed to "Repairs, gas and oil" and the $139.23 to "Depreciation on auto," it does not appear that these expenses could have been incurred by either of the petitioners in connection with travel as an employee on behalf of Triangle1955 Tax Ct. Memo LEXIS 293">303 during 1949. Petitioner resided in New York City during 1949, and we do not see how such automobile expenses could have been incurred by him on behalf of Triangle, which did a local business in and around Indianapolis, Indiana. Petitioner's wife resided in Cincinnati, Ohio, during the early part of 1949 and later moved to New York City. There is no evidence in the record that she used a car to travel on behalf of Triangle. During the period she was in Cincinnati, she did drive to Indianapolis 2 or 3 times each week in order to confer with Triangle's manager. If the automobile expenses in the itemized list were incurred by her in this fashion, rather than by petitioner, they are nevertheless nondeductible. An employee may not deduct the cost of commuting from his residence to his place of employment, no matter how distant it may be. Commissioner v. Flowers, 326 U.S. 465">326 U.S. 465 (1946); Henry C. Warren, 13 T.C. 205">13 T.C. 205 (1949); Beatrice H. Albert, 13 T.C. 129">13 T.C. 129 (1949). In order that a taxpayer's travel expenses be deductible under section 22(n), a proximate relation between such expenses and the taxpayer's duties as an employee must be shown. Douglas A. Chandler, 23 T.C. 653">23 T.C. 653,1955 Tax Ct. Memo LEXIS 293">304 filed January 19, 1955. This principle applies with equal effect to expenses which petitioner may have incurred as a result of 2 or 3 plane trips from New York City to Indianapolis, during 1949. The remaining deductions in issue consist of $1.24 for "Rent on typewriter" and $9.26 for "Business envelopes." Since petitioners elected on their joint return to take the optional standard deduction of $1,000, in lieu of itemized deductions from adjusted gross income, these items were properly disallowed. Decision will be entered for the respondent. Footnotes1. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: * (k) Bad Debts. - (1) General Rule. - Debts which become worthless within the taxable year; or (in the discretion of the Commissioner) a reasonable addition to a reserve for bad debts; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. * * This paragraph shall not apply in the case of a taxpayer, other than a corporation, with respect to a non-business debt, as defined in paragraph (4) of this subsection. * * *(4) Non-business Debts. - In the case of a taxpayer, other than a corporation, if a non-business debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months. The term "non-business debt" means a debt other than a debt evidenced by a security as defined in paragraph (3) and other than a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4620993/	Church of Scientology of California, Petitioner v. Commissioner Of Internal Revenue, RespondentChurch of Scientology v. CommissionerDocket No. 3352-78United States Tax Court83 T.C. 381; 1984 U.S. Tax Ct. LEXIS 30; 83 T.C. No. 25; September 24, 1984September 24, 1984, Filed 1984 U.S. Tax Ct. LEXIS 30">30 Decision will be entered under Rule 155. Petitioner, a Church incorporated in the State of California, was granted tax-exempt status in 1957 under sec. 501(c)(3), I.R.C. 1954. In 1967, respondent sent petitioner a letter revoking its exemption following an audit of petitioner's records which was in part sparked by litigation involving the tax-exempt status of an affiliated Church of Scientology. Subsequent to issuing the letter of revocation, respondent conducted several audits of petitioner's records for various tax years and also reviewed the tax status of several affiliated churches. Petitioner was also investigated by several intelligence groups which respondent specially formed during 1969 through 1975 to investigate taxpayers allegedly selected by essentially political criteria. During the period that petitioner's taxes were under administrative review, petitioner conspired to prevent the IRS from determining and collecting taxes due from petitioner and affiliated churches. Petitioner sold religious services, books, and artifacts according to a fixed-fee schedule through its branch churches and franchises. Petitioner's profits from these sales were not less than $ 1,494,617.53 1984 U.S. Tax Ct. LEXIS 30">31 in 1970, $ 881,131.18 in 1971, and $ 1,707,287.17 in 1972. Petitioner maintained large cash reserves in a sham corporation and in a bogus trust controlled by key church officials including petitioner's founder. Held, petitioner was not the victim of selective enforcement of the tax laws since the notice of deficiency was based on valid regulatory considerations. Held, further, various other asserted constitutional rights of petitioner not violated. Held, further, petitioner was not operated exclusively for an exempt purpose under sec. 501(c)(3), I.R.C. 1954, since petitioner had a substantial commercial purpose, since its net earnings benefited key Scientology officials, and since it had the illegal purpose of conspiring to impede the IRS from collecting taxes due from petitioner and affiliated churches and thus its activities, dictated at the highest level, violated well-defined public policy. Robert H. Harris, Christopher Cobb, Michael Wells, and Peter Young, specially recognized, for the petitioner.Martin D. Cohen, for the respondent. Sterrett, Judge. STERRETT83 T.C. 381">382 Petitioner, the Church of Scientology of California (California Church or Church), was incorporated as a nonprofit 1984 U.S. Tax Ct. LEXIS 30">32 corporation in the State of California in 1954. In 1957, respondent recognized petitioner as an organization described in section 501(c)(3)1 exempt from Federal income taxes under section 501(a). In 1967, respondent revoked petitioner's tax-exempt status. Following an extensive audit of petitioner's records for the year 1971-74, respondent, by notice of deficiency dated December 28, 1977, determined deficiencies in petitioner's Federal income taxes and additions to tax as follows: 83 T.C. 381">383 Addition to taxTaxable yearDeficiencyunder sec. 6651(a)1970$ 581,245.29$ 145,311.32197170,881.4817,720.371972498,332.10124,583.02The controversy in this case is simply stated: Petitioner claims it is exempt from taxation, and respondent claims it is not. Subsumed within this simple controversy, however, are numerous and complex subsidiary issues including several challenges to the constitutionality of section 501(c)(3). The questions presented for resolution in this case are:(1) Is the notice of deficiency null and void because respondent never issued 1984 U.S. Tax Ct. LEXIS 30">33 a final letter of revocation of exempt status?(2) Is the notice of deficiency or the letter revoking petitioner's tax-exempt status based upon political animus or hostility to the religion of Scientology in violation of the First and Fifth Amendments?(3) Do the express conditions in section 501(c)(3) for exempting religious organizations from taxation violate the First Amendment because they tax religious income?(4) Do the express conditions in section 501(c)(3) for exempting religious organizations from taxation violate the First Amendment because the Government has no compelling interest in taxing religious income?(5) Are the express conditions in section 501(c)(3) for exempting religious organizations overbroad provisions because they restrict commercial activity in aid of religion which is affirmatively protected by the free exercise clause?(6) Are the express and implied statutory conditions for exempting religious organizations from taxation unduly vague in violation of the First and Fifth Amendments?(7) Does section 501(c)(3) violate the establishment clause of the First Amendment because its enforcement advances some religions and inhibits others?(8) Does section 501(c)(3)1984 U.S. Tax Ct. LEXIS 30">34 violate the establishment clause because its enforcement results in excessive Government entanglement in church affairs?(9) Does the First Amendment's protection for religious organizations relieve petitioner of the burden of proof in this case and require respondent to assume it?83 T.C. 381">384 (10) Is the statutory scheme prohibiting some tax-exempt organizations but not others from using their net earnings to benefit private interests arbitrary and capricious?(11) Does the application of common law charitable trust doctrine to churches, requiring their conformity to fundamental public policy standards evidenced by criminal or civil statutes, violate the free exercise clause of the First Amendment because there are less restrictive ways of regulating church-sponsored misconduct?(12) Does the retroactive application of public policy standards derived from the common law of charitable trusts to petitioner's operations deprive petitioner of due process of law in violation of the Fifth Amendment?(13) May respondent, consistent with fairness, be heard to argue after the start of trial the new position that the United Kingdom Church of Scientology (United Kingdom Church) is a branch of petitioner?(14) 1984 U.S. Tax Ct. LEXIS 30">35 During the years 1970, 1971, and 1972 did petitioner's activities include a substantial commercial purpose?(15) During the taxable years in issue, did any part of petitioner's net earnings inure to the benefit of any private shareholder or individual?(16) During the taxable years in issue, did petitioner's activities violate common law standards of public policy applicable to charities and incorporated in section 501(c)(3)?(17) If petitioner is not exempt from taxation, can the determinations in respondent's notice of deficiency be upheld?(18) Is petitioner liable for additions to tax under section 6651(a) for willfully failing without reasonable cause to file corporate income tax returns (Forms 1120) in 1970, 1971, and 1972?FINDINGS OF FACTSome of the facts have been stipulated. They represent a miniscule part of the record. In some instances, the stipulated facts were contradicted by the remainder of the record. We, therefore, decline to incorporate in toto the stipulations of fact in our findings. Instead, we have made our own findings, giving weight to the stipulations only where their trustworthiness was not discredited by the remainder of the record.83 T.C. 381">385 Petitioner, the Church 1984 U.S. Tax Ct. LEXIS 30">36 of Scientology of California, was incorporated on February 18, 1954, as a nonprofit corporation in the State of California. When the petition herein was filed, petitioner's principal place of business was located at 5930 Franklin Avenue, Los Angeles, CA. Petitioner was one of many churches of Scientology organized worldwide. During the tax years at issue, 1970-72, it was considered the "Mother Church" of all churches of Scientology in the United States.The parties have stipulated that petitioner was organized exclusively for religious purposes and that petitioner has satisfied the organizational requirements found in section 1.501(c)(3)-1(b), Income Tax Regs. The Court adopts this stipulation and finds that petitioner was organized to propogate the faith of Scientology, a religion founded by L. Ron Hubbard, through such means as the indoctrination of the laity, the training and ordination of ministers, the creation of congregations, and the provision of support to affiliates and similar organizations.The ReligionScientology teaches that the individual is a spiritual being having a mind and a body. Part of the mind, called the "reactive mind" is unconscious. It is filled with 1984 U.S. Tax Ct. LEXIS 30">37 mental images that are frequently the source of irrational behavior. Through the administration of a Scientology process known as "auditing," an individual, called a "preclear," is helped to erase his reactive mind and gain spiritual competence. A trained Scientologist known as an "auditor" administers the auditing. He is aided by an electronic device called an "E-meter" which helps the auditor identify areas of spiritual difficulty for the preclear by measuring skin responses during a question and answer session.Scientology teaches that spiritual awareness is achieved in stages. The religion defines different levels of awareness and prescribes the requisite auditing to achieve each level. L Ron Hubbard researched and developed the spiritual awareness levels and the courses to train auditors. During the docketed years, L. Ron Hubbard continued this research. A chart entitled "Classification Gradation and Awareness Chart of Levels and Certificates" depicts levels of spiritual awareness 83 T.C. 381">386 and corresponding auditor training requirements in effect in 1970.One of the tenets of Scientology is that anytime a person receives something, he must pay something back. This is called the doctrine 1984 U.S. Tax Ct. LEXIS 30">38 of exchange. Petitioners branch churches applied this doctrine by exacting a "fixed donation" for training and auditing.Scientology is an international religion, and, during the docketed years, there were numerous churches of Scientology around the world. These churches were organized along hierarchical lines according to the level of services (training and auditing) they were authorized to provide. Churches which delivered Scientology services at the lowest levels were called "franchises" and later "missions." Churches which delivered auditing (also referred to as "processing") through Grade IV and training through Level IV as depicted on the Classification Gradation and Awareness Chart were known as "Class IV Orgs." Saint Hill Organizations and Advanced Organizations offered intermediate and higher level services. A branch of petitioner known as "Flag" offered the highest level training and auditing.Petitioner's branch churches were opened daily and nightly to provide auditing and training. Petitioner's ministers also officiated at weekly Sunday services and performed services such as marriages, baptisms, and funerals.Corporate StructureThe parties stipulated to seven divisions. 1984 U.S. Tax Ct. LEXIS 30">39 They are:(1) San Francisco Organization (SFO)(2) Los Angeles Organization (LAO)(3) American Saint Hill Organization (ASHO)(4) Advanced Organization of Los Angeles (AOLA)(5) Flag Operations Liaison Office (FOLO or FOLO WUS) (prior to June 6, 1972, known as United States Liaison Office (USLO))(6) Flag(7) United States Guardian Office (USGO)In addition to these seven stipulated divisions, we find that Scientology churches and organizations in the United Kingdom (hereinafter collectively referred to as the United Kingdom 83 T.C. 381">387 Church) were part of the California Church. Furthermore, the Operation Transport Corporation, Ltd. (also known as Operation Transport Services, OTC or OTS), a noncharitable Panamanian corporation, had no true, independent existence apart from petitioner's Flag division.A. The Stipulated DivisionsThe San Francisco Organization (SFO) and the Los Angeles Organization (LAO) were both "Class IV organizations." As such, they were authorized to conduct training through Class IV and auditing through Grade IV as depicted on the Classification Gradation and Awareness Chart. They were open 7 days a week for training and auditing and related activities. The American Saint Hill 1984 U.S. Tax Ct. LEXIS 30">40 Organization (ASHO) located in Los Angeles, like SFO and LAO, provided auditing and training, but at higher levels. ASHO also published and distributed Scientology books, prerecorded tapes, and E-meters throughout the United States. The staff at ASHO were mostly members of the Sea Organization, an elite order of Scientologists. The Advanced Organization of Los Angeles (AOLA) provided high levels of auditing and training to persons who had completed services at a Class IV organization. The staff at AOLA were mostly Sea Organization members, and the parishioners came from all over the United States and Canada.The Flag Operations Liaison Office (FOLO), located in Los Angeles, was an administrative unit of the California Church. 2 It did not provide religious services except to the staff. FOLO relayed administrative advice emanating from Flag, the headquarters of the California Church, to other branches of the California Church and to other Scientology churches. The staff at FOLO played a significant role in promoting the growth and development of Scientology by providing training to staff from other organizations, by supervising the implementation of new programs developed at Flag, 1984 U.S. Tax Ct. LEXIS 30">41 and by providing administrative assistance to new organizations. FOLO also relayed funds from other branches of the California Church and from other churches to Flag. The staff at FOLO were members of the Sea 83 T.C. 381">388 Organization. Other Scientology Churches in the United States and abroad had counterpart FOLO units.Flag was the highest division of the California Church. It provided spiritual leadership. It also acted as petitioner's administrative center. During the taxable years, the Flag division was headquartered aboard a ship, the Apollo, which cruised the Mediterranean Sea and docked in various countries along its shores. L. Ron Hubbard, his wife, Mary Sue, and their family lived on the Apollo with other members of the ship's crew and staff. All staff and crew were Sea Organization members. Flag also had two outposts: 1984 U.S. Tax Ct. LEXIS 30">42 The Tangier Reception Center (TRC) and the Mission European Agency (MEA). MEA served as a relay point for personnel, deliveries, and communications going to Flag, and TRC, among other things, housed the overload of students who came to Flag for training.Flag activities fell into three general areas, each conducted by a separate organization within Flag. The Flagship Organization was responsible for all nautical functions -- sailing, maintenance, and port relations. The Flag Administrative Organization provided religious and administrative training and auditing at the highest levels. The majority of the students who came to Flag for training were staff members sent from petitioner's other divisions or from other churches of Scientology. Students lived aboard the ship or stayed at TRC. After completing their course work they generally returned to their local organizations.The Flagship Bureau was petitioner's management body. This management function was fulfilled in a variety of ways which are only briefly recounted here. First, petitioner's other divisions and other churches sent reports on a regular basis to Flag. These reports supplied information, often in statistical form, 1984 U.S. Tax Ct. LEXIS 30">43 about the organizations' operations. Flag staff, on the basis of their review of these reports, issued policy letters, directives, and other kinds of administrative advice geared to improving local church operations. Second, Flag personnel researched and developed programs and techniques for improving the administration of local organizations. Finally, Flag sent teams of individuals specially trained in management techniques "on mission" to help other units or churches which were experiencing difficulties.83 T.C. 381">389 L. Ron Hubbard officially resigned his position as executive head of the California and other churches of Scientology in 1966. Despite his official resignation, various charts of petitioner depicting management functions during the docketed years continued to place him in the top position. He also held the rank of Commodore, the highest rank in the Sea Organization, which was an elite fraternity of Scientologists. He kept control over the California Church policy by authoring numerous policy letters and by allowing others to go out in his behalf. He also wrote other types of policy directives including Flag Orders, L. Ron Hubbard Executive Directives, and Orders of the Day. 1984 U.S. Tax Ct. LEXIS 30">44 He made important decisions affecting Church administration, transferring "U.S. Pubs" from the Denmark Church to ASHO and disbanding the Executive Council Worldwide which had overseen the day-to-day operations of the Church. He supervised the activities of the Franchise Office. Staff consulted with him before inaugurating major plans and whenever an operation of the Church was foundering.L. Ron Hubbard's control over petitioner's financial affairs was particularly notable and was long standing. In the years immediately preceding the taxable years, L. Ron Hubbard was a signatory on all churches of Scientology bank accounts including petitioner's. His approval was required for all financial planning. He was the sole "trustee" of a major Scientology fund into which petitioner made substantial payments. He decided to open Swiss bank accounts for petitioner and to put them in the name of OTC. He sent a Flag executive to AOLA to revamp its financial operations. He authorized the purchase of a ranch in Ensenada, Mexico, and wrote a check for $ 80,000 on one of petitioner's Zurich accounts for its purchase. His control continued during the docketed years. He remained a signatory 1984 U.S. Tax Ct. LEXIS 30">45 on petitioner's bank accounts including the OTC accounts. His approval was required for financial planning. He authorized the removal of huge sums of money from petitioner's Swiss bank accounts maintained in the name of OTC.Apart from his executive duties, L. Ron Hubbard also engaged in research and writing and supervised auditing.During the docketed years, L. Ron Hubbard was served by an executive group variously known as the Commodore's Staff 83 T.C. 381">390 Aids, the Aides Council, and the International Board of Scientology Organizations. Mary Sue Hubbard was the senior person on the Aides Council. The Aides Council had seven other members, one to oversee the planning for each division on the Scientology Org. Board. The Org. Board is a theoretical model or blueprint of the organization of a Scientology Church. All Scientology churches around the world were organized along similar lines. The Org. Board shows that each Scientology church was organized to have seven divisions and that each division carried on a specific function. Division 1, called the HCO Division, was responsible for communications. Division 2, called the Dissemination Division, was responsible for the dissemination of 1984 U.S. Tax Ct. LEXIS 30">46 Scientology literature, materials, and services. Division 3, called the Treasury Division, was responsible for finances. Division 4, called the Technical Division, was responsible for training and auditing. Division 5, called the Qualifications Division, was responsible for quality control in the delivery of services. Division 6, called the Distribution Division, was responsible for public relations, and Division 7, the Executive Division, was responsible for managing the organization and coordinating the programs and policies of the other divisions on the Scientology Org. Board. A member of the Aides Council called a CS-1, CS-2, etc., depending on the area of divisional responsibility, was in charge of the overall planning for each division. In sum, the Aides Council helped L. Ron Hubbard manage petitioner's operations and plan for churches of Scientology around the world.The CS-3 on the Aides Council was in charge of a Flag Banking Officer network. Each Scientology Organization offering advanced services had a Flag Banking Officer (FBO) who banked the organizations funds, reviewed and approved its weekly financial plan, and generally monitored its financial affairs. The FBO's 1984 U.S. Tax Ct. LEXIS 30">47 primary responsibility was to insure his church's solvency. The FBO was also responsible for collecting and sending to Flag weekly sums for support and training. The FBO network was international. During the taxable years in issue, the following branches of petitioner's stipulated divisions had an FBO: AOLA, ASHO, USLO, and Flag. A precise description of the FBO chain of command does not emerge from the record. However, it is clear that the top officials of the FBO network were the Flag FBO, the Staff Banking 83 T.C. 381">391 Officer (SBO), and the CS-3, all posted at Flag. The continental FBOs operated over the local FBOs, under the authority of the top officials of the network. At least during 1969, and perhaps during the docketed years, the FBO International, posted at AOLA, also exercised mid-level leadership.The United States Guardian Office (USGO) located in Los Angeles was in charge of petitioner's external affairs. Its chief responsibility was to safeguard petitioner's institutional well-being. Towards this end, it performed a number of functions. It handled petitioner's relations with other organizations including governmental bodies and agencies. It also handled legal matters for 1984 U.S. Tax Ct. LEXIS 30">48 petitioner and other churches of Scientology in the United States. It performed accounting services for petitioner and prepared petitioner's tax returns. It informed the public on a national level about the works and doctrines of Scientology and documented unfavorable or inaccurate public comment on Scientology. During the docketed years, the United States Guardian Office had five divisions: Legal, Public Relations, Finance, Intelligence, and Technology.The United States Guardian Office was part of an international network of Guardian offices and Guardian personnel. The highest ranking Guardian was Mary Sue Hubbard, L. Ron Hubbard's wife. She held the position of Commodore Staff Guardian (CSG). Although Mary Sue Hubbard lived on the Apollo and was the senior Guardian, the senior Guardian office, called The Guardian Office Worldwide, was part of petitioner's United Kingdom operations. Jane Kember, the Guardian Worldwide, headed the office. In addition to USGO and the Guardian Office Worldwide, the Guardian network consisted of Guardian personnel attached to other branches of the California Church and other churches of Scientology.B. United Kingdom ChurchThe notice of deficiency 1984 U.S. Tax Ct. LEXIS 30">49 issued on December 28, 1977, did not treat the United Kingdom Church as a branch of petitioner. It did not include the accounts of the United Kingdom Church, and specific transactions between the two Churches were treated as transactions between separate entities. Thus, payments made by the United Kingdom Church to petitioner's Flag branch were shown as income to petitioner and not as internal transfers of funds. Respondent's pretrial pleadings and memoranda, reflecting the notice of deficiency, also 83 T.C. 381">392 treated the United Kingdom Church as a separate entity from petitioner.The trial of this case began on November 10, 1980, and lasted 10 weeks, spread out over the course of a year. 31984 U.S. Tax Ct. LEXIS 30">51 The relationship between petitioner and the United Kingdom Church was first raised during the third week of trial, on December 11, 1980, immediately after petitioner rested its case-in-chief. Respondent raised the issue when he sought to introduce into evidence certain checks representing franchise payments drawn by the Calgary Scientology Mission and variously made payable to the Church of Scientology of California or the Church of Scientology of California, WW. Since Worldwide, or its abbreviation 1984 U.S. Tax Ct. LEXIS 30">50 "WW," was a name used by the United Kingdom Church, respondent sought to show by these checks and other evidence that the United Kingdom Church was a branch of petitioner. On December 12, 1980, the second day of respondent's case, respondent again pressed the Court to hear evidence relating to the United Kingdom Church. Respondent disavowed any intention of seeking an increase in the notice of deficiency by reason of the United Kingdom Church's income. However, respondent urged the Court to entertain the matter on the limited issue of petitioner's entitlement to tax-exempt status. Respondent proffered three theories of relevance. First, the franchises managed by the United Kingdom Church were a commercial operation. Second, petitioner's attempt to conceal the corporate status of the United Kingdom Church was one more link in the chain of activities making up petitioner's conspiracy to obstruct the Internal Revenue Service (IRS or Service). Third, L. Ron Hubbard possibly benefited from the money deposited in the Worldwide franchise accounts.As the trial progressed, respondent, on February 9, 1981, and again on April 9, 1981, stated his intention to reduce the scope of his reliance on matters relating to the United Kingdom Church, so that on April 9, 1981, respondent said he planned to use the matter solely as it was relevant to proving petitioner conspired to obstruct the IRS. However, respondent quickly retracted this decision the following day. On July 20, 83 T.C. 381">393 1981, the first day of the seventh week of trial, this Court ruled that respondent could present evidence relating to the United Kingdom Church's activities and corporate status under three theories of relevance: commercialism, inurement, and conspiracy. Petitioner began its rebuttal case on August 17, 1981. With continuances, petitioner completed rebuttal on November 12, 1981. During rebuttal, petitioner presented documentary and testimonial evidence directed toward refuting loss of tax-exempt status as a result of the United Kingdom Church's operations.Respondent knew that his claim, that the United 1984 U.S. Tax Ct. LEXIS 30">52 Kingdom Church was a branch of petitioner, made the determination in the notice of deficiency, treating payments from the British Church to OTC as Flag income, erroneous. He was aware that his new position would therefore necessitate a hearing under Rule 155 to recompute the notice of deficiency. Respondent consistently disavowed any intention to use the income from the United Kingdom Church to increase the notice of deficiency.By the end of 1974, respondent's files contained documents from various sources identifying the United Kingdom Church as a branch of petitioner. One such document was a report entitled "Enquiry Into the Practice and Effects of Scientology" (Foster Report) prepared for the House of Commons in the United Kingdom on December 21, 1971, by Sir John G. Foster, K.B.E., Q.C., M.P. The report quoted part of a letter from British Scientologists which stated:The main activities of Scientology in the United Kingdom are carried on by the Church of Scientology of California (non-profit Corporation in California registered under Part X of the Companies Act) with its branches at St. Hill Manor, London, Brighton, and Swansea. [Foster Report at 26.]The report also reprinted 1984 U.S. Tax Ct. LEXIS 30">53 in full a policy letter written by L. Ron Hubbard explaining the financial considerations which led the California Church to take over the United Kingdom Scientology organization and detailing the history of the transfer. The files of the IRS also contained balance sheets for the fiscal years ended April 5, 1967, and April 5, 1968, which the California Church had filed with the Registrar of Companies in the United Kingdom in order to conduct its operations there. The balance sheets were headed:83 T.C. 381">394 CHURCH OF SCIENTOLOGY OF CALIFORNIAA company incorporated in the State of California, U.S.A. and registered under Part X of the Companies Act 1948 on 29th March 1966 and not having a share capital.In March 1975, respondent audited the Church of Scientology of Hawaii (Hawaii Church). This audit was immediately followed by a year-long audit of the California Church's 1971-74 tax years. During these audits, respondent reviewed letters, checks, receipts, and disbursement vouchers, some bearing such names as Church of Scientology of California UK, Church of Scientology of California WW, Church of Scientology Worldwide, Publications Org. WW, or HCO WW as a name on the letterhead or as the endorsement 1984 U.S. Tax Ct. LEXIS 30">54 or payee. A few letters and receipts bore petitioner's name in bold print on the letterhead and the words "a non-profit corporation in U.S.A. Registered in England" in fine print across the bottom.A few documents prepared by the IRS show that some of respondent's employees knew that the United Kingdom Church was a branch of petitioner. The chief of respondent's Foreign Operations Division in a memorandum to the Chief of the Audit Division, Honolulu District Office, dated November 18, 1966, stated:The Hubbards attempted to organize a British corporation as a religious non-profit organization, but the British tax authorities refused to grant the corporation tax free status. They then organized the Los Angeles corporation and they now carry on their British operations as a part of that corporation.Respondent's representative in London reviewed the documents petitioner filed with the Registrar of Companies in Great Britain. In a memorandum dated November 18, 1974, transmitting these documents to respondent's Refund Litigation Division, he concluded that the accounts of the United Kingdom Church could be incorporated with petitioner's for tax purposes. At least two other reports prepared 1984 U.S. Tax Ct. LEXIS 30">55 by respondent's representatives show knowledge that the California Church was registered to conduct operations in Great Britain. One of these reports was distributed to a Scientology Task Force in December 1974. A report prepared by Service personnel after auditing the Hawaii Church in March 1975 tentatively concluded that the Publication Org. WW, a Scientology 83 T.C. 381">395 organization operating in the United Kingdom, was a division of the California Church.Lewis J. Hubbard, Jr., served as respondent's adviser on Scientology matters from middle or late 1974 until July 1977. During this period, Lewis Hubbard held the position of Staff Assistant to the Associate Chief Counsel (Litigation). Lewis Hubbard directly oversaw the exempt function audit of the Hawaii Church which took place in March 1975 (Hawaii audit) and served as the National Office adviser during the year-long audit of petitioner's 1971-74 tax years (1971-74 audit). Before overseeing the Hawaii audit, Lewis Hubbard read a few documents which either explained that the United Kingdom Church was a branch of petitioner or perhaps made passing reference to this fact. He read the Foster Report. He saw petitioner's certificate of 1984 U.S. Tax Ct. LEXIS 30">56 incorporation, which it filed with the Registrar of Companies in the United Kingdom in order to operate there. He also skimmed one transmittal memorandum dated November 18, 1974, from respondent's London representative which opined that the United Kingdom Church's accounts could be incorporated with petitioner's for tax purposes. However, Lewis Hubbard did not recall reading that portion of the memorandum. During the Hawaii audit, Lewis Hubbard questioned Joel Kreiner, a Church lawyer and high-ranking Guardian official, about the status of the United Kingdom Church. Kreiner told Lewis Hubbard that petitioner incorporated the United Kingdom Church but that it operated separately and independently. After overseeing the Hawaii audit, Lewis Hubbard authored a report in which he tentatively concluded that the Publication Org. WW was a division of the California Church. Following the 1971-74 audit, Revenue Agent Eugene Endo, on the advice of Lewis Hubbard, changed some wording in a draft of his report of the audit. The original version said that the audit disclosed that petitioner had seven branches and then listed them. The final version again stated that petitioner had seven branches 1984 U.S. Tax Ct. LEXIS 30">57 but inserted the phrase "California's submission outlined the seven branches as follows:" before listing them.On most occasions when the subject arose, petitioner misled respondent about the legal status of the United Kingdom Church. In 1967, respondent asked petitioner to list its subordinate churches. Petitioner's reply letter did not mention 83 T.C. 381">396 the United Kingdom Church. 41984 U.S. Tax Ct. LEXIS 30">59 Again, during the 1971-74 audit, respondent twice asked petitioner to list its divisions. Petitioner did not mention the United Kingdom Church. Petitioner was dissatisfied with respondent's report of the audit and so wrote its own report correcting what it viewed to be respondent's errors. Petitioner's version did not list the United Kingdom Church as a branch church. On the first day of trial, petitioner and respondent filed Stipulation of Facts (Set Number 3) listing the divisions of the Church. The United Kingdom Church was not listed. 5 During the 1971-74 audit, respondent asked for an explanation of several FOLOs including the FOLO in the United States (FOLO WUS) and the FOLO in the United Kingdom (FOLO UK) and was told that FOLO WUS was part of petitioner, but FOLO UK was part of an overseas Church. Also, 1984 U.S. Tax Ct. LEXIS 30">58 when respondent asked for a list of petitioner's bank accounts, none of the United Kingdom accounts were listed in petitioner's response. The Church's report of the 1971-74 audit, in discussing the United Kingdom Church's alleged debt repayment to OTC, named several British Scientology organizations and stated they were "part of the corporate entity of the UK Church." Prior to trial, respondent subpoenaed the records of the United Kingdom Church bank accounts used to deposit franchise payments. Objecting to the subpoena, petitioner in open court said:The accounts referred to there are not accounts of the Church of Scientology of California and they are not in its custody and control. It is true that the accounts bear the name Church of Scientology of CaliforniaWorldwide but they are actually accounts of the United Kingdom Church of Scientology which until two years ago, as I understand it, was incorporated as the Church of Scientology of California but never, ever was a part of the Church of Scientology of California that's involved in this case.Those accounts have had nothing to do with the Church of Scientology of California involved in this case.The United Kingdom Church was formally organized as a branch of petitioner in 1966 when the assets of the Scientology organizations in the United Kingdom were conveyed to petitioner 83 T.C. 381">397 which then registered to do business in the United Kingdom as a foreign corporation under the Companies Act of 1948, 11 Geo. 6, ch. 38. Tax considerations partly motivated the transfer. British authorities would not grant tax-exempt status to local Scientology organizations. Petitioner therefore took over the assets of those organizations so that they could carry on under petitioner's tax-exempt mantle.The United Kingdom Church purported to have its own board of directors. Anthony Dunleavy, a high-ranking church official who served as a Commodore Staff Aide during the docketed years, testified about his tenure on the board preceding 1984 U.S. Tax Ct. LEXIS 30">60 the docketed years. He gave three different versions of his term on the board, changing dates as he was confronted with conflicting documentary evidence. By the end of his testimony he had completely changed his initial statement regarding the dates of his tenure. He was also evasive about who were the prior members of the board. At first he claimed not to know who they were. Then confronted by one of respondent's exhibits, he claimed his memory was refreshed and listed the prior members. Testimony about board membership during the docketed years was also conflicting, one Church witness naming one set of members and another Church witness naming a different set except for one common member. A few board minutes were placed in evidence. Two of these are captioned "Church of Scientology of California" and refer in their text to officers of the United Kingdom Church as "Directors of the Church of Scientology of California." The Franchise Office was a major division of the United Kingdom Church. The board of the United Kingdom Church did not have final authority for its management. Diana Hubbard, L. Ron Hubbard's daughter and a Commodore Staff Aide, had the final authority.The 1984 U.S. Tax Ct. LEXIS 30">61 California Church and the United Kingdom Church shared responsibility for the franchises. The California Church issued the franchise charters, 6 gave them some legal advice, 83 T.C. 381">398 served occasionally as an intermediate collection point for franchise payments, and ultimately established franchise policy. For its part, the United Kingdom Church collected weekly tithes and operating reports, distributed policy letters, and gave day-to-day operating advice. United Kingdom Church 1984 U.S. Tax Ct. LEXIS 30">62 officials were signatories on the California Church's accounts, and vice versa. Mary Sue Hubbard was authorized to sign checks on virtually all the United Kingdom Church accounts, including Church of Scientology of California Rubric Worldwide Account Number 292236, at the Swiss Bank Corp. in Zurich, Switzerland, where franchise tithes were deposited. Denzil Gogerly, who by all accounts was a member of the board of directors of the United Kingdom Church during the docketed years, was a sole signatory on petitioner's accounts. He signed checks on SFO's and USGO's accounts. Jane Kember, the highest ranking official in the United Kingdom Church's Guardian Office, was also a sole signatory on petitioner's accounts. Herbie Parkhouse, the Deputy Guardian of Finance in the United Kingdom Guardian Office, issued checks on the United States Guardian Office account.The Guardian Offices of both churches were also interconnected. Mary Sue Hubbard, at Flag, was the chief executive for both offices. Furthermore, sometimes both offices collaborated and jointly issued policy directives on behalf of L. Ron Hubbard or the California board of directors.For part of the docketed years, the United 1984 U.S. Tax Ct. LEXIS 30">63 Kingdom Church tithed to the United States Churches of Scientology Trust. The trustors of this purported trust were all Scientology Churches in the United States. Petitioner was a trustor.The United Kingdom Church had several divisions. These were: Worldwide; the Hubbard College of Scientology, St. Hill; the Hubbard College of Scientology St. Hill Foundation; Advanced Organization United Kingdom; London Day; London Foundation; Plymouth; Brighton; and Swansea. Worldwide in turn had several departments: the Executive Council Worldwide; the Franchise Office Worldwide; the Guardian Office Worldwide; and the Flag Operation Liaison Office, United Kingdom (FOLO UK). In 1971 the United Kingdom Church underwent some reorganization. The Executive Council Worldwide was officially disbanded. The Hubbard College 83 T.C. 381">399 of Scientology, St. Hill, merged with the Hubbard College of Scientology St. Hill Foundation. The FOLO UK split off from Worldwide.C. Operation Transport Corp., Ltd.The Operation Transport Corp., Ltd., was a Panamanian corporation incorporated by L. Ron Hubbard, Mary Sue Hubbard, and Leon Steinberg on February 17, 1968. It was not organized as a nonprofit corporation. No shares 1984 U.S. Tax Ct. LEXIS 30">64 of stock were issued.OTC was a sham corporation controlled by L. Ron Hubbard and petitioner. Its board of directors lacked bona fides. L. Ron Hubbard, Mary Sue Hubbard, and Leon Steinberg were the original directors of OTC. They resigned immediately after the corporation's formation and were replaced by Brian Livingston, Joyce Popham, and Barry Watson. All three of these individuals were Flag employees. Joyce Popham was the secretary to L. Ron Hubbard's personal aide. Barry Watson and Brian Livingston were Class-10 auditors and served on the Aides Council. During the docketed years, these three individuals performed only one board function. Sometime in the summer of 1972, they approved L. Ron Hubbard's decision to transfer approximately $ 2 million from OTC bank accounts in Switzerland to the Apollo. That they even performed this function is questionable since there are no minutes of the board meeting adopting a resolution authorizing the transfer. A signature card for petitioner's account number 6919 at the Crocker-Citizens National Bank in Los Angeles, CA, underscores the lack of substance of the OTC board of directors. It certifies that on November 18, 1968, the board 1984 U.S. Tax Ct. LEXIS 30">65 of directors of the "O.T.S., Advanced Organization Church of Scientology of California" authorized the signatories listed on the card to sign checks on behalf of the corporation.OTC purportedly performed banking services for Flag. However, the record shows that OTC had no offices, officers, or employees and that Flag employees were actually the ones who handled all of petitioner's financial activities. During the docketed years, petitioner deposited Flag division funds in accounts maintained in the name of OTC. The signatories on the OTC accounts were all Flag employees. Except for Joyce Popham, who apparently never wrote a check, they had no connection with OTC. Besides keeping the checkbooks, Flag 83 T.C. 381">400 officials, not OTC personnel, directed the flow of funds into and out of OTC accounts, receipted money for the support of Flag operations, and controlled and managed Flag expenditures. Furthermore, Flag officials did not differentiate between Flag and OTC invoices and disbursement vouchers when they recorded Flag receipts and expenses.L. Ron Hubbard and Mary Sue Hubbard controlled OTC funds. L. Ron Hubbard initiated the practice of depositing Flag funds in OTC bank accounts. Sometime 1984 U.S. Tax Ct. LEXIS 30">66 before the Apollo went to Corfu, Greece, in August 1968, he directed a Flag official to travel to Zurich, Switzerland, to open bank accounts in the name of OTC. At that time, two numbered accounts were opened. They were account number 295,728 and account number 295,728.1. During the taxable years in issue, the major share of OTC funds were banked in those accounts. There are other OTC accounts. L. Ron Hubbard was a signatory on all the major OTC accounts. In the summer of 1972, L. Ron Hubbard authorized the transfer of approximately $ 2 million in cash from OTC accounts in Switzerland to the Apollo. The money was stored in a locked file cabinet to which Mary Sue Hubbard had the only set of keys.To avoid harassment, Flag officials on board the Apollo were instructed to tell strangers they were employed by OTC and that OTC was a management company. This cover story was first used in March 1969 when the Apollo was suddenly asked to leave Corfu. It was formalized in a Flag Order dated December 24, 1970.D. The Sea OrganizationThe Sea Organization was a fraternal organization of elite Scientologists. Its membership consisted of persons who dedicated their lives to work fulltime 1984 U.S. Tax Ct. LEXIS 30">67 for Scientology. Sea Organization members signed a "contract of employment" pledging to work for the Sea Organization for a billion years. Sea Organization members were frequently sent on missions to Scientology organizations throughout the world to handle problems interfering with the effective administration of the organization and the delivery of Scientology services. Organizations mostly or entirely staffed by Sea Organization members were called "Sea Org. Orgs." The following divisions of petitioner were Sea Org. Orgs.: Flag, ASHO, AOLA, and 83 T.C. 381">401 FOLO. The leadership of the Sea Organization came from petitioner's Flag Division.Church PolicyCalifornia Church officials administered the Church in accordance with written policy directives called "issues." There were several different kinds of issues classified by a combination of factors including author, period of effectiveness, and designated audience. The most important issue was called a Hubbard Communications Office Policy Letter (HCO PL or policy letter). These issues were usually written by L. Ron Hubbard. Sometimes, however, they were written by a high-ranking Scientologist with L. Ron Hubbard's approval or the approval 1984 U.S. Tax Ct. LEXIS 30">68 of the Aides Council (also known as the International Board). Policy letters set basic administrative policy. They took precedence over all other types of issues. Each policy letter was dated and had a legend showing its designated area of distribution on the upper-left-hand corner of the first page. Policy letters were intended to remain in full force and effect until officially canceled or modified by another policy letter.Initially, policy letters were distributed individually in looseleaf form or in packets called "hatpacks." Beginning in 1970, a Scientology organization in Denmark began to compile the policy letters and publish them by subject matter in a comprehensive set of volumes called the Organization Executive Course or OEC. The project took years to complete. Individual volumes were published as they were completed. By 1974, petitioner published the complete nine-volume work. Most of the policy letters in the OEC series contain information about Church administrative practices but some contain instructions on religious practice. As previously found, a typical Scientology church has seven operating divisions. The OEC volumes are organized so that volumes 1 through 1984 U.S. Tax Ct. LEXIS 30">69 7 of the series each contain policy letters relating to the management, operation, and activities of a corresponding division of a Scientology church. Volume 0 of the OEC series is an introductory volume. It contains policy letters describing basic staff duties and responsibilities and the rudiments of Church structure and organization. The Management Series volume contains policy letters relating to data collection, public 83 T.C. 381">402 relations, personnel practices, operational control, finances, executive duties, and the establishment of churches. The OEC series does not contain every policy letter. The OEC volumes indicate in brackets when a policy letter has been formally canceled or amended. Some HCO PLs fell into desuetude without being officially canceled. 7 There were other types of policy issues besides policy letters governing petitioner's administrative practices. In addition to writing policy letters, L. Ron Hubbard 1984 U.S. Tax Ct. LEXIS 30">70 also wrote executive directives called L. Ron Hubbard Executive Directives (LRH EDs). These communicated short-range orders and directions and described current projects and programs. They were generally written for a limited audience such as a specific organization, region, or staff position. LRH EDs were only valid for a year, and then they automatically expired. Guardian Orders were another type of issue. They set policy for the Guardian Offices and Guardian staff of the Churches of Scientology, including petitioner. Guardian Orders were issued by the authority of Mary Sue Hubbard or Jane Kember, the Guardian Worldwide. Guardian Orders did not expire automatically. Flag Orders set policy for Scientology Sea Organizations including the following divisions of petitioner: Flag, FOLO, ASHO, and AOLA. Most Flag Orders were written by L. Ron Hubbard or with his approval. Flag Orders did not automatically expire at the end of a fixed period.Another type of issue was the Order of the Day (OOD). The commanding officer of every church unit was supposed to write an OOD, daily. This form of issue was used to communicate newsworthy events, to promulgate daily schedules, and to publicize 1984 U.S. Tax Ct. LEXIS 30">71 plans and directions for current programs and projects. The first section of the Flag Order of the Day was reserved for communications from L. Ron Hubbard.The front piece of each volume in the OEC contains a partial disclaimer stating that the policy letters "should be construed only as a written report of * * [L. Ron Hubbard's] research and not as a statement of claims made by the Church or the author." Despite this disclaimer, the California Church clearly adopted and utilized the policy letters. Each California Church 83 T.C. 381">403 staff member had a folder of materials called a hatpack describing the duties of his position and the place his position occupied in the organization's structure. The hatpack contained policy letters. Staff members were expected to read the hatpack materials and were quizzed on their contents. Sometimes the failure to follow a policy letter inspired a quiz on the hatpack materials. California Church members also studied policy letters in work-training courses they were encouraged to take. One course, the OEC course offered by most of petitioner's branch churches, was entirely devoted to the study of the OEC volumes. It required 2 1/2 weeks of study for each 1984 U.S. Tax Ct. LEXIS 30">72 volume. The Franchise Office Worldwide distributed policy letters to franchise holders for use in running the missions, and Flag distributed them to the local churches for guidance. In the Flag Division, every crew member received and was required to read the Flag OOD and Flag Orders.One of the guiding principles of Scientology is that most organization problems arise from the failure to follow policy. True policy was strictly limited to the written policy found in the official issues such as HCO PLs, Flag Orders, and Executive Directives. California Church members were taught that if a directive was not in writing based on official policy, it was not to be believed. California Church officials were expected to know the contents of HCO PLs and to follow them. One high-ranking church official referred to policy letters on an average of once a day for guidance. The failure to follow policy was an offense for which a California Church member could be disciplined particularly if the failure resulted in monetary loss or bad publicity. There is no evidence in the record that this happened. California Church officials did not always robotically implement policy. If a particular policy 1984 U.S. Tax Ct. LEXIS 30">73 was questionable, staff consulted higher officials, usually in writing, to determine a more favorable course of action. Franchise holders providing services to the public had more freedom to disregard policy directives than did petitioner's officials.Discriminatory SelectionOn January 2, 1957, respondent recognized petitioner as an organization described in section 501(c)(3) exempt from income tax under section 501(a). Petitioner's tax-exempt status was reconfirmed on November 16, 1964. In August 1965, respondent 83 T.C. 381">404 examined petitioner's records for the taxable year 1963 and concluded that petitioner was a church; that petitioner received income by selling books and E-meters and by providing spiritual counseling and training; and that petitioner paid royalties to the L. Ron Hubbard Trustee Account for the use of Scientology books and materials. After the examination, respondent again confirmed the tax-exempt status of the California Church.In 1966, respondent again reviewed petitioner's tax status by examining petitioner's Annual Information Returns (Forms 990-A) for 1964 and 1965. The record does not disclose what concerns prompted the examination. Following the examination, respondent 1984 U.S. Tax Ct. LEXIS 30">74 sent petitioner a letter on July 29, 1966, recommending revocation of petitioner's tax-exempt status. The letter stated three bases for the recommendation: (1) The California Church's income was inuring to the benefit of Scientology practitioners; (2) the Church's activities were commercial; and (3) the Church was serving the private interests of L. Ron Hubbard and Scientology practitioners. The California Church was accorded the right to protest the recommendation and to submit documents in support of its protest. An informal conference was held in the Los Angeles District Office and the proposed revocation was affirmed. A conference was then held in the National Office on June 15, 1967, and again the proposed revocation of exemption was sustained. One month later, on July 18, 1967, respondent issued a formal letter of revocation which repeated the same three grounds of revocation as had been stated in the original recommendation. Respondent published the revocation in the Internal Revenue Bulletin and removed petitioner from its cummulative list of organizations qualifying under section 170 for deductible charitable contributions. Petitioner was advised that it was required 1984 U.S. Tax Ct. LEXIS 30">75 to file Federal income tax returns.Sometime in the fall of 1966, the Department of Justice asked respondent to review the tax status of several Scientology churches including petitioner. The request was made as the Department of Justice prepared to defend a case against the Founding Church of Scientology (Founding Church) in the United States Court of Claims. In that case, the Founding Church sued for refund of its Federal income taxes which it had paid after its tax-exempt status had been denied. The 83 T.C. 381">405 exemption was denied on the grounds that the Founding Church was organized and operated as a commercial venture benefiting private interests and that Scientology did not serve a religious purpose. 81984 U.S. Tax Ct. LEXIS 30">76 Believing that respondent's recognition of the tax-exempt status of other Churches of Scientology was inconsistent with the defense of the Founding Church case, the Department of Justice asked respondent to investigate the matter and rescind recognition of all similar Churches of Scientology prior to the trial of the Founding Church case.In response to this request respondent reviewed the tax status of several Scientology churches, in addition to petitioner, whose tax status was already under review. In the spring of 1967, as the trial of the Founding Church case approached, pressure to expedite proceedings relating to these churches increased. In some cases, denial or revocation of exemption was proposed. However, the record is silent with respect to what, if any, final adverse action was taken against these churches, besides petitioner, prior to the trial of the Founding Church case. Years later the tax status of some of these Scientology churches was still under administrative review.During 1966 and 1967, a few of respondent's agents spoke critically of Scientology or circulated reports calling it a medical quackery; evil; a threat to the community, medically, morally, and socially; a pseudo-religious organization; a grab bag of philosophical voodooism; and a prey on the public pocketbook. These comments were not made by agents in respondent's 1984 U.S. Tax Ct. LEXIS 30">77 Exempt Organizations Division -- the division charged with reviewing petitioner's tax status. However, agents in respondent's Exempt Organizations Division were privy to memoranda containing these comments and to materials critical of Scientology.Although petitioner was advised that it was required to file Federal income tax returns (Forms 1120), it refused to do so and continued to file Annual Information Returns (Forms 990). During 1969 and 1970, Revenue Agent Woodrow (Woody) Wilson examined petitioner's records for the taxable years 1964-67 to determine petitioner's tax liability and review its 83 T.C. 381">406 tax status. A second agent, Robert Cluberton, tried to audit petitioner's records for the taxable years 1968 and 1969. Petitioner resisted this second audit, claiming a right to be free from successive audits until its protest of the 1964-67 audit, including the denial of its tax-exempt status, was finally resolved.On June 7, 1974, respondent mailed a notice of deficiency to petitioner for the taxable years 1965 through 1967. The deficiencies were:TYE Dec. 31 --Deficiency1965$ 2,614.1919665,041.03196713,946.30Petitioner filed a timely petition in the Tax Court for the 1965 deficiency. 1984 U.S. Tax Ct. LEXIS 30">78 In late 1976, respondent settled the case by conceding petitioner's tax-exempt status for that year but without prejudice to any other year. Respondent also decided not to litigate any cases against petitioner prior to the 1968 taxable year and closed the 1966 and 1967 tax years on the basis of "no change."Returning to 1974, respondent, by the end of the year, was occupied with a number of Scientology matters. 9 Representatives of the California Church, respondent, and the Department of Justice met at a conference in Washington, D.C., on February 14, 1975, to try to settle some of these matters without resorting to litigation. No agreement about substantive issues was reached, but the representatives did establish a procedure for handling some of the ever mounting tax matters. First, the parties would temporarily suspend litigation. Second, respondent would examine the Hawaii Church to determine whether it qualified as a tax-exempt organization. Third, the ruling with respect to the Hawaii Church would govern all churches of Scientology organized and operated in a similar fashion. Fourth, respondent would examine the California83 T.C. 381">407 Church and any other church that differed from 1984 U.S. Tax Ct. LEXIS 30">79 the normal pattern and determine what effect, if any, these differences in operation or organization had on the organization's qualification for tax-exempt status. 10The audit of the Hawaii Church was an exempt function audit covering the tax year 1965 or the years 1966 through 1984 U.S. Tax Ct. LEXIS 30">80 1974. The audit lasted approximately 2 weeks. Following the audit of the Hawaii Church, the IRS asked the Church and several similarly situated churches to submit determination applications, Forms 1023. This was done and the IRS set up a special group to process the applications. The Hawaii Church received a favorable ruling and so did several other Churches of Scientology.The audit of the California Church (1971-74 audit) followed the Hawaii audit. The examination began in June 1975 and continued through July 1976 covering the taxable years 1971 through 1974. Three experienced agents 11 worked full time on the audit. Under IRS policy, cases involving a church are classified as sensitive cases and automatically referred to the National Office. Thus, from time to time, the agents received advice and guidance from Lewis Hubbard, an attorney in the National Office of respondent's Chief Counsel.The agents examined between 200 and 300 cartons of records, containing approximately 2 million documents. The audit covered the following topics: (1) Petitioner's sources of income; (2) petitioner's 1984 U.S. Tax Ct. LEXIS 30">81 corporate structure; (3) the purposes of the California Church as stated in corporate documents; (4) the administration of the Scientology trust fund; (5) compensation and benefits paid or bestowed upon L. Ron Hubbard and his family; (6) the purposes and amounts of petitioner's expenditures; (7) certain aspects of Church administration including banking practices, recordkeeping, and the implementation of policy; and (8) Scientology religious beliefs and practices.At the outset of the 1971-74 audit, no thought was given to what procedure would be used to obtain a ruling on the audit. As the audit drew to a close, the National Office and the 83 T.C. 381">408 District Office jointly decided that the technical advice procedure was best since it afforded the California Church an opportunity to comment on the facts and issues raised by the audit. 121984 U.S. Tax Ct. LEXIS 30">82 In accordance with the technical advice procedure, Agent Eugene Endo prepared a draft report of the audit. The draft report covered the following topics: (1) A description of Scientology religious beliefs; (2) a description of petitioner's corporate charter, bylaws, and amendments thereto; (3) a description of petitioner's pricing and sales policies; (4) an explanation 1984 U.S. Tax Ct. LEXIS 30">83 of the different memberships in petitioner; (5) an account of petitioner's charitable and community activities; (6) a description of petitioner's promotion methods; (7) a discussion of the role of policy letters in the administration of petitioner's affairs; (8) a description of petitioner's banking practices and management activities; (9) an analysis of petitioner's income and certain expenses by Church branch; (10) an explanation of the royalties paid to L. Ron Hubbard; (11) a description of OTC's relationship to petitioner; (12) documentation of petitioner's failure to substantiate OTC expenditures on behalf of petitioner; (13) an analysis of financial gains accruing to OTC from currency conversions; and (14) a history and description of the United States Churches of Scientology Trust.The technical advice procedure was never fully implemented. The California Church took matters into its own hands and sent the National Office Agent Endo's draft report (Service audit report) which it had been given for comment as a matter of courtesy before Agent Endo had a chance to complete it. The Church also sent the National Office a copy of its own report (Church audit report). The Church 1984 U.S. Tax Ct. LEXIS 30">84 audit report 83 T.C. 381">409 was written in the style of the Service audit report, in goodly measure adopting verbatim the text of the Service audit report. However, there were textual differences, some noted and explained in footnotes. According to Church officials, the purpose of the Church audit report was to present a fair and accurate version of the California Church's tax position. The National Office refused to accept this "end-run" and referred the matter back to the Los Angeles District Office.In accordance with the technical advice procedure, the examining agent and Church officials met in the District Office in October 1976, and tried to reach agreement on a statement of facts and issues to present to the National Office. Agent Endo reviewed the Church audit report, signified his agreement with the factual content of certain footnotes in the Church audit report, but complete agreement was never reached. 13 There remained significant differences in the texts and the footnotes of both reports. The matter was then referred to the National Office. 14 In January 1977, Church and Service representatives met in the National Office to discuss the reports. Respondent never issued a technical 1984 U.S. Tax Ct. LEXIS 30">85 advice memorandum.During 1977, petitioner and respondent engaged in settlement negotiations. These negotiations were discussed in detail by counsel at a pretrial hearing held on petitioner's Motion to Render the Notice of Deficiency Nugatory and for Other Relief. At the conclusion of the hearing, the Court made findings about the conduct of the settlement talks. The Court found (1) that there was a bona fide dispute between the parties which was the subject of negotiations; (2) that the notice of deficiency incorporates these legitimate grounds of dispute; (3) that respondent was forced to issue the notice of deficiency to protect the Government's interest in the revenue 1984 U.S. Tax Ct. LEXIS 30">86 since petitioner would not consent to extending the statute of limitations which was about to expire before a settlement could be reached; and (4) that good-faith settlement negotiations continued after the notice of deficiency was issued. The 83 T.C. 381">410 Court ultimately found that the determinations were at least sufficiently reasonable to render the notice of deficiency valid and therefore denied petitioner's motion.During negotiations, the parties came close to reaching a settlement of their disputes over income inuring to OTC's benefit from currency conversions and over alleged debt repayments from the Danish Kingdom and United Kingdom Churches. Significant differences remained on at least three other issues: (1) Petitioner's recordkeeping system; (2) petitioner's reporting obligations; and (3) petitioner's failure to satisfy respondent that it was not implicated in criminal activity to impede the IRS from performing its lawful functions. Respondent's last offer was made on December 20, 1977. The scope of the offer was limited to settlement of petitioner's 1970-72 taxable years.The notice of deficiency was drafted by Agent Endo. It was drafted sometime in November 1977, as the statute 1984 U.S. Tax Ct. LEXIS 30">87 of limitations for the taxable years in issue was about to expire. The notice was issued on December 28, 1977.On March 5, 1980, this Court ruled that compliance with public policy is a requirement for exemption from tax under section 501(c)(3). In a Memorandum Sur Order dated April 1, 1980, this Court defined the scope of the public policy requirement by stating "this requirement is limited to compliance with well defined public policy -- such as may be reflected in a criminal or civil statute." Respondent's trial memorandum, filed October 3, 1980, catalogued a series of petitioner's acts, policies, and procedures which respondent intended to prove to show petitioner's failure to comply with public policy. These acts, policies, and procedures included: (1) Conspiracy to impede and obstruct the Internal Revenue Service under 18 U.S.C. section 371; (2) abuse of the role of religious confidant by auditors; (3) the infliction of psychic harm including the loss of moral judgment through brainwashing accomplished by auditing and other practices and procedures; (4) the use of blackmail and intimidation to implement petitioner's "fair game" policy; (5) the involuntary dissolution of marriages 1984 U.S. Tax Ct. LEXIS 30">88 and family ties through the enforcement of petitioner's "disconnect" policy; (6) involuntary detention and false imprisonment; (7) the making of false statements to immigration authorities in violation of 18 U.S.C. section 1544; (8) the 83 T.C. 381">411 removal of large amounts of currency from the United States without disclosure; (9) the false registration of petitioner's fleet as private yachts used for pleasure when in fact they were used for paramilitary training and commercial activities; and (10) the drastic punishment of staff and members. By letter ruling dated October 30, 1980, the Court precluded respondent from offering proof on many of these issues and narrowed the evidence it would entertain on the remaining issues to "acts against others that violated civil or criminal law or were contrary to well-defined public policy." Respondent's trial memorandum also stated two other major issues to be tried in addition to the public policy issue: (1) Whether part of the California Church's net earnings inured to the benefit of L. Ron Hubbard and his family; and (2) whether petitioner engaged in commercial activities, such that it was not operated exclusively for religious purposes.Respondent 1984 U.S. Tax Ct. LEXIS 30">89 also contended, in a letter to petitioner in connection with peititioner's Motion To Render the Notice of Deficiency Nugatory and for Other Relief, that (1) the Church's methods are akin to brainwashing; (2) the Church employs tactics which are harmful to society; (3) petitioner is a cult; (4) Scientology operations are partially a profit-making scheme; and (5) Church policies and practices endanger the moral and physical health of citizens and create trouble in families. 15 During the years 1969 through 1975, respondent formed and maintained special intelligence units to collect information about certain taxpayers, apparently selected by essentially political criteria, to monitor their compliance with the tax laws. Two of these units, the Special Service Staff (at first called the Activist Organization Committee) and the Intelligence Gathering and Retrieval Unit, were part of respondent's National Office. The third unit, the Case Development Unit, was part of the Los Angeles 1984 U.S. Tax Ct. LEXIS 30">90 District Office. All three collected information about petitioner.In July 1969, the IRS established the Special Service Staff (SSS) to insure that dissident groups were not violating the tax laws. The SSS gathered and centralized information about 83 T.C. 381">412 taxpayers, frequently selected because of their political activism, and disseminated this information to the District Office having jurisdiction over the particular taxpayer. As a result of SSS operations, dissident groups were subject to more rigorous scrutiny for their compliance with the tax laws. Also, all exempt organizations which were scrutinized by the SSS were subject to special procedures for obtaining approval of their applications for exemption from taxation.Initially, the SSS selected 77 organizations to monitor. On October 8, 1969, an additional 22 organizations were targeted. These included the Founding Church of Scientology. After the Founding Church was selected, the SSS received some information about Scientology churches including petitioner. 161984 U.S. Tax Ct. LEXIS 30">91 When the SSS ceased functioning in 1973, it had amassed close to 3,000 files on organizations and approximately 8,500 files on individuals.In 1973, respondent established a national intelligence program called the Intelligence Gathering and Retrieval Unit (IGRU). This program differed from other intelligence operations in that the IGRU gathered general intelligence unrelated to a specific investigation of a specific allegation. Agents were free to determine whom and what to investigate, provided their investigations in some way related to IRS investigative jurisdiction. In a number of districts, IGRU agents collected intelligence having little relationship to enforcement of the tax laws.The Los Angeles District Unit of IGRU classified petitioner as a "tax resister." In 1975, certain IGRU files in St. Louis were destroyed. One file labeled "subversives" contained materials only about Scientology. 171984 U.S. Tax Ct. LEXIS 30">92 The IGRU was disbanded in mid-1975.Between 1968 and 1974, the Case Development Unit staffed by two special agents in respondent's Los Angeles Office gathered information about petitioner and Scientology. Practically all of the information they collected concerned petitioner's religious operations and financial activities. Their files, 83 T.C. 381">413 however, contained a few reports linking petitioner or Scientology with criminal activity including homicide, blackmail, guerrilla training, break-ins, drug trafficking, and the transportation of illegal firearms.EntanglementOver slightly more than a decade, respondent examined petitioner's records four times. In 1965, respondent audited petitioner's 1963 tax year and, in 1969, petitioner's 1964-67 tax years. Between 1971 and 1973, Agent Cluberton unsuccessfully tried to examine Church records for 1968 and 1969. The most comprehensive audit began in June 1975. It lasted approximately 1 year and covered petitioner's 1971-74 tax years. Three or four agents worked full time and others worked as needed. The auditors received and reviewed between 1 and 3 million records. Most of these were original financial records such as invoices, disbursement vouchers, 1984 U.S. Tax Ct. LEXIS 30">93 and canceled checks, since the California Church did not keep business journals or books of account. The examiners also reviewed policy issues, membership fees and descriptions, contracts for services and employment, organizational charts, Scientology newsletters and dissemination pieces, and similar records illustrating petitioner's organization, activities, and financial practices. The agents also inspected petitioner's premises at three or four locations.Respondent collected information about Scientology and petitioner. An index prepared by the IRS in 1974 shows that respondent had over 6,000 documents relating to Scientology in its files. Many of these documents were prepared by the IRS and related to specific audits, investigations, or lawsuits. Approximately 2,000 of these documents were policy letters similar in kind, if not identical, to the ones contained in the OEC volumes. Other documents transmitted information from confidential sources on such diverse topics as their personal experiences in the Church of Scientology, Scientology financial activities, the administration of Scientology churches, and the names of Scientology members. Respondent's files also contained 1984 U.S. Tax Ct. LEXIS 30">94 newspaper articles about Scientology and pamphlets, magazines, and newsletters published by Scientology organizations, and a few books and brochures describing Scientology doctrine and practices.83 T.C. 381">414 The trial of this case lasted 51 days, spread over 12 months. Many matters were covered: petitioner's corporate and management structure, petitioner's fee structure, petitioner's banking practices, petitioner's dissemination practices, petitioner's relationship to OTC, the administration of the Scientology trust fund, IRS antipathy toward Scientology, petitioner's efforts to obstruct the IRS, and Scientology beliefs and practices. Petitioner called three witnesses -- Joyce Isaacson, Herbert Richardson, and Renee Norton -- to provide background information about Scientology beliefs and practices. On cross-examination, respondent inquired of these witnesses whether Dianetics formed part of the religious doctrine of Scientology and whether the E-meter was used apart from auditing to conduct security checks as a condition of employment. 181984 U.S. Tax Ct. LEXIS 30">95 During the trial, respondent tried to prove that some of petitioner's activities served a commercial purpose. Respondent tried to prove that petitioner sent staff on missions to branch churches to increase profits, that petitioner developed new courses and awareness levels for commercial reasons, and that petitioner used commercial techniques to promote Scientology in order to make money.During the trial, respondent used policy issues to examine witnesses on such subjects as petitioner's corporate and management structure, petitioner's financial activities, and petitioner's efforts to obstruct the IRS. Respondent's reliance on policy issues generated collateral examination on the extent to which policy issues had to be obeyed. While following 1984 U.S. Tax Ct. LEXIS 30">96 this line of inquiry, respondent questioned witnesses, past and present members of Scientology, with respect to whether they were disciplined for failing to follow policy. Respondent also inquired into petitioner's system of discipline and ethics in pursuing his inquiry into petitioner's treatment of IRS personnel.83 T.C. 381">415 Church FinancesPetitioner mainly derived income from four sources: (1) Auditing and training; (2) sales of Scientology literature, recordings, and E-meters; (3) franchise operations; and (4) management services. Of these four areas, the largest percentage of petitioner's income came from auditing and training. By petitioner's own admission, auditing and training sales accounted for the following percentages of total income:AOLAASHOLAOSFOUK1971916885817019729450918670Petitioner exacted what it called a "fixed donation" for its auditing and training courses. With few exceptions, these services were never given for free. 191984 U.S. Tax Ct. LEXIS 30">97 Auditing sessions were offered in fixed blocks of time called "Intensives." By petitioner's own admission the general rate of the fixed donation for auditing was as follows:12 1/2-Hour intensive$ 62525-Hour intensive1,25050-Hour intensive2,35075-Hour intensive3,350100-Hour intensive20 4,250At Flag, the fixed donations were 3 to 4 times higher. Additionally, petitioner offered two specialized types of auditing for a higher fixed donation:Integrity Processing -- $ 750 per 12 1/2-Hour intensiveExpanded Dianetics -- $ 950 per 12 1/2-Hour intensive83 T.C. 381">416 Petitioner offered its parishioners a 5-percent discount on the rate of fixed donation if the donation was well in advance of the service. Petitioner also offered 1-year members and lifetime members a 10-percent and 20-percent discount, respectively, on services. Apart from these discounts, branch churches were not allowed 1984 U.S. Tax Ct. LEXIS 30">98 to deviate from standard prices. 21 There was a special fee arrangement for most staff members. In order to become a staff member, a prospective employee had to sign an employment contract. The terms of most employment contracts varied from week-to-week employment to periods of 2 1/2 years or 5 years. Sea Organization staff members pledged to work for a billion years. Contracted 1984 U.S. Tax Ct. LEXIS 30">99 staff members, except the week-to-week employees, were given free or discounted training and auditing. If, however, a staff member breached his employment contract by leaving petitioner's employ prior to the contract's expiration, the former staff member, termed a "freeloader," was contractually obligated to pay petitioner a sum equal to the full cost of all services received, or liquidated damages of $ 5,000. In order to enforce this policy, an organization that sent a staff member for training to a higher organization was required to have the staff member sign a note in the amount of $ 5,000 before commencing training. The signing of the $ 5,000 note was intended to prevent a staff member from leaving after receiving higher training. HCO PL December 14, 1969, 3 OEC 241, entitled "ORG Protection," required that "Such a Note * * * must be legally binding in that, if he breaks his Contract, he is automatically in debt to the org for $ 5,000." In order to insure collection of such amounts, petitioner paid its agents a 10 percent commission for each freeloader debt collected in full. 83 T.C. 381">417 No effort was made by petitioner to collect freeloader debts in court.Individual applicants for training 1984 U.S. Tax Ct. LEXIS 30">100 and auditing were required to execute two documents. Under the first document, entitled the "Pledge of Offering," the applicant pledged a specified amount as an offering to petitioner in exchange for a limited amount of training or auditing directed toward the attainment of a specified state of spiritual awareness.Additionally, the applicant was required to execute a second document, entitled a "Legal Contract for Auditing and Training." Under this document, the applicant declared that he or she was a proper applicant for training, which entailed among other things that the applicant was of legal age, that he or she did not have any medical illness, that he or she did not have a record of institutionalization, that he or she did not have a criminal record, and that he or she was not addicted to drugs or alcohol. Furthermore, pursuant to this contract, the applicant waived all rights of action against petitioner or L. Ron Hubbard arising from the receipt of the designated services, except the right to request a refund within 3 months of the last day of the services rendered.Petitioner promoted Scientology services through free lectures, congresses, free personality testing, handouts, 1984 U.S. Tax Ct. LEXIS 30">101 and advertisements placed in newspapers and magazines and on the radio. Petitioner geared promotional activities to be responsive to community concerns after taking surveys to ascertain community needs and desires.Two categories of staff -- registrars and Field Staff Members -- had the job of establishing contact with the public to stimulate interest in Scientology services. Registrars in the public division of petitioner's branch churches kept track of new people who showed an interest in Scientology. The registrars were trained in salesmanship. They encouraged new people to purchase introductory Scientology courses. Once a new person showed a commitment to Scientology through the purchase of a major Scientology service, responsibility for his progress was turned over to registrars in the dissemination division of petitioner's branch churches who monitored each parishioner's training and auditing progress through a central file system. This second group of registrars had the duty of 83 T.C. 381">418 contacting people listed in the central files by mail or in person and urging them to take higher Scientology services.In addition to the actions of the registrars, petitioner used another group 1984 U.S. Tax Ct. LEXIS 30">102 of people known as Field Staff Members (FSMs), who also contacted individuals in an effort to interest them in Scientology. These FSMs operated on a commission basis. They were paid an amount equal to 10 percent of the fixed donation for each person they successfully enrolled in a Scientology service. Additionally, the FSMs received awards in the form of scholarship money for Scientology courses based on their ability to make commissions.Petitioner earned money from the sale of books, E-meters, and recordings. According to petitioner, during the taxable years 1971 and 1972, AOLA, ASHO, SFO, and LAO alone generated in excess of $ 400,000 and $ 500,000, respectively, from the sale of these items. By petitioner's admission, sales of these items accounted for the following percentages of total income:AOLAASHOLAOSFOUK19711241016319725497 143ASHO PUBS, a division of ASHO, from 1971 onwards published and distributed these items. As a distributor, it sold these items to other churches and missions of Scientology as well as commercial bookstores for resale.The major portion of the books distributed by ASHO PUBS were copyrighted by L. Ron Hubbard. Through the year 1972, L. Ron Hubbard's 1984 U.S. Tax Ct. LEXIS 30">103 collected works on Dianetics, Scientology, and closely related topics included 2 multivolume encyclopedic series and more than 50 other books and publications. 22 L. Ron Hubbard also recorded more than 3,000 lectures dealing with Scientology technology, administration, and policies between the years 1950 and 1972. Tapes for 509 of such lectures were regularly available to the public. Additionally, petitioner sold E-meters which L. Ron Hubbard invented and on which he held a patent.Petitioner had an elaborate system of prices and discounts for books. In 1959, petitioner used the following formula to 83 T.C. 381">419 price its books: It took the printing cost and multiplied by 5. In 1965, this formula underwent a slight change. The basic formula, 5 times the printing cost, stayed the same, but to this figure petitioner added 2 times the cost of postage to the furthest church. This formula established a minimum price. During the docketed years, the list price of books sold by petitioner through its bookstore ranged from a low of $ 2 to a high of $ 225 or $ 300 for the OEC series. 23 Books could not be given away. 1984 U.S. Tax Ct. LEXIS 30">104 They had to be sold. Books sold to Scientology members were discounted by 10 percent. Books sold to other Scientology churches, including branches of petitioner, were discounted by 40 percent. Books sold to commercial bookstores were also discounted in accordance with the following schedule:1 Book25%2 - 9 Books33/13 [sic]10 - 49 Books4050 - 99 Books41100 - 249 Books42250 - 499 Books43500 Books45 The retail price of an E-meter during the tax years at issue was around $ 200; however, discounts were available in accordance with the following schedule:1. On individual purchases without any membership, full price, no discount.2. International Membership holders -- 20% discount.3. Bulk sales (10 - 40 meters) -- 35% discount.4. Bulk sales (50 or more meters) -- 40% discount.5. All contracted staff -- 40% discount.Petitioner's third source of income came from its franchise operations. Petitioner's Franchise Programme was first introduced in the early part of 1959. Under the Franchise Programme, interested auditors were granted franchises which authorized them to use the names "Applied 1984 U.S. Tax Ct. LEXIS 30">105 Philosophy," "Scientology," and "Dianetics," along with the copyrights associated therewith, in a certain district or territory. Additionally, 83 T.C. 381">420 franchise holders were granted 40-percent discounts on their purchases of books that they could later resell to the public. In exchange, the franchise holder agreed (1) to remit 10 percent of his or her gross income to HCO WW, and (2) to abide by the policies governing franchises. The rates franchise holders could charge for processing and courses were set by L. Ron Hubbard and made known to the franchise holders in the form of policy letters. Franchises were strictly forbidden from providing any free services.In order to obtain a franchise, an interested person had to first file an application for an interim franchise. Initially, these franchises were granted directly by L. Ron Hubbard; however, during the tax years at issue, the franchises were issued to the applicant by petitioner as agent for L. Ron Hubbard.A principal objective of the Franchise Programme was to involve members of the public and push them up to upper level orgs, such as St. Hill, AOLA, ASHO, and Flag. 24 To this end, franchise holders were only permitted to offer lower 1984 U.S. Tax Ct. LEXIS 30">106 level courses and were encouraged to send their students to the higher level orgs for more advanced training. For each student whom the franchise holder successfully referred to petitioner, he received a Field Staff Commission equal to 10 percent of the amount the student spent at the higher level organizations. In conducting the Franchise Programme, petitioner placed a heavy emphasis on statistics and the regular payment of the required 10 percent of gross income to HCO WW. In this regard, the franchise holders were required to keep a set of books and records and to submit weekly reports of the franchise holder's activities, along with their weekly remittance of the required 10 percent of gross income. Franchise holders who failed to submit the required 10 percent of gross income on a regular basis ran the risk of losing their franchise.During the tax years at issue, the franchises were administered by the Franchise Office Worldwide, which was directed by the Franchise Officer. As part of his responsibilities, 1984 U.S. Tax Ct. LEXIS 30">107 the Franchise Officer sent the franchise holders policy letters pertinent to running their franchises and collected the 10 percent 83 T.C. 381">421 payments from each franchise. These payments were then reported on the books of petitioner's United Kingdom Church under the designation "Tithes." The record is not clear how much income the Franchise Programme generated. By petitioner's own records, the income from its franchising operations during the tax years in question was as follows: 1970$ 288,6721971307,809197225 435,960Petitioner's Flag Bureau generated a fourth source of income through the provision of management services to Scientology organizations around the world, including branches of petitioner. Flag collected a variety of statistics from each local church and organization and used this data to develop programs for improving local church administration. When a local church experienced difficulty, Flag sent staff on assignments, called missions, to help manage the situation. The purposes of such missions were varied and included straightening out financial mismanagement, increasing gross income, clarifying 1984 U.S. Tax Ct. LEXIS 30">108 job responsibilities, attracting new parishioners, and insuring excellence in the delivery of services. Flag concentrated its attention on the organizations that made the greatest contribution to Flag's financial support. The fee for these management services was 10 percent of the corrected gross income of the organizations and franchises that were not obligated to pay 10 percent to Worldwide.Flag collected statistics to track Scientology's worldwide growth and expansion, as well as individual and local church productivity. These statistics were reviewed by Flag and used as a basis for the development of programs, policies, and procedures to increase the organization's growth and expansion. As a basis for these statistics, each local church was required to follow a standard method for reporting statistics to petitioner's Flag Bureau. Required statistics included measures of output for each division within a church. This statistic was called the Gross Divisional Statistic, or GDS, and was specific to each division; for example, the GDS of the Dissemination Division was gross income, while the GDS of the 83 T.C. 381">422 Treasury Division was the amount of credit collected and the amount of bills 1984 U.S. Tax Ct. LEXIS 30">109 paid. Each church had an Organizational Information Center (OIC) which graphed and posted divisional statistics. The OIC also transmitted certain statistics to Worldwide on a weekly basis. Worldwide then transmitted (via Telex) accumulated statistics to Flag, where they were graphed and posted in the Control Information Center (CIC) and on the wall outside the Flag Treasury Division. These graphs reflected overall Scientology Income, Flag Income, and LRH Comm. Statistic Revised Income, 26 as well as other income figures. In addition, each Flag staff member had a graph of his job statistic posted next to his desk.One of petitioner's articulated goals was to make money. This was expressed in HCO PL March 9, 1972, MS OEC 384, which enumerated the Governing Policy of Finance as follows:GOVERNING POLICYA. MAKE MONEY.B. Buy more money made with allocations for expense (bean theory).C. Do not commit expense beyond future ability to pay.D. Don't ever borrow.E. Know different types of orgs and what they do.F. Understand money flow lines not only in an org but org to org as customers 1984 U.S. Tax Ct. LEXIS 30">110 flow upward.G. Understand EXCHANGE of valuables or service for money (P/L Exec Series 3 and 4).H. Know the correct money pools for any given activity.I. Police all lines constantly.J. MAKE MONEY.K. MAKE MORE MONEY.L. MAKE OTHER PEOPLE PRODUCE SO AS TO MAKE MONEY.A small sack of beans will produce a whole field of beans. Allocate only with that in mind and demand money be made.Petitioner often used business terminology to describe its operations. Churches were referred to as "orgs." Church missions were called "franchises" until 1971 when their designation in the United States was officially changed to "mission." However, even after the name change, petitioner continued to refer to the administrator of the missions as the Franchise Officer. Fees for auditing were called "prices" 83 T.C. 381">423 rather than "fixed donations," and petitioner frequently said its services were "purchased," "bought," or "sold" rather than "donated," "offered," or "contributed." HCO PL May 23, 1969 (Issue III), 0 OEC 91-93, describing 134 measures to take to insure Church solvency, exemplifies these patterns of speech. It states in part:90. DEPARTMENT 17 (DEPT OF PUBLIC REHABILITATION): Sells Scientology to Governments 1984 U.S. Tax Ct. LEXIS 30">111 and broad social stratas [sic].92. Makes Scientology popular and the thing to do. * * 107. DEPARTMENT 20 (DEPT OF ACTIVITIES): Guides in new body traffic. * * 109. Sees that the Introductory Lecture and non-classed courses use no words that will be misunderstood and makes people want to buy training and processing and offers it. * * 124. DEPARTMENT 22 (DEPT OF FIELD RECRUITMENT, ESTABLISHMENT AND RECORDS): Recruits, appoints and establishes FSMs, Groups and Franchises. * * 128. Gets all commissions owed promptly paid to encourage earning more commissions.129. DEPARTMENT 23 (DEPT OF FIELD TRAINING): Trains the FSMs and Franchise holders and makes them financially successful.130. Treats the whole department activity as salesmen are handled by any other business org.[Emphasis added.]This policy letter is not an isolated phenomenon. Even during the trial of this case, the testimony of petitioner's church witnesses was heavily punctuated with business terminology.Petitioner performed charitable works. It provided assistance to prisoners, ex-offenders, the elderly, the mentally ill, and drug addicts. It helped form Narcanon, a drug-rehabilitation program. It organized a job referral 1984 U.S. Tax Ct. LEXIS 30">112 service for ex-offenders, and it developed an educational program called Applied Scholastics. On occasion, it also assisted the poor and the sick.83 T.C. 381">424 Petitioner performed christenings, funerals, and wedding ceremonies free of charge. Petitioner's chaplains provided free marriage and family counseling. Petitioner also provided a specialized form of auditing free of charge called "ARC break" auditing. This service was geared to help people in crisis.In his notice of deficiency, respondent determined that petitioner's seven stipulated divisions (SFO, LAO, FOLO, ASHO, AOLA, USGO, and Flag) had the following consolidated net incomes during the docketed years:Income197019711972Gross receipts$ 2,249,013.08 $ 3,301,143.73 $ 3,134,391.00 Advance payments373,222.37 788,704.96 1,198,763.86 Flag income263,557.47 240,932.55 Payment DanishKingdom Church 77.92 53,609.76 Payment UnitedKingdom Church 76,497.24 161,018.38 Total income 2,622,235.45 4,429,981.32 4,788,715.55 ExpensesPer Form 9902,438,646.65 4,242,124.02 4,178,876.05 Trust(28,930.34)(67,892.40)(77,986.62)Charter Mission(disallowed) (982,415.39)(1,143,928.02)(1,400,015.99)Flag expenses1,238,466.30 1,036,108.56 Total allowable expenses 1,427,300.92 4,268,769.90 3,736,982.00 Net income 1,194,934.53 161,211.42 1,051,733.55 1984 U.S. Tax Ct. LEXIS 30">113 Petitioner does not contest the accuracy of these figures, but does disagree with the tax treatment accorded them by respondent.Petitioner collected advance payments from parishioners for auditing and training services of $ 373,222.37 in 1970, $ 788,704.96 in 1971, and $ 1,198,763.86 in 1972. These were payments from people for whom no services were rendered during the year the payments were received. It was petitioner's policy to refund advanced payments upon request at any time before the services were taken. There is no evidence in the record that petitioner kept the advance payments segregated or placed restrictions on the use of these funds. Petitioner used the cash method of accounting for its receipts, except it treated advance payments as liabilities.83 T.C. 381">425 The Charter Mission expenses represented amounts transferred by petitioner to OTC during the tax years. Petitioner deducted these payments as expenses on its Forms 990. Respondent disallowed the deduction on the grounds that the payments were not a business expense but constituted an internal transfer of funds to the Flag Division. On brief, petitioner does not contest the adjustment.Petitioner deducted payments of $ 28,930.34 1984 U.S. Tax Ct. LEXIS 30">114 in 1970, $ 67,892.40 in 1971, and $ 77,986.62 in 1972 to the Central Defense and Dissemination Fund. According to petitioner, these were payments to the United States Church of Scientology Trust (the trust).Petitioner alleged that the trust originated in 1962. However, there was no trust document during the docketed years. The trust was first memorialized by Declaration of Trust on June 25, 1973. L. Ron Hubbard was the sole trustee of the trust during the docketed years.During the docketed years, no investments were made with trust funds. They were deposited in several Swiss bank accounts: Rubric Trustee Account No. 272,893.6, Church of Scientology of California Trustee Account No. 285,222, Church of Scientology of California Trustee Account No. 285,222.1, L. Ronald Hubbard Trustee Account No. 272,893.2, and L. Ronald Hubbard Trustee Account No. 272,893.3, at the Swiss Bank Corp. in Zurich, Switzerland. Funds were also deposited in Account No. 015867.226 at the Swiss-Israeli Trade Bank, Geneva, Switzerland. L. Ron Hubbard, Mary Sue Hubbard, and Denzil Gogerly (a United Kingdom Church official who administered the trust) were all sole signatories on the trust accounts. L. Ron 1984 U.S. Tax Ct. LEXIS 30">115 Hubbard kept the trust checkbooks. Member churches were required to remit 10 percent of their total income to the trust on a weekly basis.In 1972, 4,222,015 Swiss francs ($ 1,119,678) 27 was withdrawn from the trust accounts in Switzerland. Petitioner's worksheets originally showed this withdrawal as an inter-account transfer to OTS. This is crossed out, and in different handwriting, the transaction is shown as cash held. According to petitioner, this money was brought aboard the Apollo where it 83 T.C. 381">426 was kept in a locked file cabinet until 1975. Mary Sue Hubbard had the only keys to the cabinet.Membership in the trust was restricted to churches of Scientology in the United States. However, the trust was administered in England by Denzil Gogerly, a United Kingdom Church official, and the United Kingdom Church tithed to the trust until some time in 1971. Financial statements for the trust covering the docketed years were belatedly prepared in 1973. They were prepared in South Africa. They were 1984 U.S. Tax Ct. LEXIS 30">116 prepared for the benefit of 10 churches of Scientology in the United States although the Declaration of Trust recites only 5 member churches.According to the financial statements finally prepared in 1973, the trust accounts had the following net proceeds and accumulated funds for the docketed years:AccumulatedYear endedNet proceedsfundsDec. 31, 1970$ 86,170.80$ 812,134.51Dec. 31, 1971254,084.71930,400.08Dec. 31, 1972376,837.181,307,237.26July 18, 1973691,106.021,998,343.08The purported purpose of the trust was the defense of Scientology. During the docketed years there was only one disbursement for such purpose in the amount of $ 9,290.47. USGO expended substantially greater amounts for legal fees.The United Kingdom Church was a branch of petitioner. According to petitioner's records, the United Kingdom Church earned the following profits:197019711972Total receipts$ 892,783 $ 2,017,850 $ 1,815,509 Less: Total expenses(593,102)(1,221,433)(998,937)Net income 299,681 796,417 816,572 It was petitioner's policy to build large cash reserves and to deduct payments to these cash reserves as business expenses. These reserves were mainly held in OTC bank accounts. The yearend balances 1984 U.S. Tax Ct. LEXIS 30">117 of the OTC bank accounts are shown in the following table: 83 T.C. 381">427 OTC BANK ACCOUNTSYearend (Dec. 31) BalanceBank accountBanknumber1970(1)Swiss Bank Corp.295,728 $ 1,721,748.46(2)Swiss Bank Corp.295,728.1 25,757.85(3)Swiss Bank Corp.295,728.2 (4)Banque Marocaine081,920.4 (5)du 10,5616.2 (6)Exterieur 90,1924.0 (7)" 90,1928.0 (8)" 217.734.2 (9)" 02.03.C.05616.5(10)Banco de Vizcaya93,7470 20,577.44(11)Banco Unquijo15,855 (12)Banco EspiritoSanto E Comercial de Lisboa 23,718 (13)1st National20,48.007 (14)Banco de VizcayaEllen Kayman742.59(15)Banco de Vizcaya917290 2,340.66(16)Banco HispanoAmericano 8631 1,814.72Total 1,772,981.72OTC BANK ACCOUNTSYearend (Dec. 31) BalanceBank accountBanknumber19711972(1)Swiss Bank Corp.295,728 $ 1,653,475.50$ 1,825,724.25(2)Swiss Bank Corp.295,728.1 50,723.2425.81(3)Swiss Bank Corp.295,728.2 98,743.80163,820.00(4)Banque Marocaine081,920.4 110,852.06380,629.76(5)du 10,5616.2 1,330.93(6)Exterieur 90,1924.0 36,289.48(7)" 90,1928.0 8,425.93(8)" 217.734.2 11,937.4419,272.56(9)" 02.03.C.05616.543,610.02(10)Banco de Vizcaya93,7470 1,433.571,477.60(11)Banco Unquijo15,855 7,697.2919,535.64(12)Banco EspiritoSanto E Comercial de Lisboa 23,718 52,356.93106,965.05(13)1st National20,48.0079,565.87628.29(14)Banco de VizcayaEllen Kayman(15)Banco de Vizcaya917290 (16)Banco HispanoAmericano 8631 Total 2,042,831.5428 2,561,688.981984 U.S. Tax Ct. LEXIS 30">118 During the tax years at issue, L. Ron Hubbard and Mary Sue Hubbard received salaries from petitioner in the following amounts:197019711972L. Ron Hubbard$ 4,932$ 9,368$ 35,000Mary Sue Hubbard3,0172,43025,000Total 7,94911,79860,000Additionally, according to petitioner's own records, L. Ron Hubbard and Mary Sue Hubbard received 5,125.11.4 pounds in fees from the United Kingdom Church in 1970, 15,770.67 pounds in 1971, and 23,199.90 pounds in 1972. 29 Using the 83 T.C. 381">428 conversion rate of 2.4 suggested by petitioner's witness, these amounts translate into $ 12,300.27 in 1970, $ 37,849.61 in 1971, and $ 55,679.76 in 1972. Thus, by petitioner's own admission, L. Ron Hubbard 1984 U.S. Tax Ct. LEXIS 30">119 and Mary Sue Hubbard received salary payments from petitioner totaling $ 20,249.27 in 1970, $ 49,647.61 in 1971, and $ 115,679.76 in 1972.In addition to the outright salary payments detailed above, during the years at issue, L. Ron Hubbard, Mary Sue Hubbard, and their four children resided for the most part aboard the Apollo. While aboard ship, petitioner paid the Hubbards' living expenses which included free lodging, food, laundry, and medical services. In 1970, Flag expended $ 31,720 for the benefit of the Hubbard family.L. Ron Hubbard received royalty payments in connection with petitioner's sales of books and E-meters. These royalties were paid by ASHO and were computed on the basis of 10 percent of the 1984 U.S. Tax Ct. LEXIS 30">120 retail price of the publications and E-meters distributed by ASHO PUBS. Parenthetically, we note that the retail price of these items was determined by a formula developed by L. Ron Hubbard. Beginning in August of 1971, all such royalties were paid on a weekly basis, while back royalties attributable to periods prior to that time were paid intermittently on later dates.The amounts of royalties paid by ASHO to the account of L. Ron Hubbard during the years 1971 and 1972 were as follows:1971$ 10,649.221972104,618.27Additionally, as of April 29, 1972, there were unpaid back royalties of $ 17,187.70 for the year 1971 which, along with all back royalties, were paid to L. Ron Hubbard by the end of 1974. The majority of ASHO PUB's sales of E-meters and books upon which royalties were paid to the account of L. Ron Hubbard were to other Scientology churches, including branches of petitioner.It was a long-standing policy of petitioner that all works pertaining to Scientology and Dianetics had to be copyrighted to L. Ron Hubbard. As a result of this policy, a number of publications copyrighted by L. Ron Hubbard were actually written by others. For example, Ruth Mitchell wrote the book "Know 1984 U.S. Tax Ct. LEXIS 30">121 Your People," and Peter Gillum wrote the book "How 83 T.C. 381">429 To Be Successful"; however, both books were copyrighted by L. Ron Hubbard. Additionally, there are many policy letters contained in the OEC series that were actually written by paid employees of petitioner with L. Ron Hubbard's approval. Nevertheless, despite the fact that L. Ron Hubbard did not personally author the entire nine-volume set, he did receive royalty payments on the sale of this publication.Petitioner expended funds to protect L. Ron Hubbard's patents and copyrights.Sometime in the 1960's Scientology organizations around the world began paying L. Ron Hubbard 10 percent of their income in the guise of debt repayment. These payments were variously referred to as "LRH 10%s," "LRH RR," and "LRH Comm. Statistic (Stat.) Revised." The record is peppered with references to these alleged debt repayments in FBO correspondence and policy letters predating the docketed years. It is clear from these documents that there was no set amount of debt which had been negotiated between L. Ron Hubbard and petitioner or any other organization but rather a continuing obligation to make payments based on total receipts.Petitioner continued 1984 U.S. Tax Ct. LEXIS 30">122 to funnel debt repayments to L. Ron Hubbard during the docketed years. Between October 9, 1972, and December 28, 1972, USLO, also called FOLO, receipted $ 19,324.41 in debt repayment from Scientology organizations throughout the United States and Canada, including branches of petitioner. On petitioner's invoices (records of receipt), these payments were designated "LRH Repayments," "Founding Debt Payment," or "Per HCO Policy Letter 7 Sept. 72."ConspiracyPetitioner, its agents, and others willfully and knowingly conspired to defraud the United States by impairing, obstructing, and defeating the lawful functions of the IRS in the determination, assessment, and collection of income taxes due from petitioner and from other Scientology organizations and officials. The conspiracy began in 1969 and continued until approximately July 7, 1977, when the FBI, pursuant to a warrant, searched petitioner's premises for evidence of the conspiracy and related crimes.There is a written record documenting most of this conspiracy, some of it in official Church publications, some in confidential 83 T.C. 381">430 orders issued by petitioner's Guardian Office, and some in correspondence between Scientology officials. 1984 U.S. Tax Ct. LEXIS 30">123 Prior to, and during the course of the conspiracy, L. Ron Hubbard issued policy letters and directives depicting the IRS as a danger to Scientology, and threatening to make the IRS "swim in circles." During 1969, personnel in petitioner's FBO network corresponded about plans to protect petitioner's tax-exempt status by forging records to conceal petitioner's relationship with OTC. Two confidential orders formulated by petitioner's Guardian Office in 1972 and 1974, respectively, outlined plans to thwart IRS investigations into the tax status of churches of Scientology by burglarizing Government offices and stealing Government documents. Reports sent to petitioner's Guardian Office describe compliance with the confidential Guardian Order issued in 1974.In 1969, the IRS began an audit of petitioner's records to determine petitioner's tax liability for the years 1963 through 1967. In the same year, top officials on petitioner's staff in the FBO network grew concerned that petitioner's large payments to OTC, a foreign corporation not holding tax-exempt status, would jeopardize petitioner's tax-exempt status. To disguise these payments as debt repayment and to conceal the OTC sham, 1984 U.S. Tax Ct. LEXIS 30">124 a cover story was developed. 301984 U.S. Tax Ct. LEXIS 30">125 The theme of the coverup story was that OTC was a corporation which provided training and consultation services to petitioner for a fee. Petitioner planned several measures to implement this cover and some of them were actually executed.83 T.C. 381">431 On May 25, 1969, Vicki Polimeni, SBO and high-ranking official in the FBO network, by dispatch orchestrated a plan to disguise payments AOLA and other Advanced Organizations in Denmark and the United Kingdom made to OTC as debt repayment. She ordered the FBO at AOLA and various other Advanced Organizations to prepare and backdate weekly statements showing that each Advanced Organization was making expenditures on behalf of OTC. 31 The FBOs were directed to make these statements using Flag bill folders and Flag summaries. However, the Polimeni dispatch directed the FBOs not to mention Flag on the prepared 1984 U.S. Tax Ct. LEXIS 30">126 statement. A mock statement itemizing Advanced Organization expenditures on behalf of OTC was included in the dispatch as an example. 321984 U.S. Tax Ct. LEXIS 30">127 The dispatch further explained that at the same time the FBOs were preparing the statements, the SBO and others at Flag would prepare billings from OTC to the Advanced Organizations using the statements to substantiate the billings. The purpose of these statements and billings was to manufacture evidence to show to the IRS which would disguise Advanced Organization payments to OTC as debt repayment for services OTC had allegedly rendered. In fact OTC, by petitioner's own admission, did not perform services for petitioner of the type described in the mock statement.As part of the coverup plan, the FBO International wrote the FBO at AOLA on May 29, 1969, informing him that changes would have to be made to AOLA's disbursement vouchers and invoices to OTC dating back to August 1968 to make them support petitioner's tax story. (Petitioner's branch churches used disbursement vouchers to record payments, and invoices to record receipts.) On June 1, 1969, the FBO International also directed the FBO AOLA to prepare new signature cards and change the drawer's name on checks for account number 6919 used by AOLA but periodically maintained in the name of OTC at the Wilshire-Westlake Office of 83 T.C. 381">432 the Crocker-Citizens National Bank in Los Angeles. This was done. Signature cards for this account show that between August 2, 1968 (when the account was established), and August 13, 1969, the account was periodically held in the name of OTS or OTC, in combination with petitioner's name or AOLA's name. However, beginning on August 14, 1969, account number 6919 was held in AOLA's name with 1984 U.S. Tax Ct. LEXIS 30">128 no mention of OTC. Sometime in 1969, the drawer's name was also changed on checks for account number 6919 from OTS to Church of Scientology of California Advanced Organization of Los Angeles Reserve Account.During the docketed years, petitioner advocated and practiced the use of obstructionist tactics to thwart IRS investigations of petitioner and affiliated churches. In 1970, petitioner's tax returns for the taxable years 1964 through 1967 were under audit. In June or July of that year, Martin Greenberg, the Church's accountant, told an assembled group of Scientologists 33 that he purposely made the audit difficult. He said he gave the examiner boxes of original records, disbursement vouchers, and invoices in no semblance of order, with the intent of so hopelessly overwhelming and confusing the examiner that he would be forced to give up the examination and accept petitioner's version of the facts. In April 1972, Mr. Greenberg instructed a member of the financial staff at an affiliated Church of Scientology to use similar tactics if IRS agents ever came to her church to examine records. She was told to give the IRS agent a bunch of records in a box in no semblance of order; to 1984 U.S. Tax Ct. LEXIS 30">129 place the agent in a small, dark, out-of-the-way room, to refuse to give practical assistance like locating records, and to notify petitioner's Guardian Office immediately of the agent's presence. Henning Heldt, petitioner's vice president and the Deputy Guardian Finance in petitioner's Guardian Office, gave this staff member similar instructions. For approximately 2 years from May 1971 through February 1973, IRS Agent Robert Cluberton tried unsuccessfully to audit petitioner's 1968 and 1969 tax returns. 34 Part of the 83 T.C. 381">433 audit's lack of success was attributable to the IRS's failure to pursue vigorously the audit and part to petitioner's refusal to cooperate. 35 Petitioner never allowed agent Cluberton access to its financial records. On February 9, 1973, agent Cluberton served an administrative summons on Henning Heldt, vice president and director of petitioner. The summons specified records and documents to be produced and allowed a 10-day return. Heldt did not comply. On February 20, 1973, Heldt 1984 U.S. Tax Ct. LEXIS 30">130 appeared at the Los Angeles IRS Office and handed Cluberton a letter stating he had resigned as an officer of the California Church and therefore did not have control of its records. Notwithstanding his resignation, Heldt continued to exercise control over petitioner's financial records. By letter dated June 12, 1973, he authorized the Crocker-Citizens National Bank to release certain bank statements to the bearer of the letter.On or about October 26, 1971, petitioner filed an informational return, Form 990, for the taxable year 1970; on or about August 21, 1972, for 1971; and on or about October 12, 1973, for 1972. All three informational returns were prepared and signed by Martin Greenberg, certified public accountant. Reverend Mulligan as president 1984 U.S. Tax Ct. LEXIS 30">131 co-signed the 1970 return; Craig Beeney, as secretary and vice president, respectively, co-signed the 1971 and 1972 returns. The returns were signed under penalty of perjury. They do not contain financial information for the United Kingdom Church or OTC.During and after the docketed years, petitioner's Guardian Offices in the United States and the United Kingdom planned and executed a scheme to infiltrate the IRS, seize records pertaining to Scientology-related tax matters pending before the IRS, and conceal petitioner's connection to these covert, illegal activities. During this period, the highest ranking Guardian was Mary Sue Hubbard who held the position Commodore Staff Guardian. Jane Kember, the Guardian Worldwide, was just under her in rank. In the United States during the years 1970-72, the highest ranking official in the 83 T.C. 381">434 Guardian Office was Robert Thomas, the Deputy Guardian United States (DG US). His senior staff and their positions from 1970-72 were as follows:James Mulligan361984 U.S. Tax Ct. LEXIS 30">132 Deputy Deputy Guardian Joel KreinerDeputy Guardian LegalCraig BeeneyDeputy Guardian TechnologyHenning HeldtDeputy Guardian FinanceArthur MarenDeputy Guardian Public RelationsTerry Milner37 Deputy Guardian Intelligence Martin J. Greenberg, whose title was CPA US, was an adjunct of the United States Guardian Office during these years. He was petitioner's accountant. Henning Heldt reviewed his work. By the end of 1972, the USGO had 40 staff members. James Mulligan, Craig Beeney, and Henning Heldt also served as officers and directors of petitioner during the docketed years. Their positions and dates of service were --James MulliganDirector and president(Jan. 1, 1970 -- Sept. 3, 1973) Henning HeldtDirector and vice president(Feb. 23, 1971 -- Feb. 16, 1973) Craig BeeneyDirector and secretary(Feb. 23, 1971 -- Apr. 13, 1973) In April 1972, petitioner's Guardian Office formulated a three-prong plan designed to stop what it perceived to be an IRS attack on Scientology. The plan was developed in response to several unfavorable tax rulings revoking the tax-exempt status of churches of Scientology in the United States. The plan called for three separate intelligence operations: Operation Search and Destroy, Operation1984 U.S. Tax Ct. LEXIS 30">133 Random Harvest, and Operation Paris. The purpose of Operation Search and Destroy was to identify organizations and individuals furnishing information to the IRS and secure information about them covertly and overtly which could be used to discredit or "Dead Agent" them. This plan appears to have been a continuation of an earlier program since the Intelligence Bureau of the Guardian Office was already in possession of files taken from organizations 83 T.C. 381">435 providing information to the IRS. 38 Care was to be taken to prevent the Church of Scientology from being connected to the covert component of the operation.The purpose of Operation Random Harvest was to document criminal activity on the part of the IRS. The purpose of the third intelligence program, Operation Paris, was to identify IRS personnel handling Scientology tax matters and to investigate their backgrounds and activities. A segment of the plan called for recruiting a "plant" to develop social and professional contacts with IRS personnel and develop a cover to hide his affiliation with the Church of Scientology. Significant 1984 U.S. Tax Ct. LEXIS 30">134 information gleaned from Operation Paris was to be forwarded to the Intelligence Bureau of the Guardian Office. The Deputy Guardian Intelligence (DG Int US) was placed in charge of this project.The Guardian Office later developed another plan to infiltrate the IRS and appropriate documents. The plan is memorialized in Guardian Order 1361 dated October 21, 1974. The plan was developed in response to the IRS's continuing investigation of Scientology tax matters which petitioner viewed as an attack. Part of this investigation covered petitioner's tax returns for 1964-69. The purpose of the plan was to root out damaging reports considered to be false in the IRS files, so that the IRS would forget about Scientology and direct its attention elsewhere. The plan called for infiltrating IRS offices in Los Angeles, Washington, D.C., and London; stealing files on Scientology and L. Ron Hubbard; and developing a suitable cover story to disguise how the information was obtained. The Deputy Guardian Information, U.S. (DG Info US) was in charge of implementing most of the plan.Pursuant to Guardian Order 1361, the IRS offices in Washington, D.C., were burglarized, and documents relating to 1984 U.S. Tax Ct. LEXIS 30">135 petitioner and other Scientology churches were taken and forwarded to petitioner's Guardian Office. At one point, Scientology operatives had difficulty gaining access to IRS intelligence files. They tried to solve this problem by having petitioner's attorney, Joel Kreiner, a witness in this case, make a freedom of information request for these documents believing the request would lead the IRS to place the files in a 83 T.C. 381">436 central location for processing where they would be more accessible. Operatives gained inside information about the 1971-74 audit by monitoring the offices of Lewis Hubbard and his assistant and then successor, Stephen Friedberg. Their offices were monitored over a period of several months while the 1971-74 audit was in progress. At one point during this period, operatives reported they had gained access to all of the materials on Scientology kept in Lewis Hubbard's office including Chief Counsel's files. They also gained possession of Stephen Friedberg's handwritten daily notes which contained occasional references to the examiner's activities.On December 11, 1979, several ranking officials in petitioner's hierarchy were convicted in the U.S. District Court for 1984 U.S. Tax Ct. LEXIS 30">136 the District of Columbia of conspiracy to obstruct justice and to obstruct a criminal investigation in violation of 18 U.S.C. section 371. They were Mary Sue Hubbard, the founder's wife and second in the executive chain-of-command during the docketed years; Henning Heldt, petitioner's vice president and Deputy Guardian Finance during the docketed years; Duke Snider, petitioner's president from late 1975 through May 10, 1976, and USGO official; Gregory Willardson, a USGO intelligence official in the post-docketed years; and Richard Weigand, also a USGO intelligence official in the post-docketed years. On the same day, Mitchell Hermann, a.k.a. Mike Cooper, a Guardian official employed by the Church of Scientology in the District of Columbia, was convicted of conspiring to steal Government documents including ones pertaining to the 1971-74 audit. 39 A year later, on December 19, 1980, Jane Kember and Morris Budlong were convicted in the U.S. District Court for the District of Columbia of burglarizing the Exempt Organization Division of the National Office of the IRS on three occasions in 1976 while the 1971-74 audit was in progress. Jane Kember, the Guardian Worldwide, was the highest 1984 U.S. Tax Ct. LEXIS 30">137 ranking official in the United Kingdom Church during the docketed years. Morris Budlong was an official in the Guardian Office Worldwide in the post-docketed years. In the spring of 1975, Guardian Office personnel came aboard the Apollo and engaged in a project to falsify petitioner's 83 T.C. 381">437 financial records. The project was undertaken in anticipation of an IRS audit.From June 1975 through July 1976, the IRS audited petitioner's records bearing on its 1971-74 tax returns. Following the audit, petitioner prepared a Church audit report and maneuvered to have it serve as the operative statement of facts to accompany a request for technical advice. Thereafter, petitioner and respondent entered into settlement negotiations which continued even after the notice of deficiency was issued.The California Church did not keep books or journals to record its financial transactions. The examiners, therefore, worked from original records -- checks, 1984 U.S. Tax Ct. LEXIS 30">138 disbursement vouchers, and invoices. The California Church also gave the examiners tax workpapers for the years 1971 and 1972, in lieu of general ledgers or books of entry. During the course of the audit, the examiners received over 300 cartons of records containing, by conservative estimate, 2 million documents. The boxes were labeled by type of record and by year; for example, "1971 disbursement vouchers," but the labels did not always correspond with the materials inside. The records were generally not in chronological order. The checks were detached from their stubs. It took three or four examiners from 1 to 2 weeks just to organize 49 boxes of records from the San Francisco Organization. The Church's workpapers were not always prepared in accordance with generally accepted accounting principles and were insufficient to establish the information the California Church was required to report on its returns.During the audit, the examiners tried to fathom the relationship between petitioner and OTC. Several times they asked for canceled checks from the bank accounts OTC maintained on behalf of the California Church. They were told these might take several weeks to produce since 1984 U.S. Tax Ct. LEXIS 30">139 foreign banks did not return canceled checks as a matter of course. The California Church concealed from the examiners that it regularly received debit advices from the foreign banks in lieu of canceled checks, and it never produced the canceled checks. As a result, docketed-year disbursements totaling over $ 3 million from the Rubric General Account No. 295,728 on which L. Ron Hubbard was a signatory were never explained. The auditors made numerous requests for records to verify 83 T.C. 381">438 that OTC expenditures claimed to be made on petitioner's behalf were actually expended on petitioner for an exempt purpose. The California Church did not comply with some of these requests. In one instance, the California Church failed to substantiate a schedule of approximately 300 claimed expenditures. The schedule was pared down to 20 items. The IRS never received adequate documentation, e.g., canceled checks or third-party bills, to substantiate even these 20 items.During the audit and the ensuing negotiations, petitioner repeatedly represented that OTC was a separate corporation from petitioner. Petitioner represented that OTC was formed in 1968 to render financial services to the Flag Division 1984 U.S. Tax Ct. LEXIS 30">140 aboard the Apollo. Petitioner represented that OTC was a trusted agent receiving and banking petitioner's funds and then expending them on petitioner's behalf to support Flag operations. Petitioner represented that OTC personnel performed these financial services. Petitioner further represented that at the start of the agency relationship, force of circumstances led petitioner to deposit its funds in existing OTC bank accounts, a practice which continued through the taxable years in issue. Petitioner also represented that in 1972, over $ 2 million in cash belonging to OTC was transferred to the Apollo and kept in OTC's custody until the end of 1974, when it was credited to petitioner as partial payment of a debt OTC owed petitioner.All of these representations were false. OTC was in form, but not in fact, a separate entity from petitioner. Petitioner's personnel and not OTC personnel kept the OTC checkbooks, directed the flow of funds into and out of OTC accounts, receipted money for the support of Flag operations, and controlled and managed Flag expenditures. The OTC bank accounts were in reality opened and maintained by petitioner. 40 Only petitioner's personnel were signatories 1984 U.S. Tax Ct. LEXIS 30">141 on the accounts. 411984 U.S. Tax Ct. LEXIS 30">142 Mary Sue Hubbard and L. Ron Hubbard were sole 83 T.C. 381">439 signatories on the accounts. The $ 2 million in cash that was brought to the Apollo in 1972 in reality belonged to petitioner and not OTC. The cash was withdrawn from a Swiss bank account upon L. Ron Hubbard's authority, transferred to the Apollo by Flag employees, and kept in a file cabinet in a strongroom to which only Mary Sue Hubbard had keys.Throughout most of the course of the conspiracy, the California Church knowingly concealed the status of the United Kingdom Church as an operating branch of petitioner. The Forms 990 filed by petitioner for the years 1970-72 did not consolidate or include the receipts, disbursements, assets, or liabilities of the united Kingdom Church. Church submissions to the IRS made during the audit and intended to describe petitioner's corporate structure made no mention of the United Kingdom Church. Throughout the audit, petitioner's representatives referred to Scientology activities in the United Kingdom by such names as U.K. Church, U.K., United Kingdom Churches, Worldwide Church in England, and United Kingdom Scientology Organizations. They never used the term "U.K. Branch" or "Church of Scientology of California -- U.K. Branch" or a term of like import although they did furnish some records which incidentally, e.g., in letterheads, disclosed the United Kingdom Church's corporate status. The Church audit report cast the United Kingdom Church as a separate corporate entity. An affidavit of petitioner's president dated 1984 U.S. Tax Ct. LEXIS 30">143 November 9, 1980, in support of a motion to quash a subpoena to produce bank records from accounts maintained by the United Kingdom Church denied the accounts belonged to the California Church.A stipulation in this case filed November 10, 1980, listed seven of petitioner's divisions but did not include the United Kingdom Church. Prior to trial, petitioner's representatives once acknowledged a formal connection between the United Kingdom Church and the California Church while denying any more than a formal connection. In March 1975, during the audit of the Hawaii Church, petitioner's representative stated that the United Kingdom Church was incorporated as the Church of Scientology of California as a legal convenience but operated separately and independently.The United Kingdom Church had more than a nominal connection to petitioner. It lacked a bona fide board of 83 T.C. 381">440 directors. Its franchise operations were controlled by Flag. Policy directives were issued jointly by the United Kingdom Church and the California Church for the board of directors of the California Church. United Kingdom Church officials and California Church officials could and did write checks on each other's accounts. 1984 U.S. Tax Ct. LEXIS 30">144 Petitioner's "trust fund" was administered by the United Kingdom Church.Church officials knew the United Kingdom Church was only operating in the United Kingdom as a branch of petitioner. At practically the same time that the California Church's representatives in the United States were portraying the United Kingdom Church as a separate and independent entity, petitioner's representatives in the United Kingdom were filing documents with the Registrar of Companies in Great Britain, referring to the United Kingdom Church as the "Church of Scientology of California -- U.K. Branch," and stating that the United Kingdom Church "was not resident in the United Kingdom during the above year(s) [1967, 1968, 1970]" and was "not a 'Close' Company within the meaning of Schedule 18 Finance Act of 1965." Petitioner's United Kingdom accountant, Derek Field, who prepared and reviewed these documents, testified that the statement was intended to reflect the fact that the United Kingdom Church was not present in the United Kingdom as an entity. It was only present as a branch of the California Church.EvidenceOn July 8, 1977 (and past midnight into July 9, 1977), FBI agents executed a search warrant 1984 U.S. Tax Ct. LEXIS 30">145 at petitioner's premises, known as the Cedars-Sinai Complex, in Los Angeles. The search warrant was based on a 33-page sworn affidavit signed by FBI Special Agent Robert Tittle describing the Government's investigation of charges that Scientology officials from 1974 through 1976 conspired to steal documents belonging to the Federal Government and conspired to obstruct justice by covering up these crimes during a grand jury investigation of a burglary of the Office of an Assistant U.S. Attorney in the U.S. Courthouse in Washington, D.C. The search warrant specified 162 categories of items to be seized. Category 162 called for the seizure of:83 T.C. 381">441 Any and all fruits, instrumentalities, and evidence (at this time unknown) of the crimes of conspiracy, obstruction of justice and theft of government property in violation of 18 U.S. Code secs. 371, 1503 and 641 which facts recited in the accompanying affidavit make out.During the search, FBI agents seized a document, identified as "Exhibit FX" in this case, from a file cabinet in petitioner's Guardian Office. The FBI agent who seized the document did not testify.Exhibit FX consists of 19 pages. It is dated April 5, 1972. The document sets 1984 U.S. Tax Ct. LEXIS 30">146 forth a plan to sabotage IRS investigations of the tax-exempt status of Scientology churches. The plan calls for employing secret operatives to gather information to discredit persons working for, or supplying information to, the IRS on Scientology matters. The plan is written in the format of a Guardian Order.Exhibit FU, in the instant case, is a folder containing Guardian Order 1361, dated October 21, 1974, and a number of reports discussing compliance with the Guardian Order. 421984 U.S. Tax Ct. LEXIS 30">147 Guardian Order 1361 is a nine-page plan to derail governmental challenges to the tax-exempt status of Scientology churches, including petitioner. Petitioner stipulated that Guardian Order 1361 in Exhibit FU was prepared by petitioner's United States Guardian Office in 1974. Petitioner did not stipulate to the authenticity of the remaining documents in Exhibit FU. However, when the exhibit was moved into evidence some 6 months after it was first the subject of testimony, petitioner's only continuing objection was that the documents were the product of an illegal search and seizure. Guardian Order 1361 calls for infiltrating the IRS and the Department of Justice, stealing documents from IRS offices in London, Los Angeles, and Washington, D.C., and the Tax Division of the Department of Justice, and passing information culled from these documents on to the Deputy Guardians for Information, Legal, and Public Relations at petitioner's Guardian Offices in the United States and Great Britain. The contents of most of the remaining documents in Exhibit FU bear on compliance with Guardian Order 1361. Some are progress reports. Some convey strategic information about 83 T.C. 381">442 Government offices targeted for burglary. Some refer to Guardian Order 1361 on their face. Some show on their face that they were sent to a person in petitioner's United States Guardian Office. One document is a job-posting for a position as clerk-typist at the IRS.Stephen C. McKellar, a criminal investigator in the Internal Security Division of the IRS, testified about the circumstances by which the IRS came into possession of the documents comprising Exhibit FU. His investigative report of these circumstances was also placed in evidence.Agent McKellar first 1984 U.S. Tax Ct. LEXIS 30">148 saw the typewriter-case documents on February 8, 1978. On that date Alvin Jones, an attorney, came to his office in Los Angeles carrying a black, metal typewriter case full of documents in file folders. The typewriter case had no markings on it except the letters "SMC" for Smith-Corona Corp. Agent McKellar testified that Jones explained that sometime in July 1977, one of his clients found the typewriter case by itself in a Sears store parking lot located on Santa Monica Boulevard and Wilton Place in Los Angeles. Agent McKeller's report amplifies this testimony somewhat and states that Jones explained to McKellar that his client saw an unidentified man leave the typewriter case in the parking lot unattended and that his client picked it up when the man failed to return after a short while. Agent McKellar testified that Jones told him he believed the documents would be of some value to the IRS since they described information about a burglary of IRS offices in Washington, D.C. The report further amplifies this point explaining that Jones told McKellar the documents related to break-ins of IRS offices for the purpose of reviewing records concerning the Church of Scientology.Agent 1984 U.S. Tax Ct. LEXIS 30">149 McKellar did not get a search warrant before opening the typewriter case and examining its contents. When he opened it he had some belief it contained evidence of a crime.The audit of petitioner's 1971-74 taxable years began in June 1975 and lasted through July 1976. Respondent's examining agents had no authority to conduct settlement negotiations during the audit.The documents in exhibits DU and HG constitute some of petitioner's correspondence with the IRS. The documents fall into one of three categories. The majority of the documents are petitioner's responses to formal requests for information from 83 T.C. 381">443 the IRS during the audit. 43 These documents are identified by the fact that they have at least two of the following features: (1) They are addressed to an examiner and bear a date corresponding to the audit period; (2) they are captioned by, or contain an internal reference to, a specific IRS request for information; (3) their content clearly relates to a specific request for information. Exhibit DU also contains some of petitioner's correspondence with the IRS unrelated to information sought by the examiners. 44 These documents bear a date subsequent to July 31, 1976, and are 1984 U.S. Tax Ct. LEXIS 30">150 addressed to Mr. William Connett, Mr. Alvin Lurie, or Mr. Joseph Tedesco of the IRS. There are also a few miscellaneous documents in Exhibit DU which cannot with certainty be categorized as petitioner's responses to requests for information from the IRS. 45OPINIONThis is a complicated case, both legally and factually -- witness the long list of issues presented for resolution and the lengthy findings of fact we have had to make. We, therefore, think it is wise to announce our holdings at the outset, hoping this will help the reader's understanding. We hold that petitioner does not qualify for exemption from taxation under sections 501(a) and 501(c)(3) because it is operated for a substantial commercial purpose and because its net earnings benefit L. Ron Hubbard, his family, 1984 U.S. Tax Ct. LEXIS 30">151 and OTC, a private noncharitable corporation controlled by key Scientology officials. Additionally, we hold that petitioner is not entitled to tax-exempt status because it has violated well-defined standards of public policy by conspiring to prevent the IRS from assessing and collecting taxes due from petitioner and affiliated Scientology churches. We further uphold the determinations respondent has made in his notice of deficiency, except his determination that petitioner received income from the United Kingdom Church. Finally, we find that petitioner's failure to file tax returns was without reasonable cause and 83 T.C. 381">444 that respondent therefore properly determined an addition to tax.We have divided this opinion into eight sections, each of them announced by a Roman numeral. The first section deals with petitioner's challenges to the notice of deficiency (questions 1 and 2). The second section treats petitioner's objections to the constitutionality of the express conditions of section 501(c)(3). However, it does not treat petitioner's attack on the constitutionality of public policy requirements which have been read into section 501(c)(3). See Bob Jones University v. United States, 461 U.S. 574">461 U.S. 574 (1983). 1984 U.S. Tax Ct. LEXIS 30">152 In view of our holding that petitioner fails to qualify for exemption under the express conditions of section 501(c)(3), i.e., the provisions prohibiting commercialism and inurement, our holding that petitioner is not entitled to exemption because it has violated public policy is simply an additional ground of decision. We, therefore, reserve treatment of the public policy aspects of this case to a separate section. There is one minor exception. The second section does include treatment of petitioner's contention that the public policy requirement is unduly vague. In sum, the second section covers questions 3 through 10 on the list of issues presented. Midway through the trial, respondent raised a new issue. Respondent presented evidence that the United Kingdom Church is a branch of petitioner. The third section of this opinion considers the legal issues generated by respondent's claim that the United Kingdom Church is a branch church (question 13). The fourth and fifth sections deal with the Church's financial operations (questions 14 and 15). Section four elucidates our holding that the Church's activities evidence a substantial commercial purpose, and section five, our 1984 U.S. Tax Ct. LEXIS 30">153 holding that the Church's earnings inure to the benefit of private individuals. Section six treats the public policy issues raised in this case (questions 11, 12, and 16). There are three of them: (1) Whether petitioner has, in fact, violated public policy; (2) whether requiring petitioner to comport with public policy intrudes on the Church's associational and free exercise rights protected by the First Amendment; and (3) whether petitioner is deprived of due process by the retroactive imposition of a public policy requirement. The seventh section treats a number of evidentiary issues raised in this case and the 83 T.C. 381">445 eighth and last section deals with petitioner's tax liability as reflected in the notice of deficiency (questions 17 and 18).I.Petitioner mounts two attacks on the notice of deficiency. First, petitioner alleges that it is invalid for a number of administrative reasons and, second, petitioner alleges that it is invalid because of constitutional considerations. The main thrust of petitioner's first argument is that respondent never issued a final letter of revocation or, if he did, he later nullified it and therefore the notice of deficiency is null and void, since an 1984 U.S. Tax Ct. LEXIS 30">154 exempt organization cannot owe taxes. Petitioner relies on A. Duda & Sons Cooperative Association v. United States, 504 F.2d 970">504 F.2d 970, 504 F.2d 970">973 (5th Cir. 1974), stating that respondent could not assess taxes against a tax-exempt cooperative where it stipulated the revocation was void.We think petitioner misinterprets the administrative record and misreads the Duda case. On July 18, 1967, respondent formally revoked petitioner's tax-exempt status and subsequently published an announcement of the revocation in the Internal Revenue Bulletin and removed petitioner's name from its cummulative list of charitable organizations. None of respondent's actions subsequent to the revocation show, as petitioner claims, that the revocation was either tentative or later nullified. Admittedly, respondent made no unflinching effort to collect taxes from petitioner prior to the taxable years at issue in this case and continued in subsequent audits to review petitioner's tax status, but we decline to agree with petitioner that these actions either nullify the revocation or detract from its finality.Petitioner argues that respondent's disposition of its 1965-67 taxable years voided the letter of revocation issued 1984 U.S. Tax Ct. LEXIS 30">155 on July 18, 1967. In 1974, respondent issued a notice of deficiency to petitioner for the taxable years 1965-67. The deficiencies were comparatively small, ranging from slightly over $ 2,500 to slightly under $ 14,000. Petitioner contested the 1965 but not the other deficiencies in the Tax Court. In late 1976, respondent settled the 1965 case by conceding petitioner's tax-exempt status for that year only and without prejudice to any other year and closed the other two years on the basis of "no change."83 T.C. 381">446 Petitioner's contention that respondent's disposition of its 1965-67 taxable years amounts to a nullification of the letter of revocation stretches the facts far beyond their reasonable interpretation. By late 1976, respondent had concluded the 1971-74 audit. This audit revealed potential income tax liability in the hundreds of thousands of dollars. Respondent may well have decided not to pursue the comparatively small deficiencies of the earlier years in order to marshall his resources to collect the potentially greater deficiencies of the later years. The settlement entered in the Tax Court on its face only applied to 1965, and the closing of the 1966 and 1967 taxable years 1984 U.S. Tax Ct. LEXIS 30">156 on the basis of "no change" in context marks a concession of tax liability, only, and is without bearing on petitioner's tax status. 46 That respondent in post-revocation audits to determine petitioner's tax liability also reviewed petitioner's tax status is also not significant. More or less, the same records have to be examined in either type of audit. Since the double-issue review required virtually no extra work, respondent's reconsideration of petitioner's tax status shows nothing more than a desire to check for prior error. It is noteworthy that after performing these post-revocation audits, respondent never changed his ruling. 47This case is also readily distinguished from the Duda case. In that case the Government, 1984 U.S. Tax Ct. LEXIS 30">157 in a pretrial conference, stipulated that it had revoked the taxpayer-cooperative's tax exemption for the wrong reasons and also stipulated that the revocation was not based on the taxpayer's failure to act as a cooperative. 504 F.2d 970">504 F.2d at 973. The Government wanted to be relieved of these stipulations so it could collect taxes on the basis of the taxpayer's failure to act as a cooperative. 504 F.2d 970">504 F.2d at 975. The court held that the Government could not be relieved of its disastrous concessions and allowed to show that the revocation was not a nullity. 504 F.2d 970">504 F.2d at 975-976. In comparison, respondent, in the case at bar, has consistently maintained that petitioner was not operating for exempt purposes. This was communicated in the letter revoking 83 T.C. 381">447 petitioner's exempt status and in the notice of deficiency. As a general rule, the notice of deficiency is presumed to be correct (Rule 142; 48Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 290 U.S. 111">115 (1933)), and the Court will not look behind it. Riland v. Commissioner, 79 T.C. 185">79 T.C. 185 (1982); Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324">62 T.C. 324 (1974); Suarez v. Commissioner, 58 T.C. 792">58 T.C. 792 (1972), overruled on other grounds United States v. Janis, 428 U.S. 433">428 U.S. 433 (1976). 1984 U.S. Tax Ct. LEXIS 30">158 This is true even where the record discloses procedural irregularities. Cataldo v. Commissioner, 499 F.2d 550">499 F.2d 550 (2d Cir. 1974), affg. per curiam 60 T.C. 522">60 T.C. 522 (1973); Rosenberg v. Commissioner, 450 F.2d 529">450 F.2d 529 (10th Cir. 1971). Petitioner has not shown any serious procedural irregularity in the way respondent handled its case, much less action rising to the level of a nullification of the 1967 determination that it did not qualify for exemption from taxation.Petitioner also challenges the notice of deficiency and the letter of revocation on constitutional grounds. The gravamen of petitioner's complaint is that respondent selectively enforced the tax laws against petitioner, revoking the Church's exemption from taxation and determining a deficiency because of hostility to Scientology in violation of the equal protection component of the Fifth Amendment and the First Amendment. 49 In support of its argument, petitioner makes a number of factual allegations. Most of them boil down to one of three points. First, respondent's files are suffused with correspondence and memoranda denouncing Scientology. Second, 1984 U.S. Tax Ct. LEXIS 30">159 special intelligence groups within the IRS charged with investigating politically active organizations targeted petitioner and affiliated churches for surveillance. Third, respondent arbitrarily and capriciously handled numerous Scientology tax matters pending in the IRS.Ordinarily, this Court will not look behind the notice of deficiency to examine respondent's motives, policies, or procedures in making his determinations. 58 T.C. 792">Suarez v. Commissioner, supra at 813; 62 T.C. 324">Greenberg's Express, Inc. v. Commissioner, supra at 327. However, this Court has recognized a limited exception to this rule which appertains here. When there is substantial 83 T.C. 381">448 evidence of unconstitutional conduct on respondent's part, and the integrity of our judicial process would be impeded were we to let respondent benefit from it, this Court will examine respondent's conduct in reaching a determination. 62 T.C. 324">Greenberg's Express, Inc. v. Commissioner, supra at 328; 1984 U.S. Tax Ct. LEXIS 30">160 58 T.C. 792">Suarez v. Commissioner, supra.We believe that the evidence supporting petitioner's accusations raises sufficient doubts about the constitutionality of respondent's conduct that judicial scrutiny of his actions is required to prevent our system from becoming an instrument of selective enforcement of the tax laws.There are two components to petitioner's religious hostility argument, one involving equal protection, and the other, free exercise considerations. Petitioner makes the equal protection claim that it has been singled out for enforcement because of its unpopular religious views and practices. Petitioner also claims respondent violated its First Amendment rights because respondent's adverse determinations were motivated by its dislike for the Church's unorthodoxy.We first consider petitioner's selective enforcement argument. It is by now well established that equal protection requires that laws fair on their face be impartially executed ( Yick Wo v. Hopkins, 118 U.S. 356">118 U.S. 356, 118 U.S. 356">373-374 (1886)), and that discriminations based on hostility to a group's religion are constitutionally intolerable. Niemotko v. Maryland, 340 U.S. 268">340 U.S. 268 (1951). However, "the conscious exercise of some selectivity 1984 U.S. Tax Ct. LEXIS 30">161 in enforcement is not in itself a federal constitutional violation" ( Oyler v. Boles, 368 U.S. 448">368 U.S. 448, 368 U.S. 448">456 (1962)), and is even necessary, particularly "In the tax field, with millions of returns, and many thousand that reveal some basis for further investigation." United States v. Wilson, 639 F.2d 500">639 F.2d 500, 639 F.2d 500">505 (9th Cir. 1981). In the criminal field, a case of selective prosecution is made out when the defendant shows: (1) The decision to prosecute was based on impermissible grounds such as race, religion, or the exercise of constitutional rights; and (2) that others similarly situated are generally not prosecuted. Karme v. Commissioner, 673 F.2d 1062">673 F.2d 1062, 673 F.2d 1062">1064 (9th Cir. 1982), affg. 73 T.C. 1163">73 T.C. 1163 (1980); United States v. Ness, 652 F.2d 890">652 F.2d 890, 652 F.2d 890">892 (9th Cir.), cert. denied 454 U.S. 1126">454 U.S. 1126 (1981); United States v. Moon, 718 F.2d 1210">718 F.2d 1210 (2d Cir. 1983), cert. denied 466 U.S. (1984). Like the Ninth Circuit, which has appellate jurisdiction of this case, we express our concern that examining the IRS's actions 83 T.C. 381">449 here under the standard applied in criminal cases may be too stringent a test. 673 F.2d 1062">Karme v. Commissioner, supra at 1064. However, we need not decide this issue since petitioner's argument fails under 1984 U.S. Tax Ct. LEXIS 30">162 both prongs of the criminal test.Petitioner makes a number of factual allegations -- some well founded, some exaggerated, and some completely unsupported. Petitioner did demonstrate that respondent's files contain memoranda and correspondence denigrating Scientology. During the period in which petitioner's tax exemption was under active consideration, a few of respondent's agents called Scientology a "medical quackery"; a "threat to the community, medically, morally and socially"; a "prey on the public pocketbook"; and similar epithets. These comments mostly sprang from persons in respondent's Refund Litigation Division, then assisting the Department of Justice in defending the Founding Church refund tax case. However, agents in respondent's Exempt Organizations Division charged with reviewing petitioner's tax status were privy to them. These comments were the remarks of individuals. There is no evidence respondent adopted them. However, some derogatory statements about Scientology are clearly attributable to respondent. In his Trial Memorandum, respondent stated that he intended to prove petitioner violated charitable law standards of public policy by the infliction of psychic 1984 U.S. Tax Ct. LEXIS 30">163 harm, including the loss of moral judgment through brainwashing, accomplished by auditing and other practices and procedures. In correspondence sent to this Court, respondent called the Church a "cult," once again referred to the Church's "brainwashing" methods, and characterized the Church's policies and practices as a danger to the moral and physical health of citizens and responsible for trouble in families. None of these charges were proved, although this Court's rulings did not preclude respondent from showing Church policies and practices violated civil or criminal law.Between 1969 and 1975, respondent formed and maintained three special intelligence units. These units collected information about taxpayers, selected by essentially political criteria, ostensibly to monitor their compliance with the tax laws. All three units collected information about petitioner. In October 1969, one of these intelligence units, the SSS, added the Founding Church to a list of 99 organizations selected for 83 T.C. 381">450 investigation. Other groups selected at the same time included the Black United Front, the New Left Movement, and the Welfare Rights Organization. After the Founding Church was selected, 1984 U.S. Tax Ct. LEXIS 30">164 the SSS received some information from respondent's District Offices about Scientology churches. Virtually all of it concerned matters pertinent to the tax status of these churches. The Case Development Unit, a local intelligence unit operating out of respondent's Los Angeles District Office, also collected information about the California Church and Scientology. Most of the information pertained to financial, religious, or charitable matters. A few reports linked petitioner or Scientology to criminal activity. A third intelligence group, the IGRU, established in 1973, had chapters in respondent's District Offices. Intelligence reports in respondent's Los Angeles District files connected petitioner with tax-protest activity. Perhaps based on these reports, the Los Angeles IGRU chapter classified petitioner as a tax resister. Files from the St. Louis IGRU unit were destroyed in 1975. One such file labeled "subversives" contained material only about Scientology.Counterbalancing these facts evidencing respondent's political and religious hostility to petitioner is the record of petitioner's actual treatment by the IRS. The decision to revoke petitioner's exemption was based upon 1984 U.S. Tax Ct. LEXIS 30">165 legitimate Agency concerns. The decision was made after respondent examined petitioner's 1964 and 1965 information returns and following local and national protest conferences. 50 It was based on findings that the Church's activities were akin to a business, that it was serving the private interests of its members and not the public, and that its income inured to the benefit of Scientology practitioners. Thus both the procedures for and grounds of revocation were based upon the valid exercise of Agency authority.Petitioner's contention that its revocation was rushed through Agency channels as part of a wholesale effort to take away the tax-exempt status of Scientology churches is not borne out. First, the revocation was not rushed. While we do not know exactly when the audit of petitioner's 1964 and 1965 informational returns took place, we surmise that the examination 83 T.C. 381">451 must have taken place in the first half of 1966, since by July 29, 1966, respondent had sent petitioner a letter stating proposed grounds for the revocation. The formal letter of revocation was issued on July 18, 1967. 1984 U.S. Tax Ct. LEXIS 30">166 Thus, the deliberations leading to the revocation, far from being rushed, stretched out, at least, over the course of a year. Second, petitioner's loss of exemption was not part of a wholesale scheme. Admittedly, respondent examined several other Scientology churches during this period. These reviews were prompted by a request from the Department of Justice which was then defending a tax-refund case against the Founding Church. The Founding Church was denied exempt status on the grounds that it was organized and operated as a profit-making venture benefiting private interests and not serving religious or educational purposes. The Department of Justice in October of 1966 asked respondent to investigate affiliated churches holding tax-exempt status and report on ways they could be distinguished, or rescind their exemptions if they could not. Respondent acted on this request and investigated several Scientology churches. In some cases, denial or revocation of exemption was recommended. However, no other church besides petitioner appears to have lost its exemption during this period.Between 1967 and 1974, respondent delayed action or changed positions on several matters involving 1984 U.S. Tax Ct. LEXIS 30">167 Scientology churches. Respondent also issued Manual Supplement 42G-228. The manual established guidelines and procedures for identifying and examining Scientology churches and processing applications for exemption. The record disclosed no nefarious motive for respondent's indecisiveness, and we think respondent's hesitancy in rushing toward litigation was justified by the sensitivity and, in some cases, novelty of the issues involved. As for the Manual Supplement, a panel of the Ninth Circuit has already commented on this document saying that, in view of the Court of Claims decision upholding respondent's deficiency determination in the Founding Church case, the IRS might be remiss were it not to give special scrutiny to Scientology organizations. Compare United States v. Church of Scientology of California, 520 F.2d 818">520 F.2d 818, 520 F.2d 818">823 (9th Cir. 1975), with Church of Scientology of Hawaii v. United States, 485 F.2d 313">485 F.2d 313, 485 F.2d 313">317 (9th Cir. 1973).83 T.C. 381">452 The deficiency determination was based on facts learned during an extensive audit of petitioner's records. Good-faith negotiations preceded the issuance of the notice of deficiency. Petitioner's contention that respondent's conditions of settlement were 1984 U.S. Tax Ct. LEXIS 30">168 arbitrary or unconstitutional is not well taken. Certainly, respondent was well within his authority to insist that petitioner's income could not inure to the benefit of OTC, a private, for-profit corporation. Sec. 501(c)(3); sec. 1.501(c)(3)-1(d)(1)(ii), Income Tax Regs. Respondent could also require petitioner to file returns and keep records. Sec. 6001. Only exempt churches are relieved of these obligations (sec. 6033(a)(2)(A)(i)), and respondent was never willing to recognize unconditionally petitioner's exempt status. Rather, respondent's only offer of recognition was limited to petitioner's 1970-72 taxable years. Respondent was also well within his authority to demand that petitioner disavow participation in the crimes described in the Tittle affidavit. The First Amendment does not shield a church from the constraints of the criminal law ( Late Corporation of the Church of Jesus Christ of Latter-Day Saints v. United States, 136 U.S. 1">136 U.S. 1 (1890)), and the Government, through respondent, could insist its largesse not subsidize criminal activity. Regan v. Taxation With Representation of Washington, 461 U.S. 540">461 U.S. 540, 461 U.S. 540">547-551 (1983); Bob Jones University v. United States, 461 U.S. 574">461 U.S. 574, 461 U.S. 574">590-594, 461 U.S. 574">598 (1983); 1984 U.S. Tax Ct. LEXIS 30">169 Oklahoma v. Civil Service Commission, 330 U.S. 127">330 U.S. 127 (1947).Weighing all these facts, we find that petitioner's contention that respondent selectively enforced the tax laws against the California Church out of religious or political animosity falls short of the mark. On the one hand, petitioner was investigated by special intelligence groups formed to collect information about organizations selected for ideological reasons, rather than tax considerations. Also respondent, perhaps sometimes using a trial lawyer's hyperbole, denigrated the practice of auditing and made other mostly unproven charges about petitioner's harmful policies and practices. Weighed against these facts is the almost flawless record of respondent's actual treatment of petitioner's tax status and liability. The decision to revoke petitioner's exemption, the detailed and extensive audits of its records, the lengthy post-audit settlement negotiations carried on in good faith, and the final issuance of the 83 T.C. 381">453 notice of deficiency were all valid exercises of administrative authority. We are also mindful that some of respondent's expressed hostility to petitioner's practices is attributable to petitioner's proven efforts 1984 U.S. Tax Ct. LEXIS 30">170 to thwart respondent's duty to administer the tax laws.Petitioner has also failed to meet the second prong of the criminal selective enforcement test. It has failed to demonstrate that respondent has not enforced the provisions of section 501(c)(3) against others similarly situated. 673 F.2d 1062">Karme v. Commissioner, supra at 1064. Nor could petitioner meet this test. The cases in this Court alone are ample evidence of respondent's vigorous enforcement policy against churches which overreach the conditions of their exemption. See Bethel Conservative Mennonite Church v. Commissioner, 80 T.C. 352">80 T.C. 352 (1983); Ecclesiastical Order of ISM of AM, Inc. v. Commissioner, 80 T.C. 833">80 T.C. 833 (1983); Church of the Transfiguring Spirit v. Commissioner, 76 T.C. 1">76 T.C. 1 (1981); People of God Community v. Commissioner, 75 T.C. 127">75 T.C. 127 (1980); Basic Bible Church v. Commissioner, 74 T.C. 846">74 T.C. 846 (1980); Unitary Mission Church v. Commissioner, 74 T.C. 507">74 T.C. 507 (1980), affd. in an unpublished opinion 647 F.2d 163">647 F.2d 163 (2d Cir. 1981); Bubbling Well Church of Universal Love, Inc. v. Commissioner, 74 T.C. 531">74 T.C. 531 (1980), affd. 670 F.2d 104">670 F.2d 104 (9th Cir. 1981). For cases in other courts, see Founding Church of Scientology v. United States, 188 Ct. Cl. 490">188 Ct. Cl. 490, 412 F.2d 1197">412 F.2d 1197 (1969), 1984 U.S. Tax Ct. LEXIS 30">171 cert. denied 397 U.S. 1009">397 U.S. 1009 (1970); Universal Life Church v. United States, 372 F. Supp. 770">372 F. Supp. 770 (E.D. Cal. 1974). Petitioner attempts to take itself out of the simple category of churches by claiming it is the only hierarchical church to have been selected, and the only church denied exemption, on public policy grounds. It is always possible to define the relevant class so narrowly that all others are eliminated. We believe the operative class to be churches or the even broader category, religious organizations. These are the classes employed by the Code. See sections 501(c)(3), 6033(a)(2)(A)(i), 6033(a)(2)(C)(i), and 7605(c). We see no reason under the circumstances to ignore the legislative classification. Furthermore, respondent is well within his rights to mount a test case challenging a church's tax-exempt status on public policy grounds. Such action does not constitute discriminatory enforcement. 83 T.C. 381">454 Mackay Telegraph & Cable Co. v. City of Little Rock, 250 U.S. 94">250 U.S. 94, 250 U.S. 94">100 (1919).Petitioner repeats its same argument, that respondent revoked its tax-exempt status and issued a notice of deficiency out of hostility to its religion, under the First Amendment. The First Amendment, however, 1984 U.S. Tax Ct. LEXIS 30">172 offers petitioner no more protection than the Fifth Amendment. Thus, petitioner is not entitled to redress even though conduct violative of the First Amendment is a substantial factor behind adverse government action where the Government shows by a preponderance of the evidence that it would have made the same determinations without resort to unconstitutional considerations. Givhan v. Western Line Consolidated School District, 439 U.S. 410">439 U.S. 410, 439 U.S. 410">416-417 (1979); Mt. Healthy City Board of Education v. Doyle, 429 U.S. 274">429 U.S. 274, 429 U.S. 274">287 (1977); Lee v. Russell County Board of Education, 684 F.2d 769">684 F.2d 769 (11th Cir. 1982). We recognize that the cited cases are employment cases involving the firing of untenured teachers who have spoken out on political issues. However, we believe the rationale of these cases is fully applicable here. A person whose constitutional rights have been violated should not be placed in a better position than he would have been in had his rights not been violated. The proper remedy is to remove the taint. 429 U.S. 274">Mt. Healthy City Board of Education v. Doyle, supra at 286-287. Cf. Duren v. Missouri, 439 U.S. 357">439 U.S. 357, 439 U.S. 357">368 n. 26 (1979); Village of Arlington Heights v. Metropolitan Housing Development Corp., 429 U.S. 252">429 U.S. 252, 429 U.S. 252">270-271 n. 21 (1977); 1984 U.S. Tax Ct. LEXIS 30">173 Knoetze v. United States, 472 F. Supp. 201">472 F. Supp. 201, 472 F. Supp. 201">214-215 (S.D. Fla. 1979), affd. 634 F.2d 207">634 F.2d 207 (5th Cir.), cert. denied 454 U.S. 823">454 U.S. 823 (1981). Here, a healthy preponderance of the evidence shows that Service audits of the Church's records revealed petitioner had a substantial commercial purpose and had net earnings which inured to the benefit of a private corporation controlled by key Scientology officials. These are both valid statutory grounds for determining a deficiency. They overcome any taint that this case was prosecuted out of hostility to Scientology.II.Petitioner raises a number of challenges to the constitutionality of section 501(c)(3). This section of the Code is one of 83 T.C. 381">455 several sections which describe entities exempt from taxation under section 501(a). In pertinent part, section 501(c)(3) states:Corporations * * organized and operated exclusively for religious * * * purposes * * * no part of the net earnings of which inures to the benefit of any private shareholder or individual. * * The inurement restriction has received a narrow construction. While allowing reasonable expenses as deductions against gross earnings ( University of Massachusetts Medical School Group Practice v. Commissioner, 74 T.C. 1299">74 T.C. 1299, 74 T.C. 1299">1306 (1980); 1984 U.S. Tax Ct. LEXIS 30">174 Saint Germain Foundation v. Commissioner, 26 T.C. 648">26 T.C. 648, 26 T.C. 648">659 (1956)), courts have held that any money or benefits flowing to private persons which are not ordinary and necessary business expenses, no matter what the amount, constitute inurement. Unitary Mission Church v. Commissioner, 74 T.C. 507">74 T.C. 507, 74 T.C. 507">513 (1980), affd. without published opinion 647 F.2d 163">647 F.2d 163 (2d Cir. 1981); Founding Church of Scientology v. United States, 188 Ct. Cl. 490">188 Ct. Cl. 490, 188 Ct. Cl. 490">500, 412 F.2d 1197">412 F.2d 1197, 412 F.2d 1197">1202 (1969), cert. denied 397 U.S. 1009">397 U.S. 1009 (1970). The "exclusively religious purpose" restriction, on the other hand, has not been literally construed. A religious organization can have incidental nonreligious purposes and still maintain its exempt status. However, if from its activities it can be inferred that the organization has a substantial commercial purpose, it is ineligible for ex emption. Sec. 1.501(c)(3)-1(c), Income Tax Regs.Christian Manner International v. Commissioner, 71 T.C. 661">71 T.C. 661, 71 T.C. 661">668 (1979); Pulpit Resource v. Commissioner, 70 T.C. 594">70 T.C. 594, 70 T.C. 594">602 (1978). In addition to meeting these express statutory conditions, this Court has ruled that section 501(c)(3) impliedly requires petitioner to comply with fundamental standards 1984 U.S. Tax Ct. LEXIS 30">175 of public policy derived from charitable trust law. Petitioner has mounted a broadside attack on the constitutionality of these express and implied conditions. This section treats petitioner's constitutional objections to the express conditions of section 501(c)(3) reserving to another section petitioner's constitutional objections to the public policy requirement which has been read into the statute.We first consider petitioner's challenges to the express statutory conditions of section 501(c)(3) based on the free exercise clause of the First Amendment. Petitioner raises three claims of unconstitutionality. Reaching the question left open in Walz v. Tax Commission, 397 U.S. 664">397 U.S. 664 (1970), petitioner 83 T.C. 381">456 first claims that the requirement of governmental neutrality toward religion mandated by the joint provisions of the free exercise and establishment clauses constitutionally compels an exemption from taxation for "religious income." 51 Petitioner next argues that, even if an exemption for "religious income" is not constitutionally compelled, nevertheless the lack of an exemption interferes with the free exercise of religion and is not justified by a compelling governmental interest. 1984 U.S. Tax Ct. LEXIS 30">176 Thirdly, petitioner argues that section 501(c)(3) is overbroad because it penalizes commercial activity in aid of religion that is affirmatively protected by the free exercise clause.At the outset, we note there is some tension in the case law concerning the standard of review applicable to questions involving tax exemptions for preferred activities. The tension springs from the fact that tax exemptions are generally classified as acts of legislative grace not subject to judicial review, unless arbitrary. Commissioner v. Sullivan, 356 U.S. 27">356 U.S. 27 (1958); Christian Echoes National Ministry, Inc. v. United States, 470 F.2d 849">470 F.2d 849, 470 F.2d 849">857 (10th Cir. 1972), cert. denied 414 U.S. 864">414 U.S. 864 (1973); Parker v. Commissioner, 365 F.2d 792">365 F.2d 792, 365 F.2d 792">795 (8th Cir. 1966), affg. this point Foundation for Divine Meditation, Inc. v. Commissioner, T.C. Memo. 1965-77, cert. denied 385 U.S. 1026">385 U.S. 1026 (1967). Augmenting this line of cases is another line holding that 1984 U.S. Tax Ct. LEXIS 30">177 the Government has no obligation to subsidize preferred activities ( Regan v. Taxation With Representation of Washington, 461 U.S. 540">461 U.S. 540, 461 U.S. 540">546 (1983); Harris v. McRae, 448 U.S. 297">448 U.S. 297, 448 U.S. 297">316-318 (1980); Maher v. Roe, 432 U.S. 464">432 U.S. 464 (1977); Buckley v. Valeo, 424 U.S. 1">424 U.S. 1, 424 U.S. 1">93-108 (1976); Cammarano v. United States, 358 U.S. 498">358 U.S. 498, 358 U.S. 498">513 (1959)), and declining to scrutinize strictly claims of unequal distribution of Government largesse. Regan v. Taxation With Representation of Washington, 461 U.S. 540">461 U.S. at 549; 424 U.S. 1">Buckley v. Valeo, supra at 93-108. On the other hand, another line of cases holds that the Government cannot put conditions on benefits which dampen the exercise of First Amendment rights ( McDaniel v. Paty, 435 U.S. 618">435 U.S. 618 (1978); Elrod v. Burns, 427 U.S. 347">427 U.S. 347, 427 U.S. 347">358 n. 11 (1976); Pickering v. Board of Education, 391 U.S. 563">391 U.S. 563 (1968)), and the claim of chill 83 T.C. 381">457 has triggered strict judicial scrutiny ( Bob Jones University v. United States, 461 U.S. 574">461 U.S. 574, 461 U.S. 574">604 (1983); Sherbert v. Verner, 374 U.S. 398">374 U.S. 398 (1963)). 521984 U.S. Tax Ct. LEXIS 30">178 Under the lesser standard of review, one which measures the statute by its reasonableness, section 501(c)(3) clearly does not interfere with the free exercise of religion guaranteed by the First Amendment. Under the express terms of the statute as construed, a religious organization does not have to pay taxes provided it is not operated for private benefit or profit. The justification for the grant of tax exemption to charitable organizations, as a group, is that such entities confer a public benefit. Bob Jones University v. United States, 461 U.S. 574">461 U.S. at 591. They foster the mental, moral, and physical improvement of society. Walz v. Tax Commission, 397 U.S. 664">397 U.S. 664, 397 U.S. 664">672 (1970). There is an additional 1984 U.S. Tax Ct. LEXIS 30">179 justification for granting religious organizations tax exemption. The grant of exemption guards against potential acts of hostility to religion in the form of oppressive taxing measures. 397 U.S. 664">Walz v. Tax Commission, supra at 673. However, when a religious organization loses track of its charitable mission and conducts its operations for profit or private gain, the reasons for the exemption are dispelled. The organization no longer serves the public benefit. Also, in such circumstances, it is reasonable for the legislature to conclude that the exemption helps line the pockets of a chosen few rather than guards against harm to religious freedom.We believe that some, but not all, of petitioner's free exercise challenges to the constitutionality of the express conditions of section 501(c)(3) merit strict scrutiny. Strict scrutiny is not automatically triggered just because petitioner is a church. Petitioner must show that one of its fundamental rights protected by the free exercise clause is endangered by the statute. 461 U.S. 540">Regan v. Taxation With Representation of Washington, supra.Petitioner posits statutory interference with three rights: (1) The right to tax-free religious income, (2) the 1984 U.S. Tax Ct. LEXIS 30">180 83 T.C. 381">458 right to carry on church-sponsored commercial activity, and (3) the right to practice its belief in the doctrine of exchange. Only the last claim involves a fundamental right. Petitioner has no constitutional right under the religion clauses to tax-free religious income. The activities shielded by the First Amendment from Government interference -- free speech, free press, free exercise -- share a common preferred position in our constitutional scheme. Just as the press is not free from general economic regulation ( Minneapolis Star & Tribune Co. v. Minnesota Commissioner of Revenue, 460 U.S. 575">460 U.S. 575, 460 U.S. 575">581 (1983)), and is apparently subject to an ordinary tax ( Grosjean v. American Press Co., 297 U.S. 233">297 U.S. 233, 297 U.S. 233">250 (1936)), so, too, the free exercise clause does not immunize the income derived from religious activity from taxation. The free exercise clause takes the first step and protects religious beliefs and practices from governmental interference. It does not go a second step and require the Government to subsidize religion. Follett v. McCormick, 321 U.S. 573">321 U.S. 573, 321 U.S. 573">577-578 (1944); People v. Life Science Church, 450 N.Y.S.2d 664">450 N.Y.S.2d 664, 450 N.Y.S.2d 664">669 (N.Y. County Sup. Ct. 1982); Watchtower Bible & Tract Society, Inc. v. County of Los Angeles, 30 Cal. 2d 426">30 Cal. 2d 426, 182 P.2d 178">182 P.2d 178, 1984 U.S. Tax Ct. LEXIS 30">181 cert. denied 332 U.S. 811">332 U.S. 811 (1947). See also Regan v. Taxation With Representation of Washington, 461 U.S. 540">461 U.S. at 540. The establishment clause likewise does not compel a religious exemption from taxation or, at the very least, allows Congress to interpret the course of "benevolent neutrality" demanded by the religion clauses. 397 U.S. 664">Walz v. Tax Commission, supra at 669; cf. Mueller v. Allen, 463 U.S. 388">463 U.S. 388 (1983); United States v. Lee, 455 U.S. 252">455 U.S. 252, 455 U.S. 252">260-261 (1982). A compulsory subsidy of religious activity appears to have the primary effect of advancing religion, a result prohibited by the establishment clause. Sloan v. Lemon, 413 U.S. 825">413 U.S. 825 (1973); Committee for Public Education v. Nyquist, 413 U.S. 756">413 U.S. 756 (1973). An exemption for "religious income" is also potentially entangling since, borrowing petitioner's definition of the term, it requires church and Government to determine item-by-item what is and is not income derived from and dedicated to religious activity. New York v. Cathedral Academy, 434 U.S. 125">434 U.S. 125, 434 U.S. 125">133 (1977); Lemon v. Kurtzman, 403 U.S. 602">403 U.S. 602 (1971). 53 Given these dangers of entanglement and establishment, 83 T.C. 381">459 at the very least, Congress ought to be the body to decide whether religious 1984 U.S. Tax Ct. LEXIS 30">182 income is deserving of an exemption.Petitioner claims that section 501(c)(3) as construed violates its right to carry on certain commercial activity which is affirmatively protected by the First Amendment. Specifically, petitioner claims that it cannot make a profit, accumulate earnings, sell religious literature, advertise, or remunerate its founder without losing its exemption by running afoul of the commercial purpose limitation that has been read into section 501(c)(3). Petitioner exaggerates the scope of First Amendment protection for church-sponsored commercial activity. We assume, arguendo, that the First Amendment protects some, if not all, of the listed commercial practices. See, e.g., Heffron v. International Society for Krishna Consciousness, 452 U.S. 640">452 U.S. 640, 452 U.S. 640">647 (1981); 1984 U.S. Tax Ct. LEXIS 30">183 Jamison v. Texas, 318 U.S. 413">318 U.S. 413, 318 U.S. 413">416-417 (1943). However, they are protected only when they are carried on as part of a religious mission. The First Amendment draws a vital distinction between purely commercial activity and commercial activity in furtherance of a religious purpose. Murdock v. Pennsylvania, 319 U.S. 105">319 U.S. 105, 319 U.S. 105">110 (1943). Section 501(c)(3) incorporates the requirements of First Amendment tolerance for commercial activity in aid of religion. A religious organization can maintain its exemption and engage in commercial activity, provided it is incidental to its religious purpose. The exemption is only lost when church-sponsored commercial activity takes on a life of its own and assumes an independent importance and purpose. Sec. 1.501(c)(3)-1(c), Income Tax Regs.; Ecclesiastical Order of Ism of Am v. Commissioner, 80 T.C. 833">80 T.C. 833, 80 T.C. 833">839 (1983), on appeal (6th Cir., July 6, 1983); Parker v. Commissioner, 365 F.2d 792">365 F.2d 792, 365 F.2d 792">798-799 (8th Cir. 1966), cert. denied 385 U.S. 1026">385 U.S. 1026 (1967). Petitioner, therefore, does not suffer any constitutional injury on account of section 501(c)(3)'s limitation on commercial activity.Section 501(c)(3) does interfere with the California Church's practice of 1984 U.S. Tax Ct. LEXIS 30">184 its belief in the doctrine of exchange. 54 This belief led the Church to exact a fee for its religious literature, 83 T.C. 381">460 artifacts, and services. Thus, by its own admission, five of its branch churches earned between 73 and 100 percent of their income from the sale of these items. While this fact alone does not explain our decision that petitioner is ineligible for exemption because it has a substantial commercial purpose, it does measurably contribute to our decision. See infra at 476. Since there is direct conflict between petitioner's religious practices and petitioner's eligibility for exemption, this claim warrants strict judicial scrutiny. Bob Jones University v. United States, 461 U.S. 574">461 U.S. 574, 461 U.S. 574">604 (1983). Under this standard, Government "may justify a limitation on religious liberty by showing that it is essential to accomplish an overriding governmental interest." Bob Jones University v. United States, 461 U.S. 574">461 U.S. at 603, quoting United States v. Lee, 455 U.S. 252">455 U.S. 252, 455 U.S. 252">257-258 (1982). We believe petitioner's claim is directly controlled by the Lee case. There it was held that the soundness of the social security system, like the soundness of the revenue system, was an overriding governmental 1984 U.S. Tax Ct. LEXIS 30">185 interest that could not be made to accommodate exemptions based on religious tenets without destroying the integrity of the revenue base. 455 U.S. 252">455 U.S. at 260.Having disposed of petitioner's claims that the express conditions of section 501(c)(3) violate the free exercise clause of the First Amendment, we turn to petitioner's claims that section 501(c)(3) violates the establishment clause. A statute must pass three separate tests in order to satisfy the requirements of the establishment clause.First, the statute must have a secular legislative purpose; second, its principal or primary effect must be one that neither advances nor inhibits religion; finally, the statute must not foster "an excessive government entanglement with religion."Lemon v. Kurtzman, 403 U.S. 602">403 U.S. 602, 403 U.S. 602">612-613 (1971), quoting Walz v. Tax Commission, 397 U.S. 664">397 U.S. 664, 397 U.S. 664">674 (1970) (citations omitted). Petitioner claims that section 501(c)(3) violates the second and third tests. The gist of petitioner's first argument is that the 1984 U.S. Tax Ct. LEXIS 30">186 commercial purpose restriction hurts newer religions since they must rely on commercial techniques to attract members, propagate their faith, and raise income, whereas older religions already have public recognition, established coffers, and a body of followers. Although we believe there is 83 T.C. 381">461 play in section 501(c)(3) which allows newer religions to proselytize aggressively, arguably its overall impact on newer religions is harsher. However, this fact alone, even if true, does not invalidate section 501(c)(3). In addition, petitioner "must * * * show the absence of a neutral, secular basis for the lines government has drawn." Gillette v. United States, 401 U.S. 437">401 U.S. 437, 401 U.S. 437">452 (1971). Petitioner has not done this. Moreover, we are convinced that the commercial purpose test does not rest on sectarian favoritism for established religions but instead has its basis in charitable trust law which requires charitable organizations to eschew commercialism in favor of serving goals designed to benefit the community at large. See sec. 1.501(c)(3)-1(d)(1)(ii), Income Tax Regs.; see also Restatement, Trusts 2d, secs. 368, comment a, and 376 (1959).Petitioner also maintains that section 501(c)(3)1984 U.S. Tax Ct. LEXIS 30">187 on its face and as applied results in excessive Government entanglement at the administrative level in violation of the third establishment clause test set forth in 403 U.S. 602">Lemon v. Kurtzman, supra. According to petitioner, the sheer magnitude of respondent's enforcement efforts is one tell-tale sign of entanglement. In slightly more than 10 years, respondent audited petitioner four times. One of these audits lasted a full year, employed three (perhaps four) agents, and covered millions of documents. Respondent also collected thousands of documents relating to petitioner. By the end of 1974, respondent's files contained approximately 2 thousand Church policy letters and some books and brochures describing Scientology beliefs and practices. According to petitioner, respondent also unconstitutionally entangled himself in petitioner's affairs by questioning the religiosity of certain Church practices and by using petitioner's policy letters to inquire into Church discipline, structure, and policy.Usually, the entanglement test is invoked by a claimant seeking to invalidate a Government program authorizing benefits to religion. See, e.g., Mueller v. Allen, 463 U.S. 388">463 U.S. 388 (1983); New York v. Cathedral Academy, 434 U.S. 125">434 U.S. 125 (1977); 1984 U.S. Tax Ct. LEXIS 30">188 Roemer v. Board of Public Works of Maryland, 426 U.S. 736">426 U.S. 736 (1976). Here, petitioner does not want to end the Government benefit but merely to avoid respondent's interference with its enjoyment. Petitioner's complaint, therefore, sounds more like a free exercise than an establishment clause complaint. See 83 T.C. 381">462 United States v. Holmes, 614 F.2d 985">614 F.2d 985, 614 F.2d 985">989 & n. 7 (5th Cir. 1980). However, the entanglement test has been used on occasion to limit the reach of governmental power to regulate religious activity. See NLRB v. Catholic Bishop of Chicago, 440 U.S. 490">440 U.S. 490 (1979). 551984 U.S. Tax Ct. LEXIS 30">189 The establishment clause does not prevent the Government from making a threshold inquiry into whether or not a given practice is religious in nature and therefore entitled to First Amendment protection. See Wisconsin v. Yoder, 406 U.S. 205">406 U.S. 205, 406 U.S. 205">209-213 (1972); International Society for Krishna Consciousness, Inc. v. Barber, 650 F.2d 430">650 F.2d 430, 650 F.2d 430">433 (2d Cir. 1981); Jones v. Bradley, 590 F.2d 294">590 F.2d 294, 590 F.2d 294">295 (9th Cir. 1979). Petitioner's objections to respondent's inquiry into the religiosity of Dianetics and the E-meter therefore lack legal merit. The inquiry never crossed the threshold. Once petitioner's witnesses asserted that the E-meter and Dianetics had a religious purpose, respondent dropped the inquiry.Petitioner also contends that respondent, aided by Church policy letters, made an impermissibly entangling inquiry into the Church's management, corporate structure, and its dissemination practices. We disagree. The establishment clause does not cloak a church in utter secrecy, nor does it immunize a church from all governmental authority. The thrust of the entanglement component of the establishment clause is to keep Government out of the business 1984 U.S. Tax Ct. LEXIS 30">190 of umpiring matters involving religious belief and practice. Serbian Orthodox Diocese v. Milivojevich, 426 U.S. 696">426 U.S. 696, 426 U.S. 696">709-710 (1976); Presbyterian Church in the United States v. Mary Elizabeth Blue Hull Memorial Presbyterian Church, 393 U.S. 440">393 U.S. 440, 393 U.S. 440">449 (1969). However, civil authorities are not barred from settling disputes implicating the secular side of church affairs as long as they rely on neutral principles of law. Jones v. Wolf, 443 U.S. 595">443 U.S. 595, 443 U.S. 595">602-603 (1979); Maryland and Virginia Eldership of the Churches of God v. Church of God at Sharpsburg, Inc., 396 U.S. 367">396 U.S. 367 (1970).83 T.C. 381">463 Respondent did rely on Church policy letters to establish basic facts about the Church. A nine-volume encyclopedia of Scientology policy called the OEC series was placed in evidence. Some of the policy letters in these volumes contain instructions on religious practices. The majority contain information about Church administration. An expert witness for the Church compared the OEC series to the constitution of the Presbyterian Church. Respondent relied on scattered policy letters in the OEC volumes to question witnesses about the Church's dissemination practices, its corporate structure, and its management functions. 1984 U.S. Tax Ct. LEXIS 30">191 In making his inquiry, respondent skirted matters of religious doctrine, except at the threshold level of inquiry. We have also used Church policy letters to make findings on these topics and others including the Church's Franchise Programme and pricing policies. However, we have not had to resolve doctrinal matters to make our findings. The Church's documents speak for themselves. We, therefore, find that the use of Church policy letters in this case is consistent with the rule laid down in 443 U.S. 595">Jones v. Wolf, supra, which allows the State to examine Church documents, including the constitution of a church, provided the documents are scrutinized in purely secular terms and the facts determined are not attendant on the resolution of doctrinal issues. 443 U.S. 595">443 U.S. at 604. See also 396 U.S. 367">Maryland and Virginia Eldership of the Churches of God v. Church of God at Sharpsburg, Inc., supra at 368.Entanglement, per se, is not objectionable. What is objectionable is excessive entanglement. By this is meant a relationship between an arm of Government and a religious institution which threatens religious liberty by coercing, compromising, or influencing religious belief. Compare Lemon v. Kurtzman, 403 U.S. 602">403 U.S. 602 (1971), 1984 U.S. Tax Ct. LEXIS 30">192 with Mueller v. Allen, 463 U.S. 388">463 U.S. 388 (1983). In its more benign form, an entangling statute is one which establishes some type of Government surveillance of a religious institution's affairs. See, e.g., 403 U.S. 602">Lemon v. Kurtzman, supra.In its severe form an entangling statute is one which imposes a program of Government regulation. See, e.g., NLRB v. Catholic Bishop of Chicago, 440 U.S. 490">440 U.S. 490 (1979). Section 501(c)(3) does not fall into this second class. It is not a regulatory measure. The determination of a religious organization's tax liability does not entail Government control over 83 T.C. 381">464 church finances. A church remains free to structure its finances as it sees fit. United States v. Freedom Church, 613 F.2d 316">613 F.2d 316, 613 F.2d 316">320 (1st Cir. 1979). Section 501(c)(3)falls into the more benign category of entangling statutes since it exposes a religious organization to Government audits. However, the audits required under section 501(c)(3) do not share many of the features of the audits found objectionable in the entanglement cases. First, respondent does not have to monitor the activities of live human beings. Compare 440 U.S. 490">NLRB v. Catholic Bishop of Chicago, supra at 501; Tilton v. Richardson, 403 U.S. 672">403 U.S. 672, 403 U.S. 672">687-688 (1971). 1984 U.S. Tax Ct. LEXIS 30">193 Second, respondent does not have to scrutinize closely the religious content of the organization's activities. Each receipt, expenditure, and activity of the organization does not have to be reviewed for its religiosity. Compare New York v. Cathedral Academy, 434 U.S. 125">434 U.S. 125, 434 U.S. 125">132-133 (1977). Of course, records have to be examined and some judgments made about the purpose of the organization's programs, receipts, and expenses. However, respondent does not have to sit as a religious expert. His task is to judge whether the records evince a primary commercial purpose. Equally as important, respondent does not have to make determinations about each and every item of receipt or expense since section 501(c)(3) permits some commercial activity. The loss of an exemption comes about only when the church's activities in the aggregate reflect a primary purpose to engage in private enterprise. Finally, the audits need not occur on an annual basis. Compare 403 U.S. 672">Tilton v. Richardson, supra at 688. Churches which meet the qualifications for exemption do not have to file annual returns. Sec. 6033(a)(2)(A)(i).Respondent's involvement with petitioner was extensive. However, the blame for a goodly 1984 U.S. Tax Ct. LEXIS 30">194 measure of this involvement must be laid at petitioner's doorstep. From 1969 onward, petitioner schemed to block the IRS from examining its records and determining its tax liability. It delayed and stalled revenue agents. It did not keep normal business records. It falsified records, failed to respond to requests for information, and misrepresented facts in many of those it did answer. The First Amendment's injunction against entanglement was not designed to shield a church against the Government's efforts to lay and collect taxes in the face of such flagrant and often illegal resistance. 83 T.C. 381">465 Petitioner's remaining objection, that respondent evaluated the religiosity of some of its practices, is also without merit. Respondent did examine certain Church practices, characterized by petitioner as religious, for their commerciality. The inquiry, however, did not intrude upon Church dogma and belief except at the threshold level. See Walz v. Tax Commission, 397 U.S. 664">397 U.S. 664, 397 U.S. 664">697-698 n. 1 (1970) (Justice Harlan, concurring). As is so often said "the line of separation [between church and state], far from being a 'wall,' is a blurred, indistinct and variable barrier depending on all the 1984 U.S. Tax Ct. LEXIS 30">195 circumstances of a particular relationship." 403 U.S. 602">Lemon v. Kurtzman, supra at 614. We find that the enforcement measures at issue here have created no more than an incidental burden on respondent's religious liberty.Petitioner argues that the express and implied conditions for exempting religious organizations from taxation under section 501(c)(3) are unduly vague in violation of the First and Fifth Amendments. Petitioner's argument is confined to three aspects of the statute: (1) The requirement of an exclusively religious purpose; (2) the requirement forbidding inurement; and (3) the requirement of complying with public policy. 56 We do not reach the merits of petitioner's argument since we find petitioner lacks standing to raise it.A claimant raising a vagueness defense must demonstrate that the statute is vague with respect to his conduct. He is not entitled to attack the statute because the language would not give similar fair warning to others. Parker v. Levy, 417 U.S. 733">417 U.S. 733, 417 U.S. 733">756 (1974). Each of the requirements which petitioner 1984 U.S. Tax Ct. LEXIS 30">196 challenges has received narrowing constructions. The "exclusively religious" condition has been construed to mean that a substantial part of the organization's activities cannot serve a commercial purpose and that the following factors are to be considered in applying the test: amount of annual profits, amount of accumulated earnings, methods of operation, competition with like services in private enterprise, proportion of expenditures devoted to exempt purposes. See sec. 1.501(c)(3)-1(c), Income Tax Regs.; see also Parker v. Commissioner, 365 F.2d 792">365 F.2d 792, 365 F.2d 792">798 (8th Cir. 1966), cert. denied 385 U.S. 1026">385 U.S. 1026 (1967); Aid to Artisans, Inc. v. Commissioner, 71 T.C. 202">71 T.C. 202, 71 T.C. 202">21283 T.C. 381">466 (1978); Fides Publishers Association v. United States, 263 F. Supp. 924">263 F. Supp. 924 (N.D. Ind. 1967). As construed, the inurement provision allows a religious organization to make ordinary and necessary business expenditures but disallows any other payments to private individuals no matter how small the amount. Founding Church of Scientology v. United States, 188 Ct. Cl. 490">188 Ct. Cl. 490, 188 Ct. Cl. 490">497, 188 Ct. Cl. 490">500, 412 F.2d 1197">412 F.2d 1197, 412 F.2d 1197">1200, 412 F.2d 1197">1202 (1969), cert. denied 397 U.S. 1009">397 U.S. 1009 (1970). This Court construed the public policy requirement to prohibit substantial activity 1984 U.S. Tax Ct. LEXIS 30">197 in violation of well-defined public policy such as may be evidenced by a civil or criminal statute. Memorandum Sur Order filed April 1, 1980, at 56; Ruling Memorandum to the Parties, Re: Evidence with Respect to So-Called Public Policy Issues, dated October 30, 1980, at 5. For reasons only briefly stated here but amplified elsewhere in this opinion, petitioner's conduct clearly falls within the ambit of these narrowing constructions. It has made a business out of selling religion; it has diverted millions of dollars through a bogus trust fund and a sham corporation to key Scientology officials; and it has conspired for almost a decade to defraud the U.S. Government by impeding the IRS from determining and collecting taxes from it and affiliated churches. Petitioner, therefore, lacks standing to challenge section 501(c)(3) on vagueness grounds.Petitioner's final constitutional argument concerns the burden of proof. 571984 U.S. Tax Ct. LEXIS 30">199 Ordinarily the taxpayer bears the burden of proof in the Tax Court to show that respondent's determination of deficiency is erroneous. Rule 142(a). Relying on Speiser v. Randall, 357 U.S. 513">357 U.S. 513 (1958), petitioner claims this rule of procedure offends due process when 1984 U.S. Tax Ct. LEXIS 30">198 applied to a church that has been determined deficient. According to petitioner, due 83 T.C. 381">467 regard for religious liberty requires respondent to shoulder the burden of proof.357 U.S. 513">Speiser v. Randall, supra, struck down, under the due process clause of the 14th Amendment, a California taxing scheme which denied exemption to otherwise qualified taxpayers who unlawfully advocated the overthrow of the Government by force and violence. The California statute placed the burden of proof on the taxpayer to show he had not engaged in criminal speech. The Court assumed, without deciding, that a State had the power to deny tax exemptions to persons who engaged in criminal speech. 357 U.S. 513">357 U.S. at 520. It then went on to hold --when the constitutional right to speak is sought to be deterred by a State's general taxing program due process demands that the speech be unencumbered until the State comes forward with sufficient proof to justify its inhibition. [357 U.S. 513">357 U.S. at 528-529.]The similarities between Speiser1984 U.S. Tax Ct. LEXIS 30">200 and the instant case are only superficial. Both situations involve the interplay between a fundamental liberty and the Government's authority to lay and collect taxes. There the similarities end. The taxing provisions found offensive in Speiser were aimed at the suppression of speech. 357 U.S. 513">357 U.S. at 525. Also, the procedural device employed to ferret out ineligible claimants had the practical effect of deterring speech. 357 U.S. 513">357 U.S. at 526. Unlike the California provisions, section 501(c)(3) was not enacted to restrain religious liberty. The Senate debate on section 38 of the Act of August 5, 1909, 36 Stat. 112-113, a forerunner of section 501(c)(3), clearly shows that the congressional purpose behind the measure was to excuse charitable organizations from paying taxes so long as their profit was exclusively devoted to charitable purposes. See 44 Cong. Rec. 4150-4151, 4155-4156 (1909). 581984 U.S. Tax Ct. LEXIS 30">201 Moreover, as our earlier discussion of this point concluded, section 501(c)(3)does not operate as a restraint on religious liberty.83 T.C. 381">468 The function of procedural devices like the burden of proof or standard of proof is to distribute the risk of error in the factfinding process. Santosky v. Kramer, 455 U.S. 745">455 U.S. 745, 455 U.S. 745">754-755 (1982). Where a claimant is threatened with serious loss, due process requires that the claimant have greater protection against error. 455 U.S. 745">455 U.S. at 758. In determining the seriousness of a claimant's loss, a court will consider both the nature of the interest at stake and the permanency of the loss. 455 U.S. 745">455 U.S. at 758. Here, no liberty interest is at stake -- merely the loss of money. Furthermore, the Church's loss is not permanent. It can regain its exempt status. The burden of proof has traditionally been placed 1984 U.S. Tax Ct. LEXIS 30">202 on the taxpayer out of recognition that "taxes are the life-blood of government" and, therefore, the Government's burdens in collecting the revenue must be few and light. Bull v. United States, 295 U.S. 247">295 U.S. 247, 295 U.S. 247">259-260 (1935). Placing the burden of proof on the taxpayer is also justified on the basis that the facts and figures on which tax liability rests are peculiarly within the taxpayer's knowledge. Campbell v. United States, 365 U.S. 85">365 U.S. 85, 365 U.S. 85">96 (1961). Under the circumstances, we see no reason to upset the normal rule and place the burden of proof on respondent. 59III.Neither the notice of deficiency 1984 U.S. Tax Ct. LEXIS 30">203 issued on December 28, 1977, nor the pleadings treated the United Kingdom Church as a branch of petitioner. Respondent first presented evidence relating to the United Kingdom Church on December 11, 1980, during the third week of trial immediately after petitioner rested its case-in-chief. Respondent contended that the United Kingdom Church was a branch of petitioner and that its operations were relevant to petitioner's tax status under three theories. First, the franchises managed by the United Kingdom Church were a commercial operation. Second, petitioner's attempt to conceal the corporate status of the United Kingdom Church was proof that it conspired to prevent the IRS from 83 T.C. 381">469 performing its duties. Third, L. Ron Hubbard possibly made personal use of the money deposited in the Worldwide Franchise accounts. After some shilly-shallying by respondent over the scope of respondent's intended reliance on evidence relating to the United Kingdom Church, this Court, over petitioner's objection, ruled on July 20, 1981, that respondent could present evidence relating to the United Kingdom Church's activities and corporate status under all three theories of relevance.Rule 41(b)(2) encourages 1984 U.S. Tax Ct. LEXIS 30">204 this Court to accept evidence that is not within the issues raised by the pleadings "freely when justice so requires" provided the objecting party is not prejudiced by its admission. Rule 41(b)(2) closely parallels rule 15(b), Federal Rules of Civil Procedure. However, rule 15(b), Fed. R. Civ. P., instructs the bench to grant a continuance to enable the objecting party to prepare rebuttal evidence.We think that the interests of justice require us to admit respondent's evidence concerning the United Kingdom Church. First, petitioner had ample time through continuances to prepare rebuttal evidence. See Robbins v. Jordan, 181 F.2d 793">181 F.2d 793, 181 F.2d 793">795 (D.C. Cir. 1950). This case was tried intermittently over the course of a year. The matter of the United Kingdom Church was first raised on December 11, 1980. On December 29, 1980, this Court made a preliminary ruling admitting the evidence. The ruling became final on July 20, 1981, the first day of the seventh week of trial. This Court then ruled that respondent could present evidence relating to the United Kingdom Church's activities and corporate status under three theories of relevance: commercialism, inurement, and conspiracy. Petitioner 1984 U.S. Tax Ct. LEXIS 30">205 began its rebuttal case on August 17, 1981. With continuances, petitioner completed rebuttal on November 12, 1981. During rebuttal, petitioner presented ample documentary and testimonial evidence directed toward refuting loss of tax-exempt status as a result of the United Kingdom Church's operations. Thus, we find that the continuances cured the prejudice, if any, to petitioner arising from respondent's presentation of the new material. Second, we are not very sympathetic to petitioner's cry of prejudice. The facts surrounding the United Kingdom Church's legal status were known to petitioner long before the trial (see Hodgson v. Colonnades, Inc., 472 F.2d 42">472 F.2d 42, 472 F.2d 42">48 (5th Cir. 1973); Scruggs v. 83 T.C. 381">470 ., 320 F. Supp. 1248">320 F. Supp. 1248, 320 F. Supp. 1248">1250 (W.D. Va. 1970)), and respondent's tardiness in raising the issue is clearly more attributable to petitioner's efforts at obfuscation than to respondent's bad faith or negligence. Finally, we believe that there would be a miscarriage of justice were the matter excluded. Petitioner's avowed purpose in bringing the various British churches under its corporate structure was to blanket them in its tax-exempt mantle, since the British authorities 1984 U.S. Tax Ct. LEXIS 30">206 refused to grant them an exemption. Thus, if the United Kingdom Church is not subjected to our scrutiny, it will probably escape scrutiny altogether for the tax years at issue.Petitioner claims that respondent raised the new matter in bad faith. Petitioner claims that respondent knew all along that the United Kingdom Church belonged to petitioner but deliberately waited to raise the issue until petitioner had completed its case-in-chief in order to sandbag petitioner. We do not interpret the facts as petitioner does. We agree that a few of respondent's agents had knowledge that the United Kingdom Church was formally incorporated as a branch of petitioner. Chief among them was Lewis Hubbard, an attorney in the Chief Counsel's Office, who provided guidance to the 1971-74 audit team while the audit was in progress. At the time of the audit, Lewis Hubbard had clearly read documents describing the California Church as a company registered to do business in the United Kingdom. He had also read the Foster Report, a document prepared for British Parliament, which explained that the main activities of Scientology in the United Kingdom were carried on by the California Church and that 1984 U.S. Tax Ct. LEXIS 30">207 this was done for tax reasons. Nevertheless Lewis Hubbard credibly testified that at the time of the audit, he believed that the United Kingdom Church was only nominally connected to petitioner and that it had de facto independence. Certainly the Church did everything in its power to present this false picture or, what is worse, to hide the connection altogether. When, during the Hawaii audit which preceded the 1971-74 audit, Kreiner, the Church's attorney, told Lewis Hubbard that petitioner incorporated the United Kingdom Church but that it operated separately and independently, we must imagine that Kreiner said it in much the same way that another of 83 T.C. 381">471 petitioner's attorneys, when objecting to a subpoena of the bank records of the United Kingdom Church, told this Court --The accounts referred to there are not accounts of the Church of Scientology of California and they are not in its custody and control. It is true that the accounts bear the name Church of Scientology of California Worldwide but they are actually accounts of the United Kingdom Church of Scientology which until two years ago, as I understand it, was incorporated as the Church of Scientology of California but never, 1984 U.S. Tax Ct. LEXIS 30">208 ever was a part of the Church of Scientology of California that's involved in this case.Those accounts have had nothing to do with the Church of Scientology of California involved in this case.Towards the end of the 1971-74 audit, Agent Endo changed some wording in his draft report of the audit on Lewis Hubbard's advice. The original version stated outright that petitioner had seven divisions and listed them. On the advice of Lewis Hubbard, Endo changed this to state that according to petitioner's submissions the Church had seven divisions. The listed divisions did not include the United Kingdom Church. Petitioner sees some form of sinister entrapment in this. We find nothing but the professional exercise of precaution.Lewis Hubbard ceased advising respondent on Scientology matters in July of 1977. This was several months before Agent Endo drafted the notice of deficiency in November of 1977. There is no evidence that Lewis Hubbard advised Endo when the latter drafted the notice of deficiency which for all intents and purposes framed the issues in this case. Other than Lewis Hubbard, none of respondent's agents with direct responsibility for the prosecution of this case, or 1984 U.S. Tax Ct. LEXIS 30">209 the 1971-74 audit underlying it, even knew that the United Kingdom Church was connected with petitioner. During the Hawaii audit and the 1971-74 audit, respondent's agents reviewed letters, checks, receipts, and disbursement vouchers bearing such names as the Church of Scientology of California UK or Church of Scientology WW on the letterhead or as the endorsement or payee. A few letters and receipts bore petitioner's name in bold print on the letterhead, and the words "a non-profit corporation in U.S.A. registered in England" in fine print across the bottom. There were few such documents in comparison to the more than 2 million documents which the agents reviewed. Under the circumstances, where Church officials were actively misleading the audit team about the 83 T.C. 381">472 legal status of the United Kingdom Church, we do not think that the mere mention of the official name of the United Kingdom Church on a document, often in fine print, should have apprised respondent of the legal relationship. 601984 U.S. Tax Ct. LEXIS 30">210 In conclusion, we find no evidence of bad faith in respondent's initial failure to incorporate the operations of the United Kingdom Church in its case against petitioner. Admittedly, Lewis Hubbard was on the road to discovery. However, Church officials did everything in their power to throw IRS officials off the scent of the United Kingdom Church's legal and operating connection to petitioner. They were almost successful. We cannot, however, countenance their effort at obfuscation by excluding the issue from our consideration. If any party is guilty of bad faith, it is petitioner.Petitioner cites a number of cases in which this Court has disallowed the introduction of a new issue on grounds of prejudice. See, e.g., Fox Chevrolet, Inc. v. Commissioner, 76 T.C. 708">76 T.C. 708, 76 T.C. 708">733-736 (1981); 1984 U.S. Tax Ct. LEXIS 30">211 Estate of Goldsborough v. Commissioner, 70 T.C. 1077">70 T.C. 1077, 70 T.C. 1077">1085-1086 (1978), affd. in an unpublished opinion 673 F.2d 1310">673 F.2d 1310 (4th Cir. 1982); Estate of Mandels v. Commissioner, 64 T.C. 61">64 T.C. 61, 64 T.C. 61">73 (1975); Estate of Horvath v. Commissioner, 59 T.C. 551">59 T.C. 551, 59 T.C. 551">556 (1973). These cases are distinguishable. Unlike the case at bar, no continuance was granted to allow the objecting party time to meet the evidence. Also, unlike the case at bar, the objecting party did not induce or contribute to respondent's failure to grasp and raise the issue sooner.Respondent bears the burden of proving the United Kingdom Church is an operating branch of petitioner, since this matter was not pleaded, is inconsistent with the notice of deficiency, and required petitioner to produce new evidence to refute it. Rule 142(a); Achiro v. Commissioner, 77 T.C. 881">77 T.C. 881, 77 T.C. 881">890 (1981); Estate of Falese v. Commissioner, 58 T.C. 895">58 T.C. 895, 58 T.C. 895">899 (1972). Petitioner concedes that the United Kingdom Church was incorporated as the Church of Scientology of California but argues that the United Kingdom Church operated independently: 83 T.C. 381">473 De jure, it is part of petitioner; de facto, it is separate. Petitioner argues that substance should control over form. 1984 U.S. Tax Ct. LEXIS 30">212 We reject petitioner's argument. Historically, the churches that comprise the United Kingdom Church were not part of petitioner. They operated independently. However, the British authorities would not grant them nonprofit status. As a result, the assets of these churches were transferred to petitioner so that they could carry on their operations in the United Kingdom under petitioner's tax-exempt mantle. As we said in Legg v. Commissioner, 57 T.C. 164">57 T.C. 164 (1971), affd. per curiam 496 F.2d 1179">496 F.2d 1179 (9th Cir. 1974) --The petitioner's first contention has little or no justification in light of the fact that the form of the transaction was contemplated and carried out by the petitioners; it was their decision to report the sale on the installment basis. A taxpayer cannot elect a specific course of action and then when finding himself in an adverse situation extricate himself by applying the age-old theory of substance over form. [57 T.C. 164">57 T.C. 169.]Petitioner elected to make the United Kingdom Church a branch church. It cannot escape the consequences of that decision now. "[While] a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept 1984 U.S. Tax Ct. LEXIS 30">213 the tax consequences of his choice." Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U.S. 134">417 U.S. 134, 417 U.S. 134">149 (1974) (citations omitted).We also find that the United Kingdom Church was, in fact, subordinate to petitioner. Admittedly, it appears to have had some operating autonomy, and, by and large, to have kept separate financial accounts. However, the United Kingdom Church did not have a bona fide board of directors. Additionally, two of its major activities, its Guardian Office and its Franchise Office, were ultimately controlled by Flag executives. Also, key officials of both churches had authority to sign checks on the other church's accounts and sometimes exercised it. These indicia of the United Kingdom Church's dependence on petitioner are sufficient to carry respondent's burden of proof.IV.In his notice of deficiency, respondent determined that petitioner was not operated exclusively for religious or other 83 T.C. 381">474 tax-exempt purposes, as required by section 501(c)(3), during the years 1970, 1971, and 1972 and, therefore, was not exempt from tax under section 501(a). Specifically, respondent contends that petitioner was operated for a substantial commercial purpose and 1984 U.S. Tax Ct. LEXIS 30">214 that the net earnings of petitioner inured to the benefit of private individuals. At the outset, we note that the burden of proof is on petitioner to overcome these grounds for denial of exempt status by respondent. Schoger Foundation v. Commissioner, 76 T.C. 380">76 T.C. 380, 76 T.C. 380">386 (1981); Rule 142(a). See discussion 432 U.S. 464">supra at 466-468.In order for an organization to be entitled to exemption from Federal income taxes under section 501(a) and (c)(3), it must establish that it is organized and operated exclusively for exempt purposes. Thus, qualification for tax-exempt status under section 501(c)(3) is based on the satisfaction of two tests commonly known as the organizational and operational tests. In order to satisfy the organizational test, an organization's articles of incorporation must limit it to one or more exempt purposes and not authorize substantial activities which are not in furtherance of such purposes. Respondent concedes that petitioner satisfied the organizational test during the docketed years.It is the second test, the operational test, which lies at the heart of the dispute in this case. Under this test, an organization must not engage, other than in insubstantial part, in 1984 U.S. Tax Ct. LEXIS 30">215 activities which do not further an exempt purpose. Sec. 1.501(c)(3)-1(b) and (c), Income Tax Regs.; Nat. Association of American Churches v. Commissioner, 82 T.C. 18">82 T.C. 18, 82 T.C. 18">28-29 (1984). With respect to the operational test, it is "the purpose towards which an organization's activities are directed, and not the nature of the activities themselves, that is ultimately dispositive of the organization's right to be classified as a section 501(c)(3) organization." B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352">70 T.C. 352, 70 T.C. 352">356-357 (1978). See est of Hawaii v. Commissioner, 71 T.C. 1067">71 T.C. 1067, 71 T.C. 1067">1078-1079 (1979), affd. in a unpublished opinion 647 F.2d 170">647 F.2d 170 (9th Cir. 1981).Whether an organization satisfies the operational test is a question of fact to be resolved on the basis of all the evidence presented by the record. See, e.g., est of 71 T.C. 1067">Hawaii v. Commissioner, supra at 1079; 70 T.C. 352">B.S.W. Group, Inc. v. Commissioner, supra at 357. We are, of course, fully cognizant of the fact that although 83 T.C. 381">475 an organization might be engaged in a single activity, that activity may further multiple purposes, both exempt and nonexempt. However, while the term "exclusively" contained in section 501(c)(3) has not been construed to mean "solely" 1984 U.S. Tax Ct. LEXIS 30">216 or "absolutely without exception" (Church in Boston v. Commissioner, 71 T.C. 102">71 T.C. 102, 71 T.C. 102">107 (1978)), it is well established that "the word 'exclusively' places a definite limit on the 'purpose' at issue." Copyright Clearance Center, Inc. v. Commissioner, 79 T.C. 793">79 T.C. 793, 79 T.C. 793">804 (1982). Thus, the Supreme Court in Better Business Bureau v. United States, 326 U.S. 279">326 U.S. 279, 326 U.S. 279">283 (1945), explained the limit as follows:in order to fall within the claimed exemption, an organization must be devoted to * * * [exempt] purposes exclusively. This plainly means that the presence of a single * * * [nonexempt] purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly * * * [exempt] purposes.Accordingly, we must decide toward what end petitioner's activities are directed and whether such activities are "animated" by a substantial commercial purpose. 326 U.S. 279">Better Business Bureau v. United States, supra at 284. In doing so, we note that where a nonexempt purpose is not an expressed goal, the courts have generally focused on the manner in which the activities of the organization are conducted, implicitly reasoning that an end can be inferred from the chosen means. Presbyterian & Reformed Publishing Co. v. Commissioner, 743 F.2d 148">743 F.2d 148, 743 F.2d 148">155 (3d Cir. 1984), 1984 U.S. Tax Ct. LEXIS 30">217 slip op. at 14, quoting from 79 T.C. 1070">79 T.C. 1070, 79 T.C. 1070">1082-1083 (1982). Among the factors relevant in making such an inquiry are the particular manner in which an organization conducts its activities, the commercial hue of those activities, and the existence and amount of annual or accumulated profits. 70 T.C. 352">B.S.W. Group, Inc. v. Commissioner, supra at 357. The existence of any of these factors supports a conclusion that an organization was not operated exclusively for an exempt purpose.Practically everywhere we turn, we find evidence of petitioner's commercial purpose. Certainly, if language reflects reality, petitioner had a substantial commercial purpose, since it described its activities in highly commercial terms, calling parishioners, "customers"; missions, "franchises"; and churches, 83 T.C. 381">476 "organizations" -- just to mention a few of the more glaring examples of petitioner's commercial vocabulary.Petitioner was eager to make money. This was expressed in HCO PL March 9, 1972, MS OEC 381, 384. It sets out the governing policy of petitioner's financial offices by exhorting these offices to "MAKE MONEY. * * * MAKE MONEY. * * * MAKE MORE MONEY. * * * MAKE OTHER PEOPLE PRODUCE SO AS TO MAKE MONEY." 1984 U.S. Tax Ct. LEXIS 30">218 (Capitalization in the original.) This is not an isolated policy letter coming back to haunt petitioner. The goal of making money permeated virtually all of petitioner's activities -- its services, its pricing policies, its dissemination practices, and its management decisions.Perhaps the most dramatic indicator of petitioner's commercial purpose is the fact that petitioner sold virtually all of its important religious services and products. Petitioner did some things for free: weddings, funerals, baptisms, family counseling, crisis auditing, and charity work. The record does not disclose how much of petitioner's resources were devoted to these free activities. 61 We do know, however, that the heart of petitioner's religious program, its auditing and training services, had to be purchased. The public paid a fee for these services, and while staff, on contract, were allowed free service, this was secured by a legal note which became due and payable if the contract was broken. Books and artifacts also had to be purchased. The dominant role played by petitioner's sales of religious services and products is brought home by the following table. It shows the percentages of total 1984 U.S. Tax Ct. LEXIS 30">219 income each of petitioner's branch churches providing services to the public earned from the sale of petitioner's services and products: 62UKAOLAASHOLAOSFO19717392929597 19727399999810083 T.C. 381">477 Of course, we are fully aware of the fact that these services and products are religious; however, the overall manner in which they were provided evidences a commercial purpose. In reaching this conclusion, we are particularly impressed by three factors: (1) The manner in which petitioner promoted Scientology services to the public; (2) petitioner's pricing policies with respect to such services and products; and (3) the contractual arrangements entered into by petitioner and its parishioners 1984 U.S. Tax Ct. LEXIS 30">220 and staff with respect to Scientology services.Petitioner made strenuous efforts to promote Scientology to the public. It gave free lectures and personality testing. It held congresses. It advertised. Staff members called "registrars," using a filing system, contacted the public and parishioners to encourage them to purchase Scientology services. Another group of people, FSMs, operating on a commission basis, also sold services to the public. These promotional efforts were guided by the results of surveys of community needs and desires. 631984 U.S. Tax Ct. LEXIS 30">221 Many of these practices are the stock and trade of the missionary. However, a few, like the payment of commissions to FSMs, closely replicate business methods. Furthermore, it is clear that the purpose of these promotional activities was not just to spread religion but to make money. 64Pricing policies are another factor we consider in determining whether petitioner has a commercial purpose. Where prices are fixed to return a profit, we consider it some evidence of a commercial purpose, 1984 U.S. Tax Ct. LEXIS 30">222 although not determinative. Christian Manner International v. Commissioner, 71 T.C. 661">71 T.C. 661, 71 T.C. 661">670 (1979); Peoples Translation Service v. Commissioner, 72 T.C. 42">72 T.C. 42, 72 T.C. 42">5083 T.C. 381">478 (1979). Petitioner's prices for its books and services were set to earn a profit. The minimum price for books was 5 times cost. Thus, even with the various discounts that were offered, petitioner stood to make a profit. The cost of auditing was also high, ranging from approximately $ 40 to $ 50 an hour and going as high as $ 76 an hour for specialized auditing. In terms of 1970 dollars these prices seem particularly steep. At Flag, prices were even higher. Considering that staff who performed these services were paid a weekly salary of approximately $ 10 plus room and board, petitioner was clearly realizing a handsome profit.On brief, petitioner called its fees for religious services "fixed donations." However, it is clear they were not donations but payments for services rendered. Indeed petitioner, itself, repeatedly used such terms as "price," "buy," and "sell," in describing its activities, and its very own worksheets do not refer to these amounts as donations but have a separate account entitled "donations" for 1984 U.S. Tax Ct. LEXIS 30">223 charitable contributions. Consequently, we cannot help but believe that the use of the term "fixed donation" was employed by petitioner in an effort to achieve favorable tax treatment.Petitioner's pricing policies respecting discounts also show a concern for business. Thus, petitioner had a policy against offering services and products for free or reducing prices for parishioners who could not afford to pay full price. However, it did offer discounts where it stood to reap some advantage for itself, for example, on bulk sales or for advance payments.Not only did parishioners have to pay for religious services, but they also had to sign a contract to get them. Under the terms of the contract, the applicant waived all rights of action against L. Ron Hubbard and petitioner, except the right to a refund. Likewise, staff members had to sign a legal note obligating them to pay for services rendered, in the event they broke their employment contracts. Petitioner's insistence on these legal formalities as a prerequisite to the rendition of Scientology services certainly colors its services with a commercial hue.Petitioner derived substantial income from its franchising operations. By 1984 U.S. Tax Ct. LEXIS 30">224 petitioner's own records the income from its franchising operations during the tax years in question was as follows: 83 T.C. 381">479 1970$ 288,6721971307,8091972435,960In examining petitioner's activities with respect to its franchising operations, we find the manner in which these activities were conducted virtually indistinguishable from the manner in which most commercial franchises are operated. Petitioner allowed the franchise holders to market its name and copyrights in a designated area and sold them books at a discounted price; while, in turn, the franchise holders remitted 10 percent of their gross income to petitioner. These aspects of petitioner's franchising operations are closely analogous to the way in which all commercial franchising operations are conducted. Furthermore, the fact that petitioner paid its franchise holders commissions of 10 percent of the amounts their students spent at higher level organizations certainly punctuates the commercial nature of these operations. Additionally, the income generated from petitioner's franchising operations appears to be almost pure profit, since petitioner received its percentage off the top from the franchise holder's gross income.During 1984 U.S. Tax Ct. LEXIS 30">225 trial, Lorna Levett, a former franchise holder, testified that the Scientology franchise that she operated in Calgary, Alberta, Canada, from 1968 through April 1974 was run as a private business. We find her characterization appropriate not only for her individual franchise but also for petitioner's entire franchising operations. They were indeed run as commercial businesses.A further example of the commercial manner of petitioner's operations was the income generated by the Flag Bureau through the provision of management services to Scientology organizations around the world, including branches of petitioner. Flag collected statistics from local churches, developed programs to improve church administration, and sent staff on assignment to local churches to help correct areas of administrative difficulty. Most of the statistics that were reported to Flag and then charted on graphs concerned income or production. Flag concentrated its attention on the organizations that made the greatest contributions to its support. All organizations that did not tithe to Worldwide paid Flag a management fee usually set at 10 percent of gross income.83 T.C. 381">480 These management services rendered by Flag 1984 U.S. Tax Ct. LEXIS 30">226 closely resemble the types of management consulting services offered by numbers of commercial enterprises. They emphasized income production and retention and were clearly commercial in nature.Petitioner's policy of selling religious services, its franchise program, its emphasis on income and production statistics, its management services, its pricing policies, its promotion programs, especially the payment of commissions on sales of services, show convincingly that petitioner operated in a commercial manner. From this we draw the inference that petitioner had a substantial commercial purpose. However, we do not rest our decision on the commercial hue of petitioner's activities, alone. Our conclusion that petitioner had a substantial commercial purpose is buttressed by two additional factors: the existence of sizable annual profits and substantial cash reserves.Although the presence of substantial profits is not necessarily determinative of a commercial purpose, such profits constitute "evidence indicative of a commercial character." Scripture Press Foundation v. United States, 152 Ct. Cl. 463">152 Ct. Cl. 463, 152 Ct. Cl. 463">468, 285 F.2d 800">285 F.2d 800, 285 F.2d 800">803 (1961), cert. denied 368 U.S. 985">368 U.S. 985 (1962). See also Incorporated Trustees of the Gospel Worker Society v. United States, 510 F. Supp. 374">510 F. Supp. 374, 510 F. Supp. 374">378 (D. D.C. 1981), 1984 U.S. Tax Ct. LEXIS 30">227 affd. without opinion 672 F.2d 894">672 F.2d 894 (D.C. Cir. 1981), cert. denied 456 U.S. 944">456 U.S. 944 (1982); Parker v. Commissioner, 365 F.2d 792">365 F.2d 792, 365 F.2d 792">798 (8th Cir. 1966), cert. denied 385 U.S. 1026">385 U.S. 1026 (1967). In his notice of deficiency, respondent determined that petitioner's seven stipulated divisions (SFO, LAO, FOLO, ASHO, AOLA, USGO, and Flag) had the following consolidated net incomes during the docketed years:197019711972Gross receipts$ 2,249,013.08 $ 3,301,143.73 $ 3,134,391.00 Advance payments373,222.37 788,704.96 1,198,763.86 Flag income263,557.47 240,932.55 Payment DanishKingdom Church 77.92 53,609.76 Payment UnitedKingdom Church 76,497.24 161,018.38 Total income 2,622,235.45 4,429,981.32 4,788,715.55 Expenses197019711972Per Form 990$ 2,438,646.65 $ 4,242,124.02 $ 4,178,876.05 Trust(28,930.34)(67,892.40)(77,986.62)Charter Mission(disallowed) (982,415.39)(1,143,928.02)(1,400,015.99)Flag expenses1,238,466.30 1,036,108.56 Total allowable expenses 1,427,300.92 4,268,769.90 3,736,982.00 Net income 1,194,934.53 161,211.42 1,051,733.55 83 T.C. 381">481 Petitioner does not actually contest the accuracy of these figures; however, it does disagree with the tax treatment accorded them by respondent. The most 1984 U.S. Tax Ct. LEXIS 30">228 significant disagreement between the parties, at least in terms of amount, centers around the tax treatment of the amounts characterized as advance payments. In his notice of deficiency, respondent included such advance payments in income, stating:As a cash basis taxpayer, you received payments for services to be rendered in the future. These amounts were not included in the gross receipts reflected on Forms 990 but are includible in your taxable income. Accordingly, your taxable income is increased in the amounts indicated.Initially in its petition, the Church argued that not only were the advance payments not income in the years of receipt, but in addition, all amounts paid for religious services should be excluded from income since such amounts were received as charitable contributions from its parishioners. However, on brief, petitioner apparently abandons this contention and asserts, instead, that the advance payments of $ 373,222.37 in 1970, $ 788,704.96 in 1971, and $ 1,198,763.86 in 1972 were incorrectly included in its income. Petitioner claims that the advance payments should not be treated as income, since it had not earned them by rendering services, and since it had 1984 U.S. Tax Ct. LEXIS 30">229 a duty to refund them on demand at any time before the services were taken. 65As a general rule, under the cash receipts and disbursement method, money which is received must be reported as gross income in the year in which it is received. Sec. 451(a); sec. 1.446-1(c)(1)(i), Income Tax Regs. Petitioner contends, however, 83 T.C. 381">482 that the fact that it was under an obligation to refund the advance payments in full at any time prior to the rendering of services upon the request of the "donor" somehow changes this tax treatment. Petitioner is clearly wrong on the law. At least, since the seminal case of North American Oil Consolidated v. Burnet, 286 U.S. 417">286 U.S. 417, 286 U.S. 417">424 (1932), the receipt of money under a claim of right is treated as taxable income even though the recipient may be under a contingent obligation to return it later.We find the claim of right doctrine is applicable here. In order to avoid the application of the claim of right doctrine, "the recipient must at least recognize in the year of receipt 'an existing and fixed obligation to repay the amount received' 1984 U.S. Tax Ct. LEXIS 30">230 and 'make provisions for repayment.'" Nordberg v. Commissioner, 79 T.C. 655">79 T.C. 655, 79 T.C. 655">665 (1982), affd. in an unpublished opinion 720 F.2d 658">720 F.2d 658 (1st Cir. 1983); Hope v. Commissioner, 55 T.C. 1020">55 T.C. 1020, 55 T.C. 1020">1030 (1971), affd. 471 F.2d 738">471 F.2d 738 (3d Cir.), cert. denied 414 U.S. 824">414 U.S. 824 (1973). The first condition is clearly not present in the instant case since petitioner was never under an existing and fixed obligation to repay the advance payments in question. Repayment was instead contingent on a refund request initiated by one of petitioner's "donors." Furthermore, there is no evidence in the record that petitioner's contingent liability to refund the advance payments imposed any restriction upon the use of the money in its hands. If petitioner eventually was required to refund any of the advance payments in a later year, it would then be entitled to a deduction for such amounts. However, such amounts are clearly income in the year of receipt.In reaching this conclusion, we find petitioner's reliance on our holding in Miele v. Commissioner, 72 T.C. 284">72 T.C. 284 (1979), misplaced. In Miele, we found that a law firm that used a cash method of accounting did not have taxable income in the year in which its clients 1984 U.S. Tax Ct. LEXIS 30">231 transferred advances to a special bank account. We distinguished 286 U.S. 417">North American Oil Consolidated v. Burnet, supra, on two grounds. The clients' funds were kept in separate bank accounts, and the firm could only draw on the funds when an amount was undisputed. 72 T.C. 284">72 T.C. 289-290. Our holding in Miele is clearly distinguishable from the instant case, since there is absolutely no suggestion in the record that petitioner segregated the advance payments in any 83 T.C. 381">483 of its numerous bank accounts. On the contrary, it appears that these payments were commingled with petitioner's other receipts and were thus received under claim of right. 661984 U.S. Tax Ct. LEXIS 30">232 Consequently, we find that respondent correctly included the amount of the advance payments in petitioner's taxable income for the taxable years in question. Another major area of disagreement between the parties is the appropriate tax treatment of the Charter Mission expenses. These payments represented amounts transferred by petitioner to OTC during the tax years at issue. On its Forms 990, petitioner claimed them as business expenses. In his notice of deficiency, respondent disallowed petitioner's claimed Charter Mission expenses of $ 982,415.39 in 1970, $ 1,143,928.02 in 1971, and $ 1,400,015.99 in 1972, stating:It is determined that the amounts reported as Charter Mission Expense are not deductible because said amounts do not constitute ordinary and necessary expenses paid or incurred during the taxable years 1970, 1971, and 1972, but rather represent an internal transfer of funds to the Flag Division, which is a division of the Church of Scientology of California.However, concurrent with these adjustments, respondent did allow petitioner deductions for Flag Division expenses in the amounts of $ 1,238,466.30 in 1971 and $ 1,036,108.56 1984 U.S. Tax Ct. LEXIS 30">233 in 1972, which were not previously reflected on the Forms 990 filed by petitioner.It is here that the fluidity of petitioner's position is particularly impressive. Surprisingly, petitioner does not actually object to the adjustments made by respondent for either 1971 or 1972, although it does assert that respondent erred in not allowing a similar deduction for Flag expenses of $ 419,856.76 in 1970, which it now asserts was the actual amount Flag paid out for expenses that year. Basically, despite the fact that petitioner initially claimed deductions for all payments made to OTC, albeit without explanation, and despite the fact that it has steadfastly maintained that OTC is a separate corporation 83 T.C. 381">484 from petitioner, it now argues that all payments to OTC from any branch of petitioner are essentially internal transfers to Flag for purposes of running religious activities aboard the Apollo. In order to explain its position, the petitioner now argues that OTC merely acted as a "bank" or "agent" for petitioner.This relationship between petitioner and OTC was described by petitioner's accountant, Martin J. Greenberg, in his correspondence with respondent's agent. In a letter dated December 1984 U.S. Tax Ct. LEXIS 30">234 18, 1975, Greenberg stated --(1) The basic relationship of the Church with OTC during the years 1971-74 was as follows: The Church chartered the ship Apollo from OTC for $ 2,000 per month. In addition, OTC acted as the Church's agent in the financial matters relating to Flag's operations. OTC received funds on behalf of the Church, and at the Church's instructions would pay all of the Church's expenses. OTC would issue a monthly statement of each individual disbursement made and an annual statement showing the receipts and disbursements for the year and the balance that the Church still had to its credit.In a follow-up letter dated February 9, 1976, Greenberg further stated --(2c) The first point that should be made is that ALL payments to OTS/OTC from any branch of the Church of Scientology of California are essentially internal transfers to Flag to run their religious activities aboard the ship. That is the exempt purpose and the ONLY purpose of every single penny sent to OTS -- NO EXCEPTIONS! OTS merely acted as a "bank" or "agent" for the Church and the only funds actually paid to OTS for them to keep were the Charter fees and the finance charges. 67 * ** * * (2d and 2e) 1984 U.S. Tax Ct. LEXIS 30">235 * * * The Churches have no "liability" to OTS for management fees, training or any other service (except as noted in 2b). OTS, when acting as the Church's agent is in effect acting as a bank. There is no "liability" to deposit funds in the bank. As long as you maintain a credit balance the "bank" will make whatever disbursements you authorize out of the "account." They have no say at all in telling you what you have to deposit. That is basically the relationship of the Church to OTS. * * * [Emphasis added.]What appears to be happening is this. It appears that initially the Charter Mission expenses were deducted on the 83 T.C. 381">485 Forms 990, probably on the basis of the story concocted in 1969 that OTC was providing supportive services to Flag. Petitioner has now changed its story. It now argues that OTC is merely a private "bank" for petitioner. It therefore concedes that the Charter Mission payments are not deductible, since deposits in banks are not expenses, but claims it should be allowed a deduction for the actual expenses incurred by Flag in 1984 U.S. Tax Ct. LEXIS 30">236 1970 in the amount of $ 419.856.76.Before addressing this issue, we digress briefly to point out the flaws in petitioner's new story about OTC. First, it is nonsensical. According to petitioner's story, OTC was in constant debt to petitioner, since it continually transferred to OTC sums far in excess of what was currently needed by it to meet its alleged expenses. By petitioner's own admission, the balance OTC owed to petitioner increased during each of the docketed years. It is here that the logic of petitioner's story breaks down. After all, why would petitioner leave increasingly large sums in control of a commercial Panamanian corporation without any provision for interest and also pay it finance charges if it were truly independent? Second, OTC did not act as a banker for petitioner. The evidence is overwhelming that petitioner's employees handled the Church's finances. This is so because, as far as the record discloses, OTC had no offices, officers, or employees with which to perform financial services for petitioner.We turn now to petitioner's claim that respondent erred in not allowing petitioner to deduct Flag's operating expenses of $ 419,856.76 for 1970. Petitioner 1984 U.S. Tax Ct. LEXIS 30">237 bears the burden of proving the amount of allowable Flag expenses for that year. We cannot accept petitioner's records as trustworthy. In 1969, petitioner engaged in a plan to cover up OTC's relationship to petitioner. In pursuit of this plan, records were manufactured and falsified to show petitioner's branch churches in debt to OTC for support services. In April and May of 1975, shortly before the 1971-74 audit began, petitioner again engaged in a project to falsify Flag records to present to the IRS. During the 1971-74 audit, IRS auditors made repeated requests for substantiation that OTC expenditures were made on petitioner's behalf. Church officials did not comply. Instead, they offered a variety of excuses including a claim that Church activities aboard the Apollo were funded essentially through 83 T.C. 381">486 cash expenditures. This evidence casts severe doubts on whether any of the Flag expenditures were actually incurred. Petitioner has, therefore, failed to satisfy its burden of proof. We are not at liberty to redetermine the amount of deductible Flag expenditures incurred during the tax years 1971 and 1972, since respondent has not seen fit to disturb his allowance of the amounts 1984 U.S. Tax Ct. LEXIS 30">238 set forth. However, we do find that respondent correctly disallowed such expenditures for 1970 and that, in reality, the actual allowable expenditures for 1971 and 1972 should probably be substantially less than those allowed by respondent.A third major area of disagreement between the parties is the proper tax treatment of the payments made by petitioner to the United States Churches of Scientology Trust. These payments were deducted by petitioner and were designated as payments to the Central Defense and Dissemination Fund and amounted to $ 28,930.34 in 1970, $ 67,892.40 in 1971, and $ 77,986.62 in 1972. In his notice of deficiency, respondent disallowed these deductions in full, stating:It is determined that the payments to the Central Defense and Dissemination Fund (United States Churches of Scientology Trust) are not allowable as deductions under IRS section 162.In its petition, petitioner contests this disallowance on the ground that such payments to the trust were reasonable and necessary expenses. However, on brief, petitioner apparently concedes that such payments are not deductible if it is judged not be be tax exempt, although petitioner does assert that the payments 1984 U.S. Tax Ct. LEXIS 30">239 were in furtherance of its exempt purpose. We do not agree.The facts surrounding the United States Churches of Scientology Trust, which are set out in detail in our findings of fact, can only be described as bizarre. Some of the more incredible are recited again here. To begin with, although the trust purportedly originated in 1962, there was no trust document until June 25, 1973. Also financial statements were not prepared for the trust during the docketed years. Furthermore, although the trust was purportedly a United States trust, it was administered in England and the financial statements which were belatedly prepared in 1973 were prepared in South Africa. The purported purpose of the trust 83 T.C. 381">487 was the defense of the United States Churches of Scientology. However, there was only one disbursement for such purpose in the amount of $ 9,290.47, although the trust had accumulated funds of $ 812,134.51, $ 930,400.08, and $ 1,307,237.26 in 1970, 1971, and 1972, respectively, and although USGO spent substantially greater amounts for legal fees during the docketed years. The trust funds were not invested. They were kept in numbered Swiss bank accounts. L. Ron Hubbard was the sole 1984 U.S. Tax Ct. LEXIS 30">240 trustee and generally kept the trust checkbooks. According to petitioner's worksheets, in 1972 over $ 1 million in trust funds was removed from some of these accounts and placed in a locked file cabinet on the Apollo where they were allegedly kept until 1975. Mary Sue Hubbard supposedly had the only key. The circumstances of this trust are just too bizarre to credit its validity. Petitioner has not carried its burden. We therefore find that respondent correctly disallowed petitioner's claimed expenses for the Central Defense and Dissemination Fund for the tax years in question.The final area of disagreement between the parties centers on the proper tax treatment to be accorded the payments received by petitioner from the Danish Kingdom Church and United Kingdom Church. In his notice of deficiency, respondent included in petitioner's income payments from these churches as follows:YearDK payment receivedUK payment received1971$ 77.92 $ 76,497.24197253,609.76161,018.38 However, petitioner contested the inclusion of these amounts in its income, stating that these funds were actually received by OTC and represented debt repayment.For his part, respondent now contends on brief that 1984 U.S. Tax Ct. LEXIS 30">241 since the United Kingdom Church, both in form and in substance, was a branch of petitioner, such payments were merely internal transfers, which, by definition, cannot be either debt repayment or income. Furthermore, respondent states that the same is also undoubtedly true of the Danish Kingdom Church.With respect to the Danish Kingdom Church, we cannot find from the record in this case that it was in actuality a branch of petitioner. On the other hand, petitioner has not satisfied us 83 T.C. 381">488 that a bona fide debt from the Danish Kingdom Church to OTC actually existed. Consequently, we find that respondent correctly included such amounts in petitioner's income in its notice of deficiency.The same is not true for the payments from the United Kingdom Church. In light of our finding that the United Kingdom Church was in actuality merely a branch of petitioner, respondent is correct in his assertion on brief that the payments from the United Kingdom Church to OTC merely represent internal transfers and are, thus, not properly included in petitioner's income.Having resolved the contested items in the notice of deficiency, we are now in a position to calculate petitioner's net income during the 1984 U.S. Tax Ct. LEXIS 30">242 docketed years. By petitioner's own admission, the United Kingdom Church, during the docketed years, had net income of $ 299,681 in 1970, $ 796,417 in 1971, and $ 816,572 in 1972. Subtracting the United Kingdom Church payments and adding the United Kingdom Church's net taxable income to petitioner's other income, we find that petitioner's net income for the tax years in question was not less than $ 1,494,615.53 in 1970, $ 881,131.18 in 1971, and $ 1,707,287.17 in 1972. Additionally, there is considerable evidence in the record that the true income of petitioner was substantially in excess of those amounts. For example, during trial John McLean testified that in 1972, the average weekly income of United States Scientology organizations controlled by Flag was about $ 1 million and ranged as high as $ 1,400,000 during that year. Annualizing such weekly amounts would result in a figure in the $ 50- to $ 70-million range, an amount which obviously dwarfs the income reported by petitioner on its informational return for 1972. Furthermore, our finding that OTC is merely a front for petitioner, along with our recognition that the massive cash reserves held by OTC actually belong to petitioner, 1984 U.S. Tax Ct. LEXIS 30">243 certainly raises the prospect that petitioner had millions of dollars of unreported income. However, even disregarding these indications of vast undisclosed profits, we find the amount of petitioner's determinable profits in the docketed years to be substantial. The existence of these substantial profits, when viewed in light of the commercial nature of petitioner's operations, lends additional support 83 T.C. 381">489 to our finding that petitioner was operated in furtherance of a substantial commercial purpose.The remaining factor supporting our finding is the existence of substantial reserves. Several cases have recognized this factor as indicative of a commercial purpose. See B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352">70 T.C. 352, 70 T.C. 352">357 (1978); Incorporated Trustees of the Gospel Worker Society v. United States, 510 F. Supp. 374">510 F. Supp. 374, 510 F. Supp. 374">378-379 (D. D.C. 1981), affd. without opinion 672 F.2d 894">672 F.2d 894 (D.C. Cir. 1981), cert. denied 456 U.S. 944">456 U.S. 944 (1982); Parker v. Commissioner, 365 F.2d 792">365 F.2d 792, 365 F.2d 792">798 (8th Cir. 1966), cert. denied 385 U.S. 1026">385 U.S. 1026 (1967).In the instant case, the record is replete with evidence that petitioner was obsessed not only with making money but also with building up massive cash reserves. In HCO PL 1984 U.S. Tax Ct. LEXIS 30">244 March 9, 1972, MS OEC 381, L. Ron Hubbard wrote the following:If a management unit such as a Bureaux, a Continental Liaison Office, an OT-Liaison Office or any agent thereof such as a Guardian or FBO or Flag Rep is any good, THE NEAREST SERVICE ORG WILL MAKE AMPLE MONEY TO PAY the managing unit and HAVE LOTS LEFT OVER TO SWELL SO Reserves. [Capitalization in original.]In this same policy letter, L. Ron Hubbard defined "SO Reserves" as follows:SO RESERVES: Often miscalled "Flag Reserves" or "Management Reserves" which they are NOT. SO Reserves are: The amount of money collected for the corporation over and above expenses that is sent by various units (via FBOs and the Finance Network) to the corporation's Banks. It is used for purposes assigned by the BOARD OF DIRECTORS and for NO OTHER PURPOSE. These are normally employed for periods of stress or to handle situations. They are NOT profit. It is not support money for "Flag" or "Management." It is not operating money (Examples: Huge sums were required to cover WW when under attack and to catch the PUBS 1970 crash.) [Capitalization and emphasis in original.]This policy letter illustrates petitioner's fervor for building cash reserves. 1984 U.S. Tax Ct. LEXIS 30">245 More importantly for this case, petitioner's accumulations matched its fervor. In just two months in 1971, Sea Org Reserves swelled by $ 270,175. The bulk of petitioner's reserves were held in 16 active bank accounts maintained in the name of OTC. The yearend balances on these accounts were $ 1,772,981.72 in 1970, $ 2,042,832.04 in 1971, and $ 2,561,688.98 in 1972. Petitioner also accumulated reserves in 83 T.C. 381">490 the sham United States Churches of Scientology Trust. By year's end in 1972, the trust had accumulated funds totaling $ 1,307,237.26. Approximately 6 months later, this balance had grown to $ 1,998,343.08. Petitioner also kept cash reserves aboard the Apollo. In 1968 and 1969, the ship's cash reserves fluctuated between $ 50,000 and $ 200,000. In 1972, slightly over $ 3 million in cash from the OTC and trust accounts was stored on board the ship. The total amount of petitioner's reserves for the docketed years is shrouded in mystery. Whatever the exact amount, it is clear that the accumulated reserves were substantial. 681984 U.S. Tax Ct. LEXIS 30">246 1984 U.S. Tax Ct. LEXIS 30">247 1984 U.S. Tax Ct. LEXIS 30">248 In conclusion, petitioner's highly commercial method of operations, its high annual profits, and its substantial, undedicated cash reserves convince us that it had a substantial commercial purpose. 70 T.C. 352">B.S.W. Group, Inc. v. Commissioner, supra;365 F.2d 792">Parker v. Commissioner, supra.83 T.C. 381">491 V.Respondent asserts, and we agree, that petitioner fails to qualify for tax-exempt status because a portion of its net earnings inured to the benefit of private individuals. In order to qualify for tax-exempt status under section 501(c)(3), not only must an organization establish that it is organized and operated exclusively for exempt purposes, but it must also prove that no part of its net earnings inures to the benefit of any private shareholder or individual. 1984 U.S. Tax Ct. LEXIS 30">249 The term "private shareholder or individual" is defined in section 1.501(a)-1(c), Income Tax Regs., as a person having a personal and private interest in the activities of an organization. It does not refer to unrelated third parties. People of God Community v. Commissioner, 75 T.C. 127">75 T.C. 127, 75 T.C. 127">133 (1980). In other words, the inurement prohibition under section 501(c)(3) denies exempt status to an organization whose founders or controlling members have a personal stake in that organization's receipts.Basically, the thrust of the concept of private inurement is to ensure that an exempt charitable organization is serving a public and not a private interest. See Baltimore Health & Welfare Fund v. Commissioner, 69 T.C. 554">69 T.C. 554 (1978); Callaway Family Association, Inc. v. Commissioner, 71 T.C. 340">71 T.C. 340 (1978). Thus, if part of the net earnings of an organization, no matter what its purpose, inures to the benefit of any private shareholder or individual, tax exemption under section 501(c)(3) will not be allowed. An organization bears the burden of proving that it is not operated for the benefit of private interests such as that of the founder or his family. Basic Bible Church v. Commissioner, 74 T.C. 846">74 T.C. 846 (1980).The 1984 U.S. Tax Ct. LEXIS 30">250 term "net earnings" includes more than net profits, and they may inure to an individual in more ways than in the distribution of dividends. Unitary Mission Church v. Commissioner, 74 T.C. 507">74 T.C. 507 (1980), affd. in an unpublished opinion 647 F.2d 163">647 F.2d 163 (2d Cir. 1981). For example, we have found that the paying over of a portion of gross earnings to those vested with control of a charitable organization constitutes private inurement. 75 T.C. 127">People of God Community v. Commissioner, supra.Additionally, the amount or extent of such benefit is not determinative of a finding of private inurement. Church of the Transfiguring Spirit, Inc. v. Commissioner, 76 T.C. 1">76 T.C. 1, 76 T.C. 1">5 (1981). 83 T.C. 381">492 Thus, the fact that the benefit conveyed may be relatively small does not change the basic fact of inurement. Founding Church of Scientology v. United States, 188 Ct. Cl. 490">188 Ct. Cl. 490, 188 Ct. Cl. 490">497, 412 F.2d 1197">412 F.2d 1197, 412 F.2d 1197">1200 (1969), cert. denied 397 U.S. 1009">397 U.S. 1009 (1970).In the instant case, there can be no question that L. Ron Hubbard and his family are clearly private shareholders or individuals within the meaning of section 501(c)(3). 69 During the tax years at issue, the obvious indicia of benefit to L. Ron Hubbard and his family include salaries, directors 1984 U.S. Tax Ct. LEXIS 30">251 fees, management fees, complete support of the family, and royalties; while covert indicia of benefit include repayment of alleged debts in unspecified amounts and unfettered control over millions of dollars in funds purportedly belonging to OTC and the United States Churches of Scientology Trust.During the tax years at issue, L. Ron Hubbard and Mary Sue Hubbard received salaries from petitioner totaling $ 20,249.27 in 1970, $ 49,647.61 in 1971, and $ 115,679.76 in 1972. We recognize that the payment of reasonable salaries by an allegedly tax-exempt organization does not result in the inurement of net earnings to the benefit of private individuals. However, excessive salaries do result in inurement of benefit. 188 Ct. Cl. 490">Founding Church of Scientology v. United States, supra.The burden falls upon petitioner to establish the reasonableness of the compensation paid to L. Ron and Mary Sue Hubbard. Bubbling Well Church of Universal Love, Inc. v. Commissioner, 74 T.C. 531">74 T.C. 531, 74 T.C. 531">538 (1980), affd. 670 F.2d 104">670 F.2d 104 (9th Cir. 1981). In the instant case, the salaries paid by petitioner to L. Ron and Mary Sue Hubbard are far from shocking. We are puzzled, however, 1984 U.S. Tax Ct. LEXIS 30">252 by the increase in salaries in 1972 over 1971, since the record does not disclose what additional job responsibilities L. Ron and Mary Sue Hubbard undertook in 1972 to precipitate the increase. Furthermore, the salary payments are but the tip of the iceberg of the total benefits actually received by them. For example, L. Ron Hubbard, Mary Sue Hubbard, and their four children resided for the most part aboard the Apollo. While aboard ship, petitioner paid the family's living and medical expenses.L. Ron Hubbard also received royalty payments in connection with petitioner's sales of books and E-meters. We, of 83 T.C. 381">493 course, do not dispute an author's right to receive compensation in the form of royalties for his literary works. However, this does not mean that an individual can use a tax-exempt organization that he clearly controls, as is the case with L. Ron Hubbard and petitioner, to market his own works. Undoubtedly, it was this type of self-dealing that the prohibition against inurement under section 501(c)(3) was enacted to ban. For although it may indeed be common, as petitioner asserts, for an author to receive royalties of 10 percent on the sales of his copyrighted works, in a 1984 U.S. Tax Ct. LEXIS 30">253 normal commercial setting, it is the publisher and not the author who establishes the price for which the books are ultimately sold. However, in the instant case, it was L. Ron Hubbard who personally controlled what amount he received on each book and E-meter sale through his setting of the price that petitioner charged for each item, and as we have previously found, such prices were well above cost. Additionally, it is uncontroverted that the majority of ASHO PUB's sales of E-meters and books upon which royalties were paid to the account of L. Ron Hubbard were to other Scientology churches, including branches of petitioner. The combination of L. Ron Hubbard's first contracting with petitioner to sell his books and E-meters in exchange for royalty payments, then his pushing the sales of such books and E-meters through his own policy letters, and finally his establishment of the prices of such items and the fact that the majority of sales were to petitioner's branches and other Scientology churches certainly constitutes a flagrant case of self-dealing, which clearly benefited L. Ron Hubbard, personally, and thus constitutes inurement.Not only did L. Ron Hubbard receive royalty payments 1984 U.S. Tax Ct. LEXIS 30">254 on his own works, but he also received royalties attributable to the literary efforts of some of petitioner's other employees. It was a long-standing policy of petitioner that all works involving Scientology had to be copyrighted to L. Ron Hubbard. This policy was articulated by L. Ron Hubbard in HCO PL of November 15, 1958, 1 OEC 13-14, as follows:Similarly, any book on Dianetics and Scientology must be copyrighted in the name of L. Ron Hubbard and the copyright becomes the property of HCO. No copyright of anything must ever be permitted to escape. In the case of its having been done (a book on the subject copyrighted in the name of someone or something else) HCO Secretary in the area must request an 83 T.C. 381">494 assignment of copyright to L. Ron Hubbard from its present owner and must be tireless and remorseless in getting the copyright, using any available means at whatever cost.Similarly any trademark, registered mark, or patent for any sign, symbol, shield, device or design for Dianetics or Scientology or their organizations must be secured for HCO. All these are registered to L. Ron Hubbard and by blanket transfer are the property of HCO only. The name in which it is done is L. Ron 1984 U.S. Tax Ct. LEXIS 30">255 Hubbard; the owner is then HCO.* * * Don't let one seal, one copyright, one design, one device, or even the names Dianetics and Scientology escape you on this. All the money you need to hire experts, lawyers, artists and pay fees is yours for the asking from the main office of HCO. Just ask.[Emphasis added.]Pursuant to this policy, a number of publications copyrighted by L. Ron Hubbard were actually written by others. For example, Ruth Mitchell wrote the book "Know Your People," and Peter Gillum wrote the book "How to Be Successful"; however, both books were copyrighted by L. Ron Hubbard. Additionally, numerous policy letters contained in the OEC were actually written by paid employees of petitioner with L. Ron Hubbard's approval. Nevertheless, despite the fact that L. Ron Hubbard did not personally author the entire nine-volume set, he did receive royalty payments on the sale of this publication.Without addressing the legality of copyrighting materials and receiving royalty payments on the works of others, we find the policy of using paid employees of an organization to write materials that are then copyrighted to the organization's founder, and upon which he receives royalties, 1984 U.S. Tax Ct. LEXIS 30">256 to be a clear use of an organization for a private, as opposed to a public, purpose -- the crux of a finding of inurement.The record reveals glimpses of other self-dealing transactions in addition to L. Ron Hubbard's receipt of royalties from literature published, sold, and sometimes, even written, by petitioner. For example, a portion of the debt allegedly owed by petitioner to L. Ron Hubbard during the tax years in question arose from his sale in 1966 of the St. Hill Manor to petitioner. Although we know from petitioner that the sales price in that transaction was 79,410.5.6 pounds, petitioner has failed to introduce any evidence as to the fair market value of 83 T.C. 381">495 St. Hill at the time of the sale or the reason why petitioner needed L. Ron Hubbard's specific property. However, there is unrebutted evidence in the record that L. Ron Hubbard represented to the British Government on a statement of his assets to the Inland Revenue as of April 1966 that the value of this property was only 17,707.7.6 pounds -- an amount less than one-fourth the eventual sales price. Admittedly, we do not really know what the actual fair market value of St. Hill was at the time of the sale. However, in 1984 U.S. Tax Ct. LEXIS 30">257 light of the degree of control which L. Ron Hubbard maintained over petitioner and the fact that the debt arising from this transaction was apparently being serviced during the docketed years, absolute full disclosure of all facts relevant to such sale is in order.In sum, the total value of the overt benefits received by the Hubbards during the tax years at issue in living expenses, and from salaries and royalties was several hundred thousand dollars. These payments are substantial. When viewed in light of the self-dealing that transpired, they prove conclusively that petitioner was operated for the private benefit of L. Ron Hubbard and his family. However, we need not rest our conclusion on this evidence, alone, since the record also abounds with indicia of covert inurement.Probably the most covert form of compensation paid to L. Ron Hubbard was tithes (or a percentage of gross income) which petitioner and other Scientology organizations routed to him in the guise of "Founding Debt Payments." Although petitioner failed to produce a single witness who credibly testified about these payments, and we are thus left somewhat in the dark regarding the actual amounts and duration of 1984 U.S. Tax Ct. LEXIS 30">258 such payments during the docketed years, there is considerable evidence in the record that these payments did indeed take place. A trail of documentary evidence shows that Scientology organizations began making these alleged debt repayments in the 1960s. In HCO PL December 21, 1965, 3 OEC 51, L. Ron Hubbard remonstrated all Scientology organizations for their failure to keep proper records of their debts to him for his past services in establishing Scientology. He directed the organizations to correct their records and to set up a system in the Office of LRH for keeping track of these debts and collecting payments. L. Ron Hubbard went on to state that the reason for these policies stemmed from the IRS's actions against the 83 T.C. 381">496 Founding Church of Scientology. That controversy was eventually litigated in the Court of Claims. In finding that the net earnings of the Founding Church inured to the benefit of L. Ron Hubbard, the Court of Claims found that from 1957 on, L. Ron Hubbard was paid, in lieu of salary, 10 percent of the gross income of the Founding Church and of other Scientology congregations, franchises, and organizations, and that "Such an arrangement suggests a franchise 1984 U.S. Tax Ct. LEXIS 30">259 network for private profit." Founding Church of Scientology v. United States, 188 Ct. Cl. 490">188 Ct. Cl. 490, 188 Ct. Cl. 490">494, 188 Ct. Cl. 490">498, 412 F.2d 1197">412 F.2d 1197, 412 F.2d 1197">1199, 412 F.2d 1197">1201 (1969), cert. denied 397 U.S. 1009">397 U.S. 1009 (1970). Thus, HCO PL of December 21, 1965, 3 OEC 51, was apparently issued in realization of the fact that the current scheme of compensating L. Ron Hubbard placed Scientology churches in a dangerous tax position. However, although the payments made to L. Ron Hubbard from that time on certainly differed in form, it appears that they differed little in substance.HCO PL December 21, 1965, 3 OEC 51, marks the beginning of a documentary trail that leads through the tax years in issue. HCO PL June 25, 1967, 3 OEC 63, repeated L. Ron Hubbard's instructions to record debts owed to him. Flag Order 773 issued on May 25, 1968, ordered the removal of staff who incorrectly handled debt repayment to L. Ron Hubbard and, as a result, exposed him to greater income tax liability. FBO correspondence between Flag and AOLA in 1968 and 1969 discussed L. Ron Hubbard debt repayment (sometimes called "LRH RR" or LRH 10%s). A 1968 letter discussed the need to build up cash reserves aboard the Apollo, in part, to repay L. Ron Hubbard quickly. 1984 U.S. Tax Ct. LEXIS 30">260 FBO correspondence in March 1969 concerned ways to send loan repayment tithes from AOLA to L. Ron Hubbard, then on board the Apollo, in a negotiable form other than dollars to avoid possible losses from a feared devaluation of the dollar. These references to the alleged debt repayment which pepper the record convince us that L. Ron Hubbard was personally receiving a certain percentage -- in most cases 10 percent -- of petitioner's and other Scientology organizations' gross income in the late 1960s.These loan repayments continued in the docketed years. The official story with respect to these payments is detailed in HCO PL September 7, 1972, which states:83 T.C. 381">497 "REPAYMENT OR DUE MONEY COLLECTED FOR LRH PERSONALLY."What Is OwedFor years, public have thought or been told that the income of orgs goes to Ron, but this has never been true.Quite the reverse, Ron's personal income and capital -- even Veterans checks and Author's royalties -- have been invoiced and used by orgs.The entire Technology of Dianetics and Scientology have been used by orgs without reimbursement to Ron for research or development, nor even repayment for out of pocket expenses.Where such payments have been made records 1984 U.S. Tax Ct. LEXIS 30">261 will show that they were usually not received by LRH but that they too were invoiced and used by orgs and remain a debt of the Church in most cases.The Saint Hill Organization, piloted and built and made prosperous by LRH personally, now belongs to the Church of Scientology of California, but has never been paid for.The name "L. Ron Hubbard", an asset worth millions in goodwill and high credit rating, is used by all Scientology organizations but has not been paid for.In the early years, the personal funds of LRH guaranteed org overdrafts and even loaned orgs money. Income from ACC's (Advanced Clinical Courses, taught by LRH) rightfully due to LRH were instead received and used by orgs.Very little of the sums due have been repaid.Org Balance SheetsMany orgs have invoiced LRH personal income as "their own income". This gives them a raised income. But it was not their money and is actually a debt owed to LRH. Balance sheets of the orgs, particularly in the tax matters, therefore show inflated income when a debt exists.It is to the interest of all orgs that their balance sheets be correct. It is therefore incumbent upon them to furnish proper service in LRH collections.CollectionThe 1984 U.S. Tax Ct. LEXIS 30">262 post of LRH ACCOUNTS OFFICER is being established in the personal Office of LRH at Flag, directly under LRH Pers Comm Flag.LRH Accounts will provide LRH Comms with monthly statements showing monies owed and payments made, and will set weekly payment targets for LRH Comms to meet.The routing of all payments and correspondence is direct to LRH accts, via the Cont'l FOLO as a mail relay point.LRH Goodwill Repayment AccountOrgs having an LRH GOODWILL REPAYMENT ACCOUNT may use it to begin payments or to supplement current income in meeting their weekly payment target.83 T.C. 381">498 OIC CableAs OIC cable format is subsequently updated the second stat of the LRH Comm will eventually be included. Meanwhile the OIC cable remains as currently but the collection stat of each LRH Comm will be graphed at Flag based on amounts actually received and date of receipt, and graphed locally by amount and date when sent.LRH Comm DutiesAny friction or opposition encountered by LRH Comms in obtaining repayment or collection of monies due must be reported with full factual details of WHO and WHAT to LRH Accts Flag.Hat material on duties and functions relating to this collection statistic will be issued from time to time, 1984 U.S. Tax Ct. LEXIS 30">263 as the post of LRH Accts is further established and developed.However it will be found that a demand to meet the target, backed up by standard LRH Comm functions to get LRH Technology and Policy known and used correctly, will keep GI up trended and make it easy for the LRH Comm to keep his collection stat rising as well.ExchangeThe exchange factor in this is very simple and direct. To the degree that the LRH Comm gets LRH Technology and Policy known and used he will be able to make increasing repayment for it from the org to Ron, as the org will prosper and do well.So START! And good luck to you with your new stat!LRH Accounts Officer andLRH Pers Commby order ofL. Ron HubbardFOUNDERThis policy letter clearly establishes that payments, other than salary and royalties, were being made by petitioner to L. Ron Hubbard under the guise of debt repayments. Additionally, it is obvious from this policy letter that the so-called debt repayments were not just for money advanced by L. Ron Hubbard to petitioner but were also compensation for L. Ron Hubbard's past work in developing Scientology and for the use of his name. Petitioner has not produced any evidence of bona fide indebtedness, and 1984 U.S. Tax Ct. LEXIS 30">264 it is clear from the record that there was no recognized debt which had been negotiated between petitioner and L. Ron Hubbard but rather a continuing obligation to make payments based on petitioner's total receipts. 7083 T.C. 381">499 Petitioner denies such payments existed and asserts that HCO PL September 7, 1972, was canceled two days later by another policy letter. However, not only is the document allegedly cancelling the quoted policy letter self-serving, but it is totally impeached by the testimony of John McLean and Eugene Endo who both testified that such debt repayments continued to be made long after the purported cancellation. Indeed, petitioner's own financial records for the period October 9, 1972, to December 28, 1972, indicate that payments designated either "LRH Repayments," "Founding Debt Payment," or "Per HCO Policy Letter 7 Sept. 72," totaling $ 19,324.41 were made during this period. 71 We thus find that the weight of the evidence clearly indicates that HCO PL September 7, 1972, was adhered to long after its alleged cancellation. 1984 U.S. Tax Ct. LEXIS 30">265 It is, therefore, apparent that, although Scientology organizations rearranged their forms of payment to L. Ron Hubbard during the tax years in question, L. Ron Hubbard was still continuing to receive a percentage of their gross income. Finally, although the apparent existence of an arrangement whereby all Scientology organizations funneled a percentage of their gross income to L. Ron Hubbard under the guise of debt repayment certainly constitutes evidence of inurement on a grand scale, probably the most blatant source of covert inurement to L. Ron Hubbard in the present case is the complete control that he exercised over the millions of dollars transferred to OTC1984 U.S. Tax Ct. LEXIS 30">266 and the United States Churches of Scientology Trust.During the docketed years, L. Ron Hubbard had complete control of the United States Churches of Scientology Trust which in 1972 had accumulated earnings of $ 1,307,237.26. Our finding that the trust was not legitimate creates a presumption, left unrebutted, that L. Ron Hubbard privately benefited from the trust's funds.With respect to OTC, we observe that, even were we to believe petitioner's story that OTC was a truly independent 83 T.C. 381">500 corporation, we would nevertheless have to conclude that OTC's use of petitioner's funds constitutes inurement. OTC was a non-tax-exempt corporation. According to petitioner, it was constantly in debt to petitioner for huge sums of money. As petitioner's banker, this arrangement is best characterized as an interest-free loan.In Hancock Academy of Savannah, Inc. v. Commissioner, 69 T.C. 488">69 T.C. 488 (1977), we found the existence of private inurement where a non-profit corporation, formed to take over the educational functions of a non-tax-exempt corporation, required parents of its students to make interest-free loans to the non-tax-exempt corporation. In that case we held that the interest-free feature of 1984 U.S. Tax Ct. LEXIS 30">267 the loans was an unwarranted benefit to private individuals. We find the rationale of Hancock Academy equally applicable to the case at bar. If OTC had truly been independent, then certainly the huge sums transferred to it by petitioner constituted inurement to private individuals. See also 188 Ct. Cl. 490">Founding Church of Scientology v. United States, supra.("Indeed, the very existence of a private source of loan credit from an organization's earnings may itself amount to inurement of benefit." 188 Ct. Cl. 490">188 Ct. Cl. at 499, 412 F.2d 1197">412 F.2d at 1202.)We do not, however, credit petitioner's story that OTC was independent. It was a sham corporation controlled by L. Ron Hubbard.Petitioner's burden of proof with respect to inurement in this case is of necessity a heavy one. Where one individual is dominant in an organization, "there exists the opportunity for abuse which, in turn, evinces a need for open and candid disclosure of all the facts." Basic Bible Church v. Commissioner, 74 T.C. 846">74 T.C. 846, 74 T.C. 846">858 (1980). In the instant case, however, petitioner has been less than open and candid and has failed totally in carrying its burden of proof with respect to both OTC and the trust.Several key Scientology officials were noticeably 1984 U.S. Tax Ct. LEXIS 30">268 absent from the trial. L. Ron Hubbard did not testify, although he was the Church's leader, was a signatory on all Church and OTC accounts, and allegedly held sums of money in trust for petitioner. 72 Mary Sue Hubbard did not testify, although she 83 T.C. 381">501 was the senior person on the Aides Council, commanded the International Guardian Network, and held the only set of keys to the Apollo strongroom where millions of dollars belonging to OTC and the trust were stored. Greenberg, the California Church's accountant, did not testify although he coordinated the 1971-74 audit on behalf of the Church, allegedly counted on February 23, 1975, the OTC money kept aboard the Apollo, and prepared petitioner's tax returns for the docketed years. 73 Mary Rezzonico did not testify although she served as Greenberg's assistant during the 1971-74 audit and was invested with the power of attorney to represent the California Church before the IRS on all matters and all years. H.A. Ross did not appear although he was the auditor of the trust accounts for the docketed years. Neither Fred Hare nor Vicki Polimeni testified although they were the Church officials who allegedly transported the trust funds from 1984 U.S. Tax Ct. LEXIS 30">269 Switzerland to the Apollo. We stop here although there were others who were privy to facts and transactions of critical importance to the issues in this case, particularly concerning the trust and OTC, who did not testify.Petitioner also failed to introduce important documentary evidence. The trust records were not produced although a file containing trust banking records and correspondence was allegedly maintained at the United Kingdom Church. The Church never produced records of OTC's expenditures, claiming OTC was a separate corporation over which it had no control and also claiming that the Swiss banks, where the OTC accounts were maintained, 1984 U.S. Tax Ct. LEXIS 30">270 did not return canceled checks. These claims were false. OTC was a separate corporation in name only. Furthermore, petitioner regularly received debit advices from the OTC accounts, which provided the same information as would have been shown on a canceled check. The ready availability of these debit advices is underscored by the fact that at least one Church witness reviewed them in Los Angeles before giving testimony. Finally, petitioner did not produce instructions called "Flag Mission Orders" and reports83 T.C. 381">502 The failure of a party to produce relevant evidence within its possession or control gives rise to the presumption that, if produced, it would be unfavorable. United States for the Use and Benefit of C.H. Benton, Inc. v. Roelof Construction Co., 418 F.2d 1328">418 F.2d 1328, 418 F.2d 1328">1332 (9th Cir. 1969); Malat v. Commissioner, 302 F.2d 700">302 F.2d 700, 302 F.2d 700">706 (9th Cir.), affg. 34 T.C. 365">34 T.C. 365 (1960), cert. denied 371 U.S. 934">371 U.S. 934 (1962). This is especially true where the party failing to produce the evidence has the burden of proof. Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158">6 T.C. 1158, 6 T.C. 1158">1165 (1946), affd. 162 F.2d 513">162 F.2d 513 (10th Cir. 1947). The need for full and candid disclosure is also particularly great where a 1984 U.S. Tax Ct. LEXIS 30">271 church is dominated by its founder, since there is obvious opportunity for abuse of its tax-exempt status. Basic Bible Church v. Commissioner, 74 T.C. 846">74 T.C. 846, 74 T.C. 846">858 (1980); Bubbling Well Church of Universal Love, Inc. v. Commissioner, 74 T.C. 531">74 T.C. 531 (1980), affd. 670 F.2d 104">670 F.2d 104 (9th Cir. 1981). In view of L. Ron Hubbard's unfettered control of the OTC and trust funds ranging in the millions of dollars, petitioner's failure to come forward with relevant evidence bearing on these holdings constitutes an overwhelming failure of proof. Consequently, we find petitioner was operated for the private benefit of L. Ron Hubbard and his family and that its net earnings inured to their benefit.VI.In a pretrial ruling, we held that in order to qualify for exemption under section 501(c)(3) petitioner must meet the express conditions of that section and, in addition, must comply with fundamental notions of public policy. Our ruling anticipated the holding in Bob Jones University v. United States, 461 U.S. 574">461 U.S. 574 (1983), which found that section 501(c)(3)was informed by charitable trust law and which read into the section a requirement that charitable organizations seeking to qualify for exemption from federally 1984 U.S. Tax Ct. LEXIS 30">272 imposed taxes must serve a valid public purpose and confer a public benefit. 461 U.S. 574">461 U.S. at 586-588 n. 12.[To] warrant exemption under section 501(c)(3), an institution must fall within a category specified in that section and must demonstrably serve and be in harmony with the public interest. The institution's purpose must not be so at odds with the common community conscience as to undermine any 83 T.C. 381">503 public benefit that might otherwise be conferred. [461 U.S. 574">461 U.S. at 592; fn. ref. omitted.]Pursuant to our ruling, respondent offered proof that petitioner did not satisfy this public policy requirement because it conspired to impede the IRS in performing its duty to determine and collect taxes from petitioner and other Scientology churches, a felony offense under 18 U.S.C. sec. 371. Petitioner contends that our construction of 501(c)(3) impermissibly intrudes upon its associational rights and free exercise rights because there are less restrictive ways to purge petitioner's misconduct than to withhold its exemption. 741984 U.S. Tax Ct. LEXIS 30">274 1984 U.S. Tax Ct. LEXIS 30">275 Petitioner suggests that the Government's interests could just as well be vindicated by prosecuting Church officials who broke the law as by penalizing the entire California1984 U.S. Tax Ct. LEXIS 30">273 Church and denying its tax exemption. Petitioner reminds us that the First Amendment principle of requiring the least restrictive means has a sympathetic chord in charitable trust law. "If the purposes for which a charitable trust is created are legal, the mere fact it would be possible to accomplish the purposes by illegal means does not make the charitable trust invalid." Restatement, Trusts 2d, sec. 377, comment d (1959). This issue 83 T.C. 381">504 was also raised in a slightly different form in the Bob Jones University case. There the Court pondered what remedy should apply where an exempt organization confers some benefit, but also violates a law.[We] need not decide whether an organization providing a public benefit and otherwise meeting the requirements of section 501(c)(3) could nevertheless be denied tax-exempt status if certain of its activities violated a law or public policy. [Bob Jones University v. United States, 461 U.S. 574">461 U.S. at 596 n. 21.]It is axiomatic that a charitable trust is invalid if it is created for an illegal purpose. Restatement, Trusts 2d, sec. 377 (1959). Thus, a trust can be voided at the request of 1984 U.S. Tax Ct. LEXIS 30">276 an interested party if trust property is used to perpetrate a crime defined by statute, or if the object of the trust is to defraud the Government, or if its purpose is to evade taxes. 4 A. Scott, Trusts 377 (3d ed. 1967); G. Bogert, Law of Trusts and Trustees, sec. 211, at 63-64, 114 (2d ed. 1979). See also Carriage Square, Inc. v. Commissioner, 69 T.C. 119">69 T.C. 119 (1977); Temple Square Mfg. Co. v. Commissioner, 36 T.C. 88">36 T.C. 88 (1961). Respondent has conceded that petitioner's stated purposes, i.e., the purposes described in petitioner's organizing documents, are religious. However, to qualify for a charitable exemption, not just the stated purposes, but the actual purposes manifested through the organization's activities must further a charitable purpose. Sec. 1.501(c)(3)-1(a), Income Tax Regs. This is a question of fact to be determined from all the circumstances. B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352">70 T.C. 352, 70 T.C. 352">357 (1978); Pulpit Resource v. Commissioner, 70 T.C. 594">70 T.C. 594, 70 T.C. 594">602, 70 T.C. 594">604 (1978); Parker v. Commissioner, 365 F.2d 792">365 F.2d 792, 365 F.2d 792">795 (8th Cir. 1966), cert. denied 385 U.S. 1026">385 U.S. 1026 (1967).When we consider all the facts spread across the voluminous record in this case, we are left with the inescapable 1984 U.S. Tax Ct. LEXIS 30">277 conclusion that one of petitioner's overriding purposes was to make money. We also conclude that criminal manipulation of the IRS to maintain its tax exemption (and the exemption of affiliated churches) was a crucial and purposeful element of petitioner's financial planning. 75 We need not repeat in detail 83 T.C. 381">505 petitioner's financial planning. 75 We need not repeat in detail our findings regarding petitioner's efforts to block the IRS from investigating, determining, and collecting taxes from petitioner and affiliated churches. The highlights of the conspiracy show its nature and scope. The conspiracy spanned 8 years beginning in 1969 and continuing at least until July 7, 1977, when the FBI, pursuant to a warrant, searched petitioner's premises for evidence of the conspiracy and related crimes. The scheme involved manufacturing and 1984 U.S. Tax Ct. LEXIS 30">278 falsifying records to present to the IRS, burglarizing IRS offices and stealing Government documents, and subverting Government processes for unlawful purposes. For example, Freedom of Information Act requests were planned for the purpose of having the IRS amass records in one central place where they would be easier to steal. At first, petitioner's FBO network masterminded the conspiracy, developing plans to conceal that OTC was a sham by falsifying and manufacturing records. Later, petitioner's Guardian Office, whose top officials served on petitioner's board of directors during the docketed years, directed the conspiracy. The Guardian Office developed plans to infiltrate the IRS and steal documents. Later it monitored the implementation of these plans.In pursuit of the conspiracy, petitioner filed false tax returns, burglarized IRS offices, stole IRS documents, and harassed, delayed, and obstructed IRS agents who tried to audit the Church's records. Petitioner gave false information to, and concealed relevant information from, the IRS about its corporate structure and relationship to OTC. In the end, Jane Kember, the Guardian Worldwide, acting just under L. Ron and Mary Sue 1984 U.S. Tax Ct. LEXIS 30">279 Hubbard in petitioner's hierarchy, was convicted of burglarizing the offices of respondent's Exempt Organizations Division on three occasions in 1976. The burglaries occurred while an extensive audit of petitioner's records was in progress. Furthermore, Mary Sue Hubbard, Duke Snider, and Henning Heldt were convicted of conspiring to obstruct justice. Their convictions in part rested on their efforts to conceal petitioner's connection to burglaries of IRS offices and83 T.C. 381">506 Petitioner's course of conduct between 1969 and 1977 constitutes a violation of 18 U.S.C. sec. 371 and convincingly shows that petitioner had a substantial illegal purpose during the docketed years. We are, therefore, faced with the question of what remedy to apply. Are we required by either the First Amendment or charitable trust principles to find that the Government's only remedy is a criminal prosecution? For a number of reasons, we think not. First, 18 U.S.C. sec. 371, which provides that it is a felony offense for two or more persons to conspire to defraud the United States or its agencies, is a venerable and major Federal criminal statute. It was first enacted as section 30 of "An Act to amend existing laws 1984 U.S. Tax Ct. LEXIS 30">280 relating to Internal Revenue and for other purposes" on March 2, 1867, 14 Stat. 471, 484, and has continued in effect almost in its present form ever since then. See United States v. Gradwell, 243 U.S. 476">243 U.S. 476, 243 U.S. 476">481 (1917). One has only to look at the numerous annotations which follow 18 U.S.C. sec. 371 in the United States Code Annotated to realize its importance in safeguarding our governmental functions. Second, petitioner's conspiratorial efforts were systemic and long lived. People in petitioner's FBO network, Guardian Office, and affiliated churches were involved. Church officials at the highest level of the hierarchy, not just ordinary Church members, participated in the conspiracy. Indeed, some high Church officials were finally convicted for their illegal activities. Three held top-ranking positions in petitioner's hierarchy during the docketed years and four others held important positions in petitioner's Guardian Offices in later years. At least four of petitioner's branch churches were affected by the conspiracy. There were plans to manufacture and falsify records at Flag and AOLA. Also officials at Flag and the Guardian Offices in the United Kingdom and United States1984 U.S. Tax Ct. LEXIS 30">281 spearheaded the conspiracy. The conspiratorial plan knew no geographic boundaries. Guardian Order 1361 called for infiltrating and stealing documents from IRS offices in London, Los Angeles, and Washington, D.C. Third, the Government's interest in ferreting out crime is not the only interest at stake here. The Government also has an interest in not subsidizing criminal activity. Were we to sustain petitioner's exemption, we would in effect be sanctioning petitioner's right to conspire to thwart the IRS at taxpayer's expense. We think such paradoxes are 83 T.C. 381">507 best left to Gilbert and Sullivan. Finally, under the statutory scheme, the denial of an exemption is not a permanent loss to petitioner. Only petitioner's 1970-72 tax years are before us. Petitioner is free to show that it qualifies for exemption in subsequent years since each tax year is a separate cause of action. Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591, 333 U.S. 591">598 (1948).Petitioner states that in 1970, 1971, and 1972 it had no warning that public policy violations could lead to a denial of its tax-exempt status. Petitioner, therefore, claims respondent cannot, consistent with due process, invoke this requirement to deny its exemption. 1984 U.S. Tax Ct. LEXIS 30">282 The public policy requirement is not strictly speaking a new provision. It is an implied condition of section 501(c)(3). However, it has only recently been read into that section, and it was not until the trial of this case was over that the requirement received Supreme Court sanction in Bob Jones University v. United States, 461 U.S. 574">461 U.S. 574, decided May 24, 1983. The application of a public policy requirement to petitioner's operations during the taxable years at issue, therefore, has retroactive effect.Holding petitioner subject to public policy standards embodied in charitable trust law does not violate petitioner's right to due process. The application of this requirement to petitioner's operations calls into play a form of limited retroaction first discussed in United States v. Schooner Peggy, 5 U.S. 103">5 U.S. (1 Cranch) 103 (1801). There it was held that if a law changes while a case involving public rights is pending, the new law must govern the case. 5 U.S. (1 Cranch) at 110. This approach has been followed not only in instances where a statutory change has intervened ( Carpenter v. Wabash Railway Co., 309 U.S. 23">309 U.S. 23 (1940)), but also where judicial decision has clarified or overruled 1984 U.S. Tax Ct. LEXIS 30">283 earlier case law. Vandenbark v. Owens-Illinois Glass Co., 311 U.S. 538">311 U.S. 538 (1941); Oklahoma Packing Co. v. Oklahoma Gas & Electric Co., 309 U.S. 4">309 U.S. 4, 309 U.S. 4">7-8 (1939). See also Linkletter v. Walker, 381 U.S. 618">381 U.S. 618, 381 U.S. 618">625-627 (1965).Petitioner's claim fails even when measured by general due process considerations in the area of retroactive law. The due 83 T.C. 381">508 process clause does not make every retroactive law unconstitutional. Usery v. Turner Elkhorn Mining Co., 428 U.S. 1">428 U.S. 1, 428 U.S. 1">16 (1976); Welch v. Henry, 5 U.S. 134">305 U.S. 134, 5 U.S. 134">146 (1938). A retroactive tax law offends the due process clause only when the nature of the tax and the circumstances in which it is laid leave little doubt that it is harsh and oppressive. 5 U.S. 134">Welch v. Henry, supra at 147; Hospital Data Center of S.C., Inc. v. United States, 225 Ct. Cl. 158">225 Ct. Cl. 158, 225 Ct. Cl. 158">163, 634 F.2d 541">634 F.2d 541, 634 F.2d 541">544 (1980). See also Hazelwood Chronic & Convalescent Hospital, Inc. v. Weinberger, 543 F.2d 703">543 F.2d 703, 543 F.2d 703">708 (9th Cir. 1976), vacated on other grounds 430 U.S. 952">430 U.S. 952 (1977).Under the circumstances, we find that the retroactive application of the public policy requirement is neither harsh nor oppressive. First, petitioner had ample notice that it was against the law to conspire to obstruct the IRS. 1984 U.S. Tax Ct. LEXIS 30">284 18 U.S.C. sec. 371 has been in effect for over 100 years. If the threat of criminal penalties was not sufficient to keep petitioner within the bounds of the law, it can hardly be supposed that petitioner would have acted differently had it known it would incur a tax liability for planning a campaign to thwart the IRS. Second, section 7805places petitioner on notice that the Commissioner has broad authority to make tax rulings retroactive. Cf. Central Illinois Public Service Co. v. United States, 435 U.S. 21">435 U.S. 21, 435 U.S. 21">33 (1978) (Justice Brennan, concurring). Third, the public record belies petitioner's assertion that it did not have warning that it must comply with public policy standards to maintain its eligibility for exemption. In Rev. Rul. 67-325, 1967-2 C.B. 113, respondent stated his view that an organization which is not "charitable in the generally accepted legal sense" does not qualify for section 501(c)(3) status. Rev. Rul. 67-325, 290 U.S. 111">supra at 117. Regulations in effect during the docketed years defining the term "charitable" state the term is "used * * * in its generally accepted legal sense." See 26 C.F.R. sec. 1.501(c)(3)-1(d)(2) (1970), (1971), and (1972). The Commissioner 1984 U.S. Tax Ct. LEXIS 30">285 of the IRS was on record in 1970 as saying that an organization seeking exemption within the meaning of section 501(c)(3) must meet the test of being "charitable" in the legal sense. Statement of Randolph W. Thrower, Commissioner of Internal Revenue, Before the Senate Select Committee on Equal Educational Opportunity, 91st Cong., 2d Sess. 1995 (1970). Rev. Rul. 71-447, 1971-2 C.B. 230, states:83 T.C. 381">509 All charitable trusts * * * are subject to the requirement that the purpose of the trust may not be illegal or contrary to public policy.This same rule was also stated in Green v. Connally, 330 F. Supp. 1150">330 F. Supp. 1150, 330 F. Supp. 1150">1159 (D. D.C.) decided on June 30, 1971, and affd. per curiam sub nom. Coit v. Green, 404 U.S. 997">404 U.S. 997 (1971). 76 Some, but not all, of these rulings were made in the context of determining whether racially discriminatory schools qualified for tax-exempt status, since they violated Federal public policy against racial discrimination. We find this of little significance, since the rule was stated broadly enough to throw into question petitioner's eligibility for exemption for violating 18 U.S.C. sec. 371. For all of the above reasons, we find that petitioner is not unduly injured by the retroactive 1984 U.S. Tax Ct. LEXIS 30">286 application of public policy standards. VII.Several of respondent's witnesses were former Scientologists. Petitioner challenges their credibility, claiming their disenchantment with the Church caused their testimony to be biased. This Court had ample opportunity to observe these witnesses. Most of them were questioned at length under cross-examination. With one exception, this Court found all of them to be credible. The exception is Lauren Gene Allard. There were significant inconsistencies in his testimony, and this Court has therefore only credited his testimony where it is corroborated by documentary evidence. The remaining ex-Scientologists were credible and markedly 1984 U.S. Tax Ct. LEXIS 30">287 free of any tendency to be vindictive. Lorna Levett, a former Scientologist who had been in charge of a Scientology mission in Canada, admitted that she was disillusioned with Scientology. However, her disillusionment did not prevent her from giving candid and straightforward answers. Petitioner, on brief, did not point to any inconsistencies in her testimony, although she was cross-examined at length. Kathryn Hirsch was reluctant to testify and had to be subpoenaed. She worked in finance 83 T.C. 381">510 positions at the Celebrity Center Church of Scientology during the docketed years and testified about instructions from her superiors regarding techniques to resist passively IRS inquiries. Her testimony was unimpeached. Scott Mayer, another former Scientologist, served as an unpaid consultant to respondent's counsel. During the course of the trial, at the request of respondent's counsel, he became a paid consultant. Mayer was in the courtroom throughout the trial, and this Court, therefore, had ample opportunity to observe him both on and off the witness stand. Some of the details of his testimony regarding a 1975 project to falsify Church financial records were impeached, but the essentials 1984 U.S. Tax Ct. LEXIS 30">288 of his story stood up under attack. On balance, this Court found Mayer to be both truthful and well informed.The most sterling witness among the many former Scientologists who testified was John McLean. Petitioner tried very hard to impeach his testimony, since he had damaging things to say. He told about orders to falsify records, direct payments to L. Ron Hubbard, the removal of money from secret Swiss bank accounts, and the Church's heavy emphasis on making money. Petitioner tried hard to impeach three collateral aspects of McLean's testimony: (1) That McLean traveled to join Flag in 1971 with a man named Foster Tompkins; (2) that Flag kept statistics on "paid completions" in May 1971; and (3) that McLean's salary was suspended for a time as punishment.The impeachment failed. McLean testified that on his journey from Los Angeles to join the Flag ship in Tangier, Morocco, he was met in New York by Foster Tompkins, who then accompanied him on his journey. Foster Tompkins testified as an impeachment witness. He said that he traveled from New York to Madrid and then on to Tangier, but not with McLean. However, a passport and travel vouchers show that both men were at the Barajas 1984 U.S. Tax Ct. LEXIS 30">289 Airport in Madrid on February 19, 1971. Furthermore, both men testified that on arrival in Madrid, they went to a Flag outpost or relay point to meet with a man named David Rapp for a briefing. The similarities in the men's stories about their course of travel, combined with the documentary evidence placing both men at the Madrid airport on the same day, convince us of the truth of the gist of McLean's testimony. We find that the two men must have traveled from New York to the Flag outpost in Madrid 83 T.C. 381">511 together, although it appears from other evidence that the men traveled separately on the very last leg of the journey from Madrid to the Apollo in Tangier. The Church also tried to impeach McLean's story that his pay was temporarily suspended as punishment because Church money in his custody was stolen from him while he was on a Church mission. However, this testimony was corroborated by a Flag Order dated June 22, 1971, and disbursement vouchers signed by him. 771984 U.S. Tax Ct. LEXIS 30">291 The Church also failed to impeach McLean's testimony about "paid completions." (A "paid completion" is a course or level that is completed and paid for.) McLean testified that in May 1971, the file room aboard the Apollo1984 U.S. Tax Ct. LEXIS 30">290 had files for the different churches including AOLA, and that the AOLA files had subdivisions for statistics on gross income and "paid completions." Petitioner tried to establish that statistics on paid completions were not kept until August 1971 when L. Ron Hubbard wrote a policy letter declaring that it was harmful for Scientology organizations to concentrate on increasing gross income at the expense of delivering quality services. The policy letter explains that L. Ron Hubbard therefore developed a new statistical goal called "paid completions accompanied by an acceptable success story." This new goal was meant to counteract the misguided tendencies of certain organizations to emphasize gross income statistics over quality services. However, it is clear from other policy letters that as early as March of 1969 Scientology organizations were instructed to report statistics on the number of grade levels that were paid for and completed. We, therefore, credit McLean's testimony and surmise that the new statistic introduced in 1971 had to do with quality paid completions and not just paid completions which were already being tabulated. Lewis Hubbard and the examining agents for the 1971-74 audit testified at length in this trial and underwent extensive cross-examination by petitioner's counsel. They each displayed a high degree of professional dedication and an absence of any prejudice towards petitioner or Scientology.83 T.C. 381">512 This Court does not credit the testimony of two Church witnesses, Fran Harris and Joel Kreiner. Harris was very evasive on cross-examination about topics that were clearly within her area of competence. She did not know what discount prices were given to staff members; whether ASHO paid money to the so-called trust; how much money ASHO sent to Flag; what percentage of the ASHO budget was devoted to operating expenses; which organizations sent staff to train at 1984 U.S. Tax Ct. LEXIS 30">292 Flag; whether staff training payments were routed through Los Angeles to Flag or went directly to Flag; how the Swiss banks notified her of their intention to charge negative interest on foreign deposits; whether one or two Swiss trust accounts were closed out in 1972; how she could be certain no one had access to the OTC and trust moneys; why the OTC cash aboard the Apollo was not deposited in the Banque du Benelux account in Luxembourg until 1975, even though the account was opened in 1973 and held other cash deposits from the Apollo; what the terms of her contract with the Sea Organization were; or why her close friend, Robin Roos, lost her position as CS-3 on the Aide's Counsel. Taking into account that Harris served as the chief financial officer at USLO, ASHO, AOLA, and then Flag, and considering that she and L. Ron Hubbard masterminded the transfer of the OTC and trust moneys from banks in Switzerland to the Apollo, we can only conclude that her evasiveness was intentional.Joel Kreiner was the Church's chief legal officer (Deputy Guardian Legal, U.S.) from the fall of 1969 to June 1974. In June, he stepped down from his position as chief legal adviser but continued to hold 1984 U.S. Tax Ct. LEXIS 30">293 a legal post in petitioner's Guardian Office. Kreiner was the Church's primary tax attorney and had custody and control of the Church's tax files. Kreiner's manner of giving testimony raised doubts about his credibility. He repeatedly revised his statements. Under respondent's examination, his memory was short and often had to be refreshed by documentary evidence. This Court was ultimately persuaded to disbelieve Kreiner by three factors. First, Kreiner prepared applications for exemption for several Scientology missions. Statements on the application form about the mission's relationship to the United Kingdom Church were misleading. The form failed to mention the mission's obligation to remit 10 percent of its corrected gross income to the 83 T.C. 381">513 United Kingdom Church and described its practice of sending financial reports to the United Kingdom Church as purely voluntary, although, in fact, it was obligatory. Second, Kreiner wrote a letter transmitting the Church audit report to the IRS which characterized the report as "a fair and accurate version" of the Church's tax position. The report is filled with falsehoods about OTC, the trust, and the United Kingdom Church. Kreiner, as 1984 U.S. Tax Ct. LEXIS 30">294 the Church's chief tax counsel during the docketed years, must have known this. Third, when Church operatives pursuant to Guardian Order 1361 were having difficulty stealing documents from IRS intelligence files, a Freedom of Information request prepared by Kreiner was made to the IRS for the purpose of amassing these documents in a central location where they would be easier of steal.Petitioner raises four evidentiary objections to the introduction of the OEC series, a nine-volume compilation of Scientology policy letters. 78 Petitioner claims (1) that the compilation is hearsay; (2) that the policy letters predating the docketed years are irrelevant; (3) that the policy letters are not comprised of statements within the meaning of Fed. R. Evid. 801(a); and (4) that volumes cannot be admitted wholesale without examination of each policy letter for nonadmissible material. None of these objections is well founded.Under the Federal Rules of Evidence, a party-admission is not hearsay. Fed. R. Evid. 801(d)(2)(B) provides:A 1984 U.S. Tax Ct. LEXIS 30">295 statement is not hearsay if -- * * * The statement is offered against a party and is * * * a statement of which he has manifested his adoption or belief in its truth.Petitioner notes the following disclaimer published in the front of each OEC volume and contends that the volumes, therefore, do not constitute a party-admission:This is part of the religious literature and works of the Founder of Scientology, L. Ron Hubbard. It is presented to the reader as part of the record of his personal research into Life, and should be construed only as a written report of such research and not as a statement of claims made by the Church or the author.83 T.C. 381">514 A statement can be adopted by conduct as well as by words. State v. Hamilton, 236 N.W.2d 325">236 N.W.2d 325, 236 N.W.2d 325">330 (Iowa 1975); 4 J. Weinstein, Evidence, par. 801(d)(2)(B)[01], at 801-144 (1981). Here, despite its written disclaimer, petitioner has clearly manifested its adoption of the policy letters in the OEC series by its conduct. Petitioner distributed policy letters to staff throughout the Church. Staff were expected to know and follow the policy letters. The policy letters made up some of the material in staff folders containing job instructions and staff 1984 U.S. Tax Ct. LEXIS 30">296 were quizzed from time to time on their content. Petitioner even offered a course, the OEC course, devoted to the study of policy letters -- each volume requiring 2 1/2 weeks of study. On balance, petitioner's actions speak louder than its words, and the OEC series must be considered the statements of a party-opponent within the meaning of Fed. R. Evid. 801(d)(2)(B).Some of the policy letters in the OEC series predate the docketed years, and petitioner claims they are, therefore, irrelevant. Evidence is remote and irrelevant only when it bears no connection to provable issues in the case. N.L.R.B. v. Ed Chandler Ford, Inc., 718 F.2d 892">718 F.2d 892, 718 F.2d 892">893 (9th Cir. 1983). Policy letters were effective until officially canceled. An editor's note in the OEC series marks when a policy letter has been canceled. Thus, all the policy letters in the OEC volumes predating the docketed years are relevant except the ones marked by an editor's note showing they were canceled. Petitioner claims that some policy letters fell into desuetude without being officially canceled. As a general proposition, this is probably true. However, according to petitioner, each Church allegedly kept a current index of 1984 U.S. Tax Ct. LEXIS 30">297 updated orders and policy letters. Petitioner never produced this index. 79 Under the circumstances we think the early policy letters in the OEC series must be deemed to be in effect during the docketed years in the absence of specific evidence to the contrary.Petitioner claims that the policy letters should not be admitted because they are so obscure that they cannot be said to be written assertions within the meaning of Fed. R. Evid. 801(a). Petitioner relies on Zenith Radio Corp. v. Matsushita 83 T.C. 381">515 ., 505 F. Supp. 1190">505 F. Supp. 1190 (E.D. Pa. 1980), which held that certain diaries kept by Japanese businessmen were not admissible because they were unintelligible. The diaries were written purely for the diarist. They were not intended for an audience. They contained mostly coded notations which would have required the services of a cryptographer to decipher. 505 F. Supp. 1190">505 F. Supp. at 1211. The Zenith court did note, however, 1984 U.S. Tax Ct. LEXIS 30">298 that a proper foundation for the diaries could have been laid had their meaning been explained. 505 F. Supp. 1190">505 F. Supp. at 1242. The policy letters at issue here are markedly different from the diaries. The policy letters were collected for publication and sold in petitioner's bookstore which was open to the general public. They were written in sentences rather than coded notations. Words or abbreviations which had idiosyncratic meaning were explained at the trial by witnesses.Petitioner's final objection to the OEC series is the admission of the volumes as a whole without separate analysis of each policy letter for inadmissible material. Petitioner again relies on the Zenith case which held that "Rule 801(d)(2) requires that each statement [in a compilation] be separately admissible." 505 F. Supp. 1190">505 F. Supp. at 1240. The Zenith court was dealing with vicarious admissions under Fed. R. Evid. 801(d)(2)(C) and (D). The policy letters are, however, adoptive admissions within the meaning of Fed. R. Evid. 801(d)(2)(B) so that different considerations are at stake. The Zenith court was concerned that the diaries contained entries which did not qualify as admissions for one of three reasons. They were 1984 U.S. Tax Ct. LEXIS 30">299 not assertions. They were not made in the scope of employment. They contained double hearsay. No such problems exist here. First, as we have already explained, the policy letters contain statements within the meaning of Fed. R. Evid. 801(a). Furthermore, since we are dealing with adoptive admissions and not vicarious admissions, we need not be concerned whether the statements were made in the course of employment. Finally, there is no double hearsay problem. California Church officials were expected to know the content of policy letters and to follow them lock, stock, and barrel. Under these circumstances all of the policy letters in the OEC series constitute adoptive admissions, including the ones containing double hearsay, 505 F. Supp. 1190">505 F. Supp. at 1243 n. 64; cf. United States v. Article of Drug, 362 F.2d 923">362 F.2d 923 (3d Cir. 1966).83 T.C. 381">516 The admissions of a party-opponent have been freed under the Federal Rules of Evidence from many of the restraints placed on other forms of evidence to guaranty their trustworthiness, and the policy respecting them is one which calls for "generous treatment" of their admissibility. Advisory Committee's Note to Rule 801, reprinted in P. Rothstein, Rules of Evidence 1984 U.S. Tax Ct. LEXIS 30">300 for the United States Courts and Magistrates 355-356 (2d ed. 1983). In keeping with this policy, we see no reason to scrutinize, individually, each policy letter in the OEC series prior to its admission.The following Flag Orders were conditionally received in evidence provided respondent demonstrated they were applicable during the docketed years: Flag Orders RS391 (Exhibit AG), 565 (Exhibit AH), 773 (Exhibit AI), 2132 (Exhibit AJ), 3152 RR (Exhibit AK), 3302 (Exhibit AL), 3385-1 (Exhibit AN), 3385-7R (Exhibit AO), 3474-2 (Exhibit AP). Flag Order 3152 RR is dated March 30, 1972, and, therefore, shows on its face that it was in effect during the docketed years. Flag Orders RS391, 565, 773, and 2132 were all issued prior to the docketed years. Respondent demonstrated that Flag Orders did not automatically expire and thus made a prima facie showing that these orders continued in effect during 1970-72. McLean's testimony corroborated the continuing vitality of one Flag Order in this group. Flag Order RS391 states that L. Ron Hubbard must approve financial planning, and McLean testified this practice continued during the docketed years. Fran Harris was the only witness to rebut respondent's 1984 U.S. Tax Ct. LEXIS 30">301 showing. Since this Court did not find her to be a credible witness, we find that Flag Orders RS391, 565, 773, and 2132 were in effect during the docketed years. Flag Orders 3302, 3385-1, 3385-7R, and 3474-2 post date the docketed years and were not in effect during 1970-72.Petitioner objects to several bits of evidence which respondent used to prove petitioner violated public policy. Petitioner objects to any evidence of conspiratorial events occurring after the docketed years on relevancy grounds; to Exhibit FG, the stipulation of evidence filed on October 26, 1979, in United States v. Hubbard, Crim. No. 78 401 (D. D.C. 1979), affd. per curiam sub nom. United States v. Heldt, 668 F.2d 1238">668 F.2d 1238 (D.C. Cir. 1981), cert. denied 456 U.S. 926">456 U.S. 926 (1982), on hearsay grounds; to Exhibit FU, the typewriter case documents, on 83 T.C. 381">517 Fourth Amendment grounds; and to Exhibit FX, a Guardian Order, on Fourth Amendment grounds. We consider each of these objections in turn.Many of the events making up the conspiracy to prevent the IRS from assessing and collecting taxes from Scientology churches occurred after the taxable years at issue in this case. To recapitulate, the most significant of these activities 1984 U.S. Tax Ct. LEXIS 30">302 were the execution of petitioner's 1972 return, the burglaries of the IRS, the coverup of the burglaries, the falsification of petitioner's records on board the Apollo, and the misrepresentations made to the IRS auditors during the 1971-74 audit. Petitioner claims that evidence of these and similar conspiratorial events occurring after 1972 is irrelevant.We recognize that each tax year is a separate cause of action. However, this rule does not force us to blind ourselves to events occurring outside the docketed years which have a direct bearing on the taxable years at hand. Fed. R. Evid. 404(b)authorizes the use of evidence of other crimes, wrongs, or acts to prove "motive, opportunity, intent, preparation, plan, knowledge, identity, or absence of mistake or accident." Pursuant to this rule, a trial court has broad discretion to admit evidence of subsequent similar acts and crimes provided it is probative of one of these purposes and is not used merely to show criminal disposition. United States v. Arroyo-Angulo, 580 F.2d 1137">580 F.2d 1137, 580 F.2d 1137">1149 (2d Cir.), cert. denied 439 U.S. 913">439 U.S. 913 (1978); United States v. Cavallaro, 553 F.2d 300">553 F.2d 300, 553 F.2d 300">305 (2d Cir. 1977). See also United States v. King, 587 F.2d 956">587 F.2d 956, 587 F.2d 956">962 (9th Cir. 1978); 1984 U.S. Tax Ct. LEXIS 30">303 United States v. McDonald, 576 F.2d 1350">576 F.2d 1350 (9th Cir. 1978). The burglaries, the thefts, the coverup, the falsification of records, all represent actions taken on petitioner's part to alter the facts and influence the issues presented in this very case. They are probative of petitioner's intent and plan to prevent the IRS from inquiring into the tax status of Scientology churches. Petitioner has insisted that it is innocent of any wrongdoing prior to and during the docketed years. For example, on brief, petitioner attempts to characterize a 1969 FBO network plan to disguise payments to OTC as an honest effort to record Flag expenses in a more organized fashion. Also, on brief, petitioner claims that Exhibit FX, a 1972 Guardian plan to counter IRS investigations of Scientology churches, does not contemplate illegal activity. The subsequent conspiratorial acts are, therefore, 83 T.C. 381">518 highly probative of petitioner's criminal intent. They also show the magnitude of petitioner's plan. In sum, December 31, 1972, is not a magic cutoff date for evidence that so clearly elucidates petitioner's role in a conspiracy that was rooted in the docketed years but continued to grow and flourish for a 1984 U.S. Tax Ct. LEXIS 30">304 long time afterwards. Cf. 587 F.2d 956">United States v. King, supra at 962; United States v. Testa, 548 F.2d 847">548 F.2d 847, 548 F.2d 847">852 (9th Cir. 1977). This is especially so where a primary purpose of the subsequent acts was to influence the very matters before us.Exhibit FG is a stipulation of evidence entered on October 26, 1979, in United States v. Hubbard, Crim. No. 78-401 (D. D.C. 1979). On the basis of this stipulation, several of petitioner's officials were convicted of conspiracy to obstruct justice in violation of 18 U.S.C. sec. 371. Petitioner claims that this Court cannot rely on Exhibit FG because it is hearsay. We agree that the stipulation is hearsay and that it cannot be used by itself for substantive purposes. However, petitioner misconceives what is being done here. The stipulation is not being used as substantive evidence. It has merged into the convictions of Mary Sue Hubbard, Henning Heldt, and others. Their judgments of conviction were received in evidence and we are here relying on the stipulation to determine the facts underlying the convictions.Fed. R. Evid. 803 (22)allows evidence of a judgment of a felony conviction "to prove any fact essential to sustain the judgment." It is 1984 U.S. Tax Ct. LEXIS 30">305 the duty of the trial judge in the subsequent case to determine just which facts were essential to the previous conviction. The Supreme Court in Emich Motors Corp. v. General Motors Corp., 340 U.S. 558">340 U.S. 558 (1951), discussed the difficulties of the problem and the trial judge's task:The difficult problem, of course, is to determine what matters were adjudicated in the antecedent suit. A general verdict of the jury or judgment of the court without special findings does not indicate which of the means charged in the indictment were found to have been used in effectuating the conspiracy. And since all of the acts charged need not be proved for conviction * * such a verdict does not establish that defendants used all of the means charged or any particular one. Under these circumstances what was decided by the criminal judgment must be determined by the trial judge * * * upon an examination of the record, including the pleadings, the 83 T.C. 381">519 evidence submitted, the instructions under which the jury arrived at its verdict, and any opinions of the courts. [340 U.S. 558">340 U.S. at 569. 801984 U.S. Tax Ct. LEXIS 30">306 Citations omitted.]See also United States v. Podell, 572 F.2d 31">572 F.2d 31, 572 F.2d 31">36 (2d Cir. 1978).Ordinarily, the evidentiary utility of a finding of guilt on a general count of conspiracy is limited to the essentials of the conspiracy, due to the difficulty in determining what substantive violations occurred. See 340 U.S. 558">Emich Motors Corp. v. General Motors Corp., supra at 569-571; see also United States v. Guzzone, 273 F.2d 121">273 F.2d 121, 273 F.2d 121">122-123 (2d Cir. 1959); United States v. Kates, 419 F. Supp. 846">419 F. Supp. 846, 419 F. Supp. 846">852-853 (E.D. Pa. 1976). In the instant case, however, we do not have to operate in a vacuum. Petitioner's officials were convicted on the basis of a detailed uncontested stipulation of evidence. We can, therefore, determine with precision what the unlawful objects of the conspiracy were and what means were taken to effect its purposes.Under the circumstances, we can safely conclude that the criminal court which handed down the convictions must have found facts in complete accordance with the stipulation 1984 U.S. Tax Ct. LEXIS 30">307 of evidence. This follows from its duty to consider rationally the evidence. Jackson v. Virginia, 443 U.S. 307">443 U.S. 307 (1979). The only evidence presented was an uncontested, written stipulation supported by documents. There were no witnesses. Thus, since credibility was not an issue, and since the stipulation was devoid of internal inconsistency and not contrary to the laws of nature, the criminal court had no principled basis for accepting only part of the stipulation and rejecting other parts. As a rational trier-of-fact, it had to adopt the stipulation in its entirety. We, therefore, are entitled to rely on the stipulation not as a discrete piece of substantive evidence but as a comprehensive statement of the facts clothing the convictions.Exhibit FU consists of Guardian Order 1361 and a number of reports discussing compliance with the order. The documents were brought to the IRS in Los Angeles in an unmarked typewriter case by an attorney in private practice named "Jones." They were received by Agent McKellar. Petitioner claims that respondent should have obtained a warrant before 83 T.C. 381">520 opening the typewriter case, since attorney Jones told McKellar that he had read the documents 1984 U.S. Tax Ct. LEXIS 30">308 and they appeared to relate to burglaries of IRS offices for the purpose of reviewing IRS records concerning the Church of Scientology. Petitioner lacks standing to pursue this Fourth Amendment claim. The typewriter case was found abandoned in a Sears parking lot sometime in July 1977 by a client of attorney Jones. The client saw an unidentified man leave the case containing the documents in the parking lot and, after a short while, when the person did not return to retrieve the case, the client took it and later gave it to attorney Jones. The typewriter case had no markings on it identifying it as belonging to the California Church and it appears from the record that it was not even locked. Under these facts, petitioner's objections to Exhibit FU lack merit. Abandoned property is not protected by the Fourth Amendment. Abel v. United States, 362 U.S. 217">362 U.S. 217 (1960). Furthermore, a person who voluntarily abandons property lacks standing to complain of its search and seizure. United States v. Kendall, 655 F.2d 199">655 F.2d 199 (9th Cir. 1981), cert. denied 455 U.S. 941">455 U.S. 941 (1982); United States v. Cella, 568 F.2d 1266">568 F.2d 1266 (9th Cir. 1977); United States v. Jackson, 544 F.2d 407">544 F.2d 407 (9th Cir. 1976).Exhibit 1984 U.S. Tax Ct. LEXIS 30">309 FX is a 19-page document dated April 5, 1972, written in the format of a Guardian Order. FBI agents seized the document from a file cabinet in petitioner's Guardian Office during a search of petitioner's offices on July 8, 1977. The FBI agents had a warrant for the search. We agree with petitioner that Exhibit FX falls outside the scope of the warrant. The search warrant enumerated 162 items to be seized. In most instances, each item described a specific document. However, item 162 was a catchall calling for the seizure of "Any and all * * * evidence * * * of the crimes of conspiracy * * * which facts recited in the accompanying affidavit make out." The reference to the "accompanying affidavit" is the affidavit of FBI Special Agent Robert Tittle. His affidavit describes, among other crimes, a conspiracy to steal documents from the IRS, but the conspiracy is limited to the years 1974 through 1976. Exhibit FX describes a plan to infiltrate the IRS and so is logically related to the conspiracy described in the Tittle affidavit. However, Exhibit FX is dated April 5, 1972, and thus predates the conspiracy described in the Tittle affidavit. We conclude that the FBI agents who 83 T.C. 381">521 1984 U.S. Tax Ct. LEXIS 30">310 seized FX acted in excess of their authority under the warrant. Marron v. United States, 5 U.S. 192">275 U.S. 192, 5 U.S. 192">196 (1927); United States v. Heldt, 668 F.2d 1238">668 F.2d 1238, 668 F.2d 1238">1256-1257 (D.C. Cir. 1981) (per curiam), cert. denied sub nom. Hubbard v. United States, 456 U.S. 926">456 U.S. 926 (1982).This does not end the matter. In a few carefully defined circumstances, searches without a warrant do not offend the Fourth Amendment. Coolidge v. New Hampshire, 403 U.S. 443">403 U.S. 443, 403 U.S. 443">455 (1971) (Justice Stewart, plurality opinion). A warrantless search is justified in exigent circumstances where evidence will most likely be destroyed in the time it takes to obtain a warrant. Vale v. Louisiana, 399 U.S. 30">399 U.S. 30, 399 U.S. 30">35 (1970). Another exception to the warrant requirement is the "plain view" exception. Under this exception, police, armed with a warrant to search a given area for specified objects, may seize an unlisted, incriminating object which inadvertently falls into plain view. 403 U.S. 443">Coolidge v. New Hampshire, supra at 465. These are the two most likely exceptions justifying the seizure of Exhibit FX. There are others, but we do not consider any of them, for however wellfounded one of these grounds may be, they are of no avail here because 1984 U.S. Tax Ct. LEXIS 30">311 of respondent's failure of proof. The rule is well settled that, when evidence is presented showing that an item was seized that was not listed in the warrant, the burden is on the proponent of the evidence to prove that the seizure of the item was justified under one of the exceptions to the warrant requirement. 399 U.S. 30">Vale v. Louisiana, supra at 34; United States v. Jeffers, 342 U.S. 48">342 U.S. 48, 342 U.S. 48">51 (1951); McDonald v. United States, 335 U.S. 451">335 U.S. 451, 335 U.S. 451">456 (1948). The seizing officer did not testify so we have no way of knowing if Exhibit FX was in plain view; nor was there convincing evidence put before us to support a finding under the requirements of 399 U.S. 30">Vale v. Louisiana, supra, that the document stood in imminent danger of destruction. We, therefore, conclude that Exhibit FX was seized in violation of the Fourth Amendment.In Suarez v. Commissioner, 58 T.C. 792">58 T.C. 792 (1972), we held "that as a matter of law, the protective rule of the fourth amendment which excludes evidence illegally obtained is applicable in a civil tax case." 58 T.C. 792">58 T.C. 806. In that case, we applied the rule to exclude records unlawfully seized by the Miami police in a raid on an abortion clinic. Our holding was partially overruled 1984 U.S. Tax Ct. LEXIS 30">312 in United States v. Janis, 428 U.S. 433">428 U.S. 433 (1976), which 83 T.C. 381">522 held that the exclusionary rule did not prevent one sovereign from using in a civil proceeding evidence illegally seized by another sovereign's law enforcement officers. 428 U.S. 433">428 U.S. at 459-460. What has become clear since our holding in Suarez is that the exclusionary rule is not a constitutional right but a judicially created remedy designed to deter unreasonable invasions of privacy by governmental officials. United States v. Leon, 468 U.S. (1984); United States v. Calandra, 414 U.S. 338">414 U.S. 338, 414 U.S. 338">348 (1974). The rule is thus properly invoked only where its deterrent effect is likely to outweigh the societal cost of proscribing relevant evidence. Immigration and Naturalization Service v. Lopez-Mendoza, 468 U.S. (1984); 428 U.S. 433">United States v. Janis, supra at 453-454. As a general proposition, the exclusionary rule is most efficacious where it is used to exclude evidence from a proceeding in the seizing officer's zone of primary interest. 428 U.S. 433">United States v. Janis, supra at 458. However, even in such a case, the application of the rule is not automatic. The societal cost of invoking the rule may be too great a price to pay (see Immigration and Naturalization Service v. Lopez-Mendoza, supra), 1984 U.S. Tax Ct. LEXIS 30">313 or under the particular facts of the case, the application of the rule might be of little deterrent value. See United States v. Leon, supra.The FBI was solely responsible for the seizure of Exhibit FX. The IRS had nothing to do with it. FBI agents seized the document during an authorized search of petitioner's premises on July 8, 1977. The search was made pursuant to a warrant for the purpose of gathering evidence about seven criminal conspiracies involving Scientology officials. Exhibit FX was one of some 23,000 documents seized. The rather complex history of these documents following their seizure is set out in United States v. Hubbard, 650 F.2d 293">650 F.2d 293 (D.C. Cir. 1980). For our purposes, it suffices to say the documents were initially used in connection with criminal proceedings against 11 officials of the Church of Scientology and were kept under seal first by the California District Court and then by the District Court for the District of Columbia. Our record does not disclose when respondent first came into physical possession of Exhibit FX. However, it is clear that respondent's counsel first examined a copy of the document in Washington sometime in May 1980 during a period 1984 U.S. Tax Ct. LEXIS 30">314 when the seal on the Church's records was improperly lifted by the District Court for the 83 T.C. 381">523 District of Columbia, and the document was thus available to the general public for inspection. 81 Sometime thereafter, Exhibit FX was forwarded to respondent's counsel in Los Angeles. Under these facts, the attenuation between the FBI's initial seizure of Exhibit FX and its subsequent use by the IRS in this proceeding is so great that we perceive no meaningful deterrent effect to be achieved by excluding the document from evidence. On the other hand, Exhibit FX is a highly relevant document. It shows that during the docketed years petitioner was developing plans to prevent the IRS from investigating Scientology churches. It is, therefore, a significant building block in respondent's public policy case against petitioner. We, therefore, hold 1984 U.S. Tax Ct. LEXIS 30">315 that the exclusionary rule does not preclude the receipt of Exhibit FX into evidence.VIII.For the reasons we have stated, in part IV of this opinion, we agree with respondent's determinations in the notice of deficiency, except his inclusion in petitioner's income of payments of $ 76,497.24 in 1970 and $ 161,018.38 in 1972 from the United Kingdom Church. In light of our finding that the United Kingdom Church is a branch of petitioner, these payments represent an internal transfer of funds. They, therefore, are not properly included in petitioner's income. Respondent concedes this point.On brief respondent, for the first time, asks us to offset this downward adjustment to the deficiency notice with income from the United Kingdom Church. We decline to do so. In its preliminary ruling and its final ruling, this Court said it would entertain evidence concerning the United Kingdom Church's activities under one of three theories of relevance: to prove the Church operated commercially, to prove it benefited private interests, or to prove it violated public policy. During the trial, respondent repeatedly disavowed any intent to increase the notice of deficiency by reason of the United 1984 U.S. Tax Ct. LEXIS 30">316 Kingdom Church's 83 T.C. 381">524 activities. He made this disavowal knowing that, if he proved his claim that the United Kingdom Church was a branch of petitioner, the notice of deficiency would be in error and a Rule 155 hearing would be required to recompute the deficiency. Nevertheless, during the course of the trial, respondent repeatedly disavowed any intent to increase the notice of deficiency by reason of the United Kingdom Church's income. Now, for the first time on brief, respondent seeks to shore up the faulty notice of deficiency with income from the United Kingdom Church's accounts.We need not delve into the thorny question whether increasing and shoring up the notice of deficiency are legal equivalents. There may well be circumstances where the distinction is meritorious. However, here we must treat respondent's disavowal of intent to increase the notice of deficiency as inclusive of his intent not to shore up the notice of deficiency with income from the United Kingdom Church's accounts. We interpret respondent's disavowal expansively since he made it with full realization that his claim that the United Kingdom Church was a branch of petitioner would cause the notice of deficiency 1984 U.S. Tax Ct. LEXIS 30">317 to be in error and would necessitate a Rule 155 hearing. Respondent now seeks to get out from under this requirement. Respondent's concession in open court not to seek an increase in the notice of deficiency was the equivalent of a stipulation. Massachusetts Ave. Heights Citizens Assoc. v. Embassy Corp., 433 F.2d 513">433 F.2d 513, 433 F.2d 513">515 (D.C. Cir. 1970) (per curiam). Respondent is bound by his stipulations. Kampel v. Commissioner, 634 F.2d 708">634 F.2d 708, 634 F.2d 708">710 n. 3 (2d Cir. 1980); United States v. 237,500 Acres of Land, 236 F. Supp. 44">236 F. Supp. 44, 236 F. Supp. 44">46 (S.D. Cal. 1964), affd. sub nom. United States v. American Pumice Co., 404 F.2d 336">404 F.2d 336 (9th Cir. 1968).Respondent also asks this Court to shore up the notice of deficiency with OTC's income. This is a new theory advanced for the first time on brief. Respondent is well aware of the lateness of this theory but nevertheless urges this Court to adopt it under the authority of Wilkes-Barre Carriage Co. v. Commissioner, 39 T.C. 839">39 T.C. 839 (1963), affd. per curiam 332 F.2d 421">332 F.2d 421 (2d Cir. 1964), which held that "a deficiency may be approved on the basis of reasons other than those relied upon by the Commissioner." 39 T.C. 839">39 T.C. 845.83 T.C. 381">525 It is too late in the day for respondent to raise this 1984 U.S. Tax Ct. LEXIS 30">318 issue. Respondent knew well before trial that OTC was a sham corporation but did nothing to adjust the notice of deficiency to include this source of unreported income. 821984 U.S. Tax Ct. LEXIS 30">319 While OTC was clearly a sham and had substantial reserves in its bank accounts, petitioner has had no opportunity to prove that these reserves were not income. Petitioner cannot be expected to shoulder its burden if it does not know under which Code provision the Commissioner has proceeded and "if it does not know which transactions or group of transactions the Commissioner has determined to have resulted in distortions of true net income." Commissioner v. Chelsea Products, 197 F.2d 620">197 F.2d 620, 197 F.2d 620">624 (3d Cir. 1952).The case of 39 T.C. 839">Wilkes-Barre Carriage Co. v. Commissioner, supra, on which respondent relies, is inapposite. In that case, unlike the case at bar, the taxpayer was aware at the outset which particular transactions were disputed by the Commissioner. The rule laid down simply allowed the Commissioner to put forward a new legal theory in support of deficiencies arising from well-defined transactions. In other words, the very same source of income was supported under a different theory. Here, however, respondent attempts to support his determination not only with a new legal theory but also from an entirely different source of income. Respondent is too late. See Brook v. Commissioner, 360 F.2d 1011">360 F.2d 1011, 360 F.2d 1011">1013 (2d Cir. 1966). 831984 U.S. Tax Ct. LEXIS 30">320 Respondent determined an addition to tax under section 6651(a) for failure to file a corporate income tax return (Form 1120). Section 6651(a)provides a mandatory 5 percent per month addition on the amount of tax owed not to exceed 25 percent for failure to file a required return unless it is shown that the failure to file "is due to reasonable cause and not 83 T.C. 381">526 * * willful neglect." The burden of proof is on the taxpayer to show reasonable cause for failing to file a required return. Funk v. Commissioner, 687 F.2d 264">687 F.2d 264 (8th Cir. 1982). Generally, the taxpayer must file his return on the proper form to satisfy this filing requirement. Parker v. Commissioner, 365 F.2d 792">365 F.2d 792, 365 F.2d 792">800 (8th Cir. 1966), cert. denied 385 U.S. 1026">385 U.S. 1026 (1967); Olean Times Publishing Co. v. Commissioner, 42 B.T.A. 1277">42 B.T.A. 1277, 42 B.T.A. 1277">1279 (1940).On July 18, 1967, respondent revoked petitioner's tax exemption and instructed petitioner it was thereafter required to file a Federal income tax return, in petitioner's case, Form 1120. Petitioner ignored this instruction and continued to file its returns on Forms 990 "Return of Organization Exempt From Income Tax." Petitioner claims that it was justified 1984 U.S. Tax Ct. LEXIS 30">321 in continuing to file its returns on Forms 990, since the revocation of exemption was null and void. We hold in part II of this opinion that the revocation was valid and effective. Petitioner's unilateral doubts about its effectiveness are not "reasonable cause" for its failure to file a proper return.Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as amended and in effect during the taxable years in issue.↩2. As FOLO evolved and developed, it went through several name changes. At its inception it was called Operation Transport Liaison Office (OTL). It then became variously referred to as the Continental Liaison Office (CLO) and the United States Liaison Office (USLO). Finally, it was designated Flag Operation Liaison Office, Western United States (FOLO WUS or FOLO).↩3. The petition in this case was filed Mar. 28, 1978. Final supplemental briefs on the public policy issue in this case were filed on Aug. 4, 1983 (petitioner), and Aug. 22, 1983 (respondent), after the decision in Bob Jones University v. United States, 461 U.S. 574">461 U.S. 574↩, was handed down on May 24, 1983.4. The text of the letter listed several branch churches but omitted mention of the United Kingdom Church. In fine print, the stationery referred to petitioner as "a non-profit corporation in U.S.A. registered in England."5. The stipulation is carefully worded and does not explicitly state that the list is a list of petitioner's divisions, but the impression created is that it is a list of the Church's divisions.↩6. Petitioner claimed that missions were actually chartered by the United Kingdom Church and not the California Church. For several reasons we find that the California Church chartered the missions. First, the Charter Agreement form recites that the California Church is the chartering authority, and Clive Whittaker, the Franchise Communicator for the United States, testified that this form was faithfully adhered to during the docketed years. Second, the Calgary Scientology Mission was chartered by the California Church. Third, the Church's report of the 1971-74 audit states that the California Church had the authority to charter missions. The only evidence to the contrary is the unsupported statements of Church witnesses.↩7. Throughout this opinion, we have cited specific policy letters by the abbreviation "HCO PL," followed by the letter's date, and where applicable, the volume and page number in the OEC series so that a typical cite reads as follows: HCO PL June 15, 1984, 3 OEC 164.↩8. Whether Scientology served a religious purpose was an issue that was never reached in the Founding Church case. Founding Church of Scientology v. United States, Ct. Cl. Com. Rept. (Aug. 7, 1968), 7 Stand. Fed. Tax Rep. (CCH) par. 7927 (1968), modified 188 Ct. Cl. 490">188 Ct. Cl. 490, 412 F.2d 1197">412 F.2d 1197 (1969), cert. denied 397 U.S. 1009">397 U.S. 1009↩ (1970).9. These included a summons enforcement action against petitioner for the taxable years 1968 and 1969 on appeal to the Ninth Circuit; reconsideration of the revocation of exemption of the Florida Church issued on Nov. 7, 1969; negotiations to settle a refund case involving the Hawaii Church; consideration of the eligibility of Scientology ministers for exemption from the self-employment tax; and review of pending applications of numerous Churches of Scientology for recognition as tax-exempt organizations. Between 1967 and 1974, respondent had delayed action or changed positions on some of these issues.↩10. The procedural understandings that were reached at the conference on Feb. 14, 1975, were not reduced to writing. Petitioner's lawyer wrote a letter dated Feb. 26, 1976, purportedly memorializing the agreements reached at the conference. This letter is a one-sided reflection of the understandings that were reached.↩11. The record mentions a fourth agent, Melvin Young, but does not disclose if he worked full time.↩12. The technical advice procedure is described in Rev. Proc. 73-8, 1973-1 C.B. 754, modified by Rev. Proc. 78-14, 1978-2 C.B. 486. "Technical advice" is a term of art meaning "guidance as to the interpretation and proper application of internal revenue laws * * furnished by the National Office upon request of a district office in connection with the examination of a taxpayer's return * * * as a means of assisting Service personnel in closing cases." Rev. Proc. 73-8, supra↩. The District Office writes a statement of facts and issues for submission to the National Office. However, before it is sent to the National Office, it is given to the taxpayer for his concurrence. If the taxpayer does not agree with the statement of facts and issues, he drafts his own, and both statements are submitted to the National Office. If after review of the statements, the National Office proposes advice adverse to the taxpayer, the taxpayer is entitled to a conference. Following the conference, the National Office issues a technical advice memorandum addressed to the District Office giving the conclusions of the National Office and instructing the District Office on how to process the case.13. When Agent Endo accepted the factual content of the footnotes at face value, he had no independent knowledge to judge the Church's representations.↩14. The transmittal memorandum presented four issues for consideration by the National Office: (1) Whether petitioner was a religious organization; (2) whether petitioner was organized and operated for religious purposes; (3) whether petitioner had a substantial commercial purpose; and (4) whether petitioner's net earnings inured to the benefit of private individuals.↩15. These admissions form an attachment to a letter dated Oct. 3, 1980, from respondent to petitioner, a copy of which was sent to the Court. The letter and the attachments have been marked as Court's "Exhibit 6."↩16. Almost all of the materials that the SSS collected on Scientology, which have been made a part of this record, are tax related. Only two sentences in one report on the Hawaii Church arguably refer to non-tax matters, making reference to complaints from neighbors about the use of "pot" and LSD at the Church.17. Some other files on militants were also destroyed, but there is no evidence they contained material about Scientology or petitioner.18. Before the trial of this case began, as we have noted, respondent pressed several different grounds in support of his contention that petitioner should be denied tax-exempt status for public policy violations. One such ground was that petitioner used the E-meter to conduct security checks on employees in violation of California State law. This Court ruled that it would not accept evidence on this ground if petitioner established that the E-meter was a religious artifact. Petitioner's witnesses testified that the E-meter was a religious aid, and respondent afterwards abandoned this claim.19. HCOPL Sept. 27, 1970 (Issue I), 3 OEC 89, describes petitioner's policy against free services and price cutting. It states:Price cuts are forbidden under any guise.1. PROCESSING MAY NEVER BE GIVEN AWAY BY AN ORG.Processing is too expensive to deliver.* * * 9. ONLY FULLY CONTRACTED STAFF IS AWARDED FREE SERVICE, AND THIS IS DONE BY INVOICE AND LEGAL NOTE WHICH BECOMES DUE AND PAYABLE IF THE CONTRACT IS BROKEN. * ↩20. Historically, the price of a 25-hour intensive was fixed at an amount equal to 3 months of pay for the average middle class worker in the district of the Scientology church providing the service.↩21. Petitioner's policy against reducing established prices is set forth in HCO PL Apr. 27, 1965, 3 OEC 91, 92, which states:Therefore we can draw up some policies on prices.1. The advertised and reported price of anything sold by an org must be the actual price received by the org for that item.2. There may be no hidden discounts, trick reductions, whims or favours given in pricing.3. Merchandising by advertising that prices are going up soon is forbidden.4. Anyone covertly reducing prices is guilty of suppressing an org which is a high crime.5. Any price passed upon at Saint Hill by myself may not be changed for anything by anyone else in an org.And finally:6. Efforts to reduce prices below a set scale will be considered suppressive acts.This policy was reaffirmed in HCO PL Sept. 27, 1970 (Issue I), 3 OEC 89.↩22. "Dianetics" and "Scientology" are the registered trademarks of L. Ron Hubbard.↩23. Book prices fluctuated during the course of the docketed years, so that these amounts may have varied.↩24. This objective was expressed by L. Ron Hubbard in HCO PL May 1, 1971, 6 OEC 294, as follows: "MOTIF: THE ROLE OF A MISSION: RAW PUBLIC, GET THEM IN AND UP THE LINE TO ORGS."↩25. For purposes of this case, a conversion ratio of $ 2.4 per pound has been used.↩26. The LRH Comm. Statistic Revised income was money that went to L. Ron Hubbard personally as debt repayment.↩27. For purposes of this case, we used a conversion ratio of 0.2652 dollars per Swiss franc which is the rate quoted for Dec. 29, 1972, in 46 Bank and Quotation Record (January 1973, N.Y.).↩28. These balances are taken from petitioner's exhibit. We note that the yearend balance for 1971 is mathematically incorrect and should be $ 2,042,832.04. OTC's cash reserves may have even been larger than the amounts shown in these accounts. Petitioner contends that OTC had $ 1,986,409.50 in cash on board the Apollo↩ on Dec. 31, 1972. There is some confusion in the record whether this amount is in addition to the listed bank accounts. Consequently, we were unable to ascertain the actual amount of cash reserves held by OTC.29. According to petitioner's own records, L. Ron Hubbard received or was expected to receive a salary from Worldwide of 10,000 pounds per year, while Mary Sue Hubbard was to receive from Worldwide an annual salary of 6,340 pounds. However, petitioner now asserts that L. Ron Hubbard and Mary Sue Hubbard were not actually paid these full amounts during the tax years in question. Without endorsing the accuracy of these amounts, we shall use them for purposes of our discussion.↩30. This scheme draws on L. Ron Hubbard's advice for handling tax matters set forth in a policy letter dated June 25, 1967. L. Ron Hubbard stated --"Now as to TAX, why this is mainly anybody's game of what is a PROFIT. The thing to do is to assign a significance to the figures before the government can. The whole thing is a mess only because arithmetic figures are symbols open to ANY significance. So I normally think of a better significance than the government can. I always put enough errors on a return to satisfy their bloodsucking appetite and STILL come out zero. The game of accounting is just a game of assigning significances to figures. The man with the most imagination wins. BUT there must be correct figures and there must not be gross misassignment of debts as profits or the whole thing won't hang together."Income tax is a suppressive effort to crush individuals and businesses and deprive the state of national gross product (since none can expand). The thing which baffles any suppressive is truth. It's the only thing that works. Significances one assigns figures are neither true nor false but always must be reasonable and defendable. And the figures themselves must always check out."Income does not mean profit. One can and should make all the INCOME one possibly can. Always. The only crime really is to be broke. But when one makes INCOME be sure it is accounted for as to its source and↩ that one covers it with expenses and debts. Handling taxation is as simple as that."31. This cover story underwent modification so that by the time of the 1971-74 audit, petitioner was claiming that OTC, as petitioner's banking agent, was making expenditures on behalf of petitioner↩.32. The mock statement was addressed to OTC and had a blank space for indicating the name of the Advanced Organization which prepared the billing. The mock statement provided four examples of expenditures paid by the Advanced Organization on behalf of OTC: (1) A payment for marine fuel for the Apollo; (2) a payment to an OTC employee for expenses while on field assignment; (3) an airfare payment, and (4) a payment to the captain of the Neptune↩ to cover ship's expenses.33. Those present were: Kima Jason, Assistant to the Deputy Commodore; Jane Kember, Guardian Worldwide; and Scott Mayer, a low-level Scientology official and later a Government witness.↩34. Initially, the audit covered just the 1968 tax return. In March 1972, petitioner's 1969 tax return was added. Office policy required audits to cover all back tax years until the taxpayer was brought up to date.↩35. Petitioner maintained that the purpose of the IRS audit of its 1968 and 1969 tax returns was harassment, and justified its refusal to cooperate on this ground. Our findings on this issue are contained 374 U.S. 398">supra↩ at 403 -- 413.36. In 1973, James Mulligan's title was changed to "Commodore Staff Guardian Communicator, U.S."37. The Intelligence Division of the Guardian Office was also referred to as "B-4" or "Bureau 4."↩38. The Guardian Office trained personnel to filch documents critical of Scientology from other organizations.↩39. Three other Scientology officials were convicted at the same time. One of these officials was not convicted of a crime related to the conspiracy of obstructing the IRS. We were unable to tell which churches employed the remaining two Scientologists.↩40. In n. 108 of the Church audit report, petitioner represented that OTC put its own moneys into OTC accounts used by petitioner. IRS Agent Eugene Endo initialed n. 108. His initials signified his agreement with the facts in the footnote but not their interpretation. The factual portion of n. 108 states that Church-prepared summaries of OTC accounts "show that in 1971 OTC deposited $ 2,295,164 into these accounts out of total deposits of $ 3,957,813 or 58%. In 1972, OTC deposited 38%, in 1973, 64%, and in 1974, 64%." The Church audit report contained many false representations and material omissions. Respondent did not ratify or adopt Agent Endo's admission.↩41. Joyce Popham was a signatory on major OTC accounts. She served on the OTC board of directors but was also a Flag employee and apparently never wrote a check on the OTC accounts.42. The documents which comprise Exhibit FU are sometimes referred to as "the typewriter-case documents," since they were brought to the IRS in a typewriter case.43. All of the documents in Exhibit HG belong in this category. The following pages of Exhibit DU also contain documents in this category: pp. 1-121, 129-132, 132A-132B, 133-148, 150-201, 225-241.↩44. The following pages of Exhibit DU contain documents in this category: pp. 210-216, 221-223, 247-249.↩45. The following pages of Exhibit DU contain documents in this category: 122-128, 149, 202-209, 217-220, 224, 242-246.↩46. The Court takes judicial notice of the fact that all indexed references to "no change" cases or reports in the Internal Revenue Manual refer to the closing of cases on the basis of no tax liability.↩47. Petitioner placed in evidence the "Foley memorandum" referring to the tentative revocation of petitioner's exempt status. The memorandum was not written by an IRS employee, and petitioner, itself, questioned the trustworthiness of the information in this memorandum.↩48. All references to Rules shall refer to the Tax Court Rules of Practice and Procedure.↩49. Petitioner first raised this argument in a pretrial Motion to Render the Notice of Deficiency Nugatory and for Other Relief. The motion was denied after a hearing. However, the Court allowed petitioner to present evidence on this issue during trial and to reargue it on brief.↩50. Petitioner's allegation that it had no opportunity to contest the revocation is not borne out.↩51. Petitioner avoids defining "religious income" but concedes it is not income gained from nonreligious activities, income gained from religion and put to nonreligious uses, income taxed to defray Government services, or income earned by ministers and church employees.↩52. The tension between these lines of cases was present in Federal Communications Commission v. League of Women Voters of California, 468 U.S. (1984). There, the Supreme Court examined sec. 399 of the Public Broadcasting Act of 1967 and found that the provision did more than merely prohibit Government funding of editorial broadcasts by noncommercial television stations; it even barred them from using private funds to finance editorial activity. 468 U.S. at - . Applying a slightly more exacting standard of review than it ordinarily does in broadcasting cases (468 U.S. at - ), the Supreme Court held that the statute was an unconstitutional interference with First Amendment↩ activities.53. We note that petitioner has made no attempt to provide a careful definition of the claim to exemption it asks us to carve out and protect. As a general rule, the more complicated the basis of classification for exemption, the greater the danger of involving the Government in entangling inquiries. Gillette v. United States, 401 U.S. 437">401 U.S. 437, 401 U.S. 437">456-457 (1971); Walz v. Tax Commission, 397 U.S. 664">397 U.S. 664, 397 U.S. 664">698-699↩ (1970) (Justice Harlan, concurring).54. Respondent did not challenge the sincerity or the religiosity of this belief, and we, therefore, accept it as a sincerely held tenet of Scientology. United States v. Lee, 455 U.S. 252">455 U.S. 252, 455 U.S. 252">257↩ (1982).55. In NLRB v. Catholic Bishop of Chicago, 440 U.S. 490">440 U.S. 490 (1979), the Supreme Court construed the National Labor Relations Act, holding that it did not give the National Labor Relations Board (NLRB) jurisdiction over schools operated by a church. Noting the risk of entanglement and other interferences with religious freedom were the act to confer jurisdiction over church schools (440 U.S. 490">440 U.S. at 501-504), the Court, in order to avoid serious questions about the act's constitutionality, declined to construe the act to confer such jurisdiction in the absence of an affirmative showing that Congress intended to bring church schools under the NLRB's jurisdiction. 440 U.S. 490">440 U.S. at 501↩.56. We treat this one public policy issue here. As we noted earlier, the other public policy issues in this case are considered in section VI of this opinion.↩57. Petitioner tacked on one other constitutional issue in its post-trial brief without discussion. Petitioner claims that sec. 501(c) enumerating exempt organizations is arbitrary and capricious because it prohibits some exempt organizations but not others from allowing their net earnings to inure to the benefit of private individuals. Congress has broad discretion in enacting tax legislation ( Madden v. Kentucky, 309 U.S. 83">309 U.S. 83, 309 U.S. 83">87-88 (1940)), and the courts will not set aside a legislative classification in the tax field if it can be justified under any set of facts. United States v. Maryland Savings-Share Insurance Corp., 400 U.S. 4">400 U.S. 4, 400 U.S. 4">6 (1970). The entities which are exempted from the inurement provision are either mutual self-help organizations or funds dedicated to the welfare of a specific group. These groups by definition have earnings which inure to the benefit of private individuals as the inurement provision has been construed to prohibit organizations from operating for the benefit of members. See secs. 1.501(a)-1(c), 1.501(c)(3)-1(c)(2), 1.501(c)(3)-1(d)(1)(ii), Income Tax Regs.; Spokane Motorcycle Club v. United States, 222 F. Supp. 151">222 F. Supp. 151, 222 F. Supp. 151">153↩ (E.D. Wash. 1963). See also B. Hopkins, The Law of Tax Exempt Organizations 209-227 (4th ed. 1983). It would be self-defeating for Congress to help these groups by granting a tax break in one breath and in the very next breath take it away.58. The exemption for religious, charitable, and educational organizations originated in sec. 32 of the Act of August 27, 1894, 28 Stat. 509, 556, which was the first Federal statute to impose an income tax on corporations. The congressional debates preceding the enactment do not reveal the reasons for the exemptions. However, similar exemptions for mutual savings banks and life insurance companies were created because they were not operated as businesses for gain. 26 Cong. Rec. 6622-6623 (1894). Furthermore, the income tax provisions of the Act of August 27, 1894, were modeled, in measure, on the English system. 26 Cong. Rec. 6612-6613 (1894).59. We note the possibility of constitutional infirmity in placing the burden of proof on the Church to disprove it violated 18 U.S.C. sec. 371. Norwood v. Harrison, 413 U.S. 455">413 U.S. 455 (1973) ("no one can be required, consistent with due process, to prove the absence of violation of law." 413 U.S. 455">413 U.S. at 471.) However, we need not decide this issue. Respondent raised this issue after filing his answer. The parties, therefore, agreed that the burden of proof was upon respondent to show that petitioner had an illegal purpose which disqualified it for exemption under sec. 501(c)(3). See Rule 142(a)↩.60. While the Church now claims that its stationery put respondent on notice of the status of the United Kingdom Church, the Church obviously did not think so in 1967. Writing on Church stationery to the IRS in 1967, the Church, in response to a request, listed its subordinate branches failing to mention the United Kingdom Church. The stationery, in fine print, referred to petitioner as "a non-profit corporation in U.S.A. registered in England." In a true display of "chutzpah" the Church placed the letter in evidence as an example of the type of document which should have given IRS officials notice that petitioner incorporated the United Kingdom Church.61. The Church audit report estimates that 38 percent of the Church's time was spent on those activities, but no substantiation of this estimate was ever produced.↩62. Two of petitioner's branches, FOLO and USGO, did not provide religious services to the public. Flag mainly provided religious services to Scientology staff. The United Kingdom Church received a substantial portion of its income from franchise tithes. When these payments are added in, the percentages increase to 88 percent for 1971 and 97 percent for 1972.↩63. An excellent illustration of the businesslike philosophy petitioner employed in marketing its services is found in HCO PL, Nov. 21, 1969, 6 OEC 133. This letter provides in relevant part:"The purpose of this policy letter is to provide a SET FORMAT that can be used over and over again by Orgs to find out in their country, area, city, community WHAT IS NEEDED AND WANTED. Once this is known to an organization it can angle its promotion on it and produce it. For example, an area wants more INTELLIGENT PEOPLE AND ACTIONS and LESS STUPIDITY. The Org of the area finds out and goes into a promotional programme of 'We can RAISE your IQ!!' or 'Tired of being STUPID? We can restore your NATURAL INTELLIGENCE!' Of course through training and processing an organization can produce this exact result."If an organization or group does this over and over continually to keep up with the trends and cover new areas its income will ROCKET. A 'Needed and Wanted Survey' as laid out below should be done by an org or group AT LEAST twice a year and again if the trend seems to be changing or a new area is disseminated to. As we expand we repeat↩ the action."64. This purpose of making money lies barely beneath the surface in the promotional activities described in HCO PL May 23, 1969 (Issue III), 6 OEC 91-93, quoted in our findings of fact, 332 F.2d 421">supra↩ at 423.65. Petitioner failed to produce any evidence regarding the actual amounts, if any, of such refunds during the tax years at issue.↩66. Petitioner also relies on five other cases: Rosenthal v. Commissioner, 32 T.C. 225">32 T.C. 225 (1959); Draper v. Commissioner, 6 T.C. 209">6 T.C. 209 (1946); Greenwood v. Commissioner, 22 B.T.A. 1187">22 B.T.A. 1187 (1931); Webb Press Co. v. Commissioner, 9 B.T.A. 238">9 B.T.A. 238 (1927); Webb Press Co. v. Commissioner, 3 B.T.A. 247">3 B.T.A. 247 (1925); Carey Van Fleet v. Commissioner, 2 B.T.A. 825">2 B.T.A. 825 (1925). The Rosenthal case involved the question of the applicability of the installment method and is clearly inapplicable to the present facts. The other four cases are irrelevant because they predate the seminal case of 286 U.S. 417">North American Oil Consolidated v. Burnet, supra↩.67. OTC allegedly received a 1-percent monthly finance handling charge, which was computed based on its total disbursements for the month.↩68. We find that petitioner's large reserves are a factor indicating petitioner had a substantial commercial purpose even under the test announced in Presbyterian & Reformed Publishing Co. v. Commissioner, 743 F.2d 148">743 F.2d 148 (3d Cir. 1984), revg. 79 T.C. 1070">79 T.C. 1070 (1982). In the Presbyterian & Reformed Publishing Co. case the Third Circuit, relying by analogy on the accumulated earnings tax, sec. 531 et seq., held that accumulations of cash may be considered evidence of a commercial purpose where they are unexplained by the legitimate needs of the organization, but that cash accumulations which are explained and dedicated to meet legitimate needs of the organization are not evidence of a nonexempt purpose. Presbyterian & Reformed Publishing Co. v. Commissioner, 743 F.2d 148">743 F.2d 148, - (3d Cir. 1984), slip op. at 18-21. See also Incorporated Trustees of the Gospel Worker Society v. United States, 510 F. Supp. 374">510 F. Supp. 374, 510 F. Supp. 374">379 and n. 13 (D. D.C. 1981), affd. without opinion 672 F.2d 894">672 F.2d 894 (D.C. Cir. 1981), cert. denied 456 U.S. 944">456 U.S. 944 (1982).Petitioner offered several justifications for its large reserves. Petitioner claimed that they were needed to purchase a land base for petitioner's operations; to protect the Church from its many foes; and to pay the Church's tax liability in the event it lost its battle for tax-exempt status. It is true that many years later the Church did secure land headquarters in Clearwater, FL. Also, no doubt, the Church needed money to protect itself from its detractors. Finally, since the IRS revoked the Church's tax-exempt status in 1967, there was a strong likelihood it would have to pay taxes.However, the bulk of the evidence in the record undermines the legitimacy of these justifications, so that we have no difficulty in concluding that the reserves were accumulated to make money for the Church and its leaders. Thus, although the Church eventually secured land headquarters, this was done several years after the reserves were built up. Furthermore, the Church failed to introduce any evidence of the cost of the new headquarters in Clearwater, FL, or that reserves were used to pay for the premises. We also note that, although the purported purpose of the trust was the defense of Scientology, only one small disbursement was made for this purpose during the docketed years. The Church presented no evidence that the amount of its reserves bore any relationship to its anticipated needs. These facts alone cast doubt on the Church's stated reasons for accumulating reserves. However, what compels us further to conclude that the Church's justifications are mere pretense is the manner in which the reserves were maintained. They belonged to a bogus trust and a sham corporation and were mostly held in cash and numbered Swiss bank accounts. Under these facts, the Church has not carried its burden in demonstrating that the reserves were accumulated to further its tax-exempt purposes.In light of our conclusion, we need not decide whether we concur in the Third Circuit's reversal in 743 F.2d 148">Presbyterian & Reformed Publishing Co. v. Commissioner, supra↩.69. Indeed, petitioner concedes as much on brief.↩70. Indeed, in light of L. Ron Hubbard's degree of control over petitioner, there could be no independent negotiations between L. Ron Hubbard and petitioner.↩71. We are not at all convinced that these records represent the total amount of such alleged debt repayments in light of John McLean's testimony. McLean credibly testified that, during the fall of 1972, statistics were posted aboard the Apollo↩ each week showing the amount of weekly payments to L. Ron Hubbard. According to McLean, the weekly payments to L. Ron Hubbard which were posted pursuant to the policy letter of Sept. 7, 1972, ranged between $ 7,000 and $ 22,000 per week. We credit McLean's testimony on this point.72. Petitioner's counsel acknowledged his awareness of the negative inferences that could be drawn from the Church's failure to produce a witness. Nevertheless, he represented that petitioner would not allow L. Ron Hubbard to appear as a witness thereby tacitly confirming the California Church's ability to produce him.↩73. Respondent's agents spent about 20 hours trying to serve Greenberg with a subpoena. They were not successful. However, several Church witnesses spoke with Greenberg during the course of the trial and found him in good health.↩74. Petitioner raises two other objections to the public policy requirement we have read into sec. 501(c)(3). First, petitioner claims that the Bob Jones Court reserved ruling on the applicability of charitable law public policy standards to churches. We disagree. We believe the Bob Jones opinion unqualifiedly held that all organizations seeking exemption under 501(c)(3) must comply with fundamental standards of public policy. Ruling was limited only on the second issue presented in the case -- whether the particular fundamental interest in eradicating racial discrimination could be applied to churches. In any event, we believe that the application of public policy requirements to churches does not in and of itself offend the Constitution. Churches are not above the law. Historically, there have been a number of compelling governmental interests justifying curtailment of religious liberty. See, e.g., Reynolds v. United States, 98 U.S. 145">98 U.S. 145 (1878) (monogamy); Late Corporation of the Church of Jesus Christ of Latter-Day Saints v. United States, 136 U.S. 1">136 U.S. 1 (1890) (monogamy); Jacobson v. Massachusetts, 197 U.S. 11">197 U.S. 11 (1905) (control of smallpox); Prince v. Massachusetts, 321 U.S. 158">321 U.S. 158 (1944) (protection of children from exploitative labor); Gillette v. United States, 401 U.S. 437">401 U.S. 437 (1971) (conscription); United States v. Lee, 455 U.S. 252">455 U.S. 252 (1982) (soundness of the social security system). If the Government has the power to prohibit religious practices outright which interfere with fundamental public interests, and even to deny corporate existence for engaging in such practices ( 136 U.S. 1">Late Corporation of the Church of Jesus Christ of Latter-Day Saints v. United States, supra), then, a fortiori, it has the power to deny tax benefits to churches which espouse and practice such beliefs.Petitioner also claims that this Court's interpretation of the public policy requirement is an overbroad regulation of its free exercise rights. Prior to trial, this Court ruled that petitioner must comply with fundamental public policy such as may be evidenced in a civil or criminal statute. Respondent did not rely on this definition. Except for some brief cross-examination at the very beginning of the trial, respondent confined his case to showing petitioner conspired to defraud the Government in violation of 18 U.S.C. sec. 371↩. Since petitioner does not dispute that a charitable trust is invalid if it has an illegal purpose, petitioner's overbreadth claim is moot.75. Organizations qualifying for tax-exempt status under sec. 501(c)(3) are doubly rewarded. Not only do they not have to pay taxes, but they also stand in a better position to attract income since taxpayers who contribute to sec. 501(c)(3)↩ organizations are permitted by sec. 170(c)(2) to deduct the amount of their contributions on their Federal tax returns.76. Subsequent to the decision in Coit v. Green, 404 U.S. 997">404 U.S. 997 (1971), the Supreme Court has twice questioned its precedential value. See Allen v. Wright, 468 U.S. , (1984); Bob Jones University v. Simon, 416 U.S. 725">416 U.S. 725, 416 U.S. 725">740↩ n. 11 (1974). We find this of little significance for notice purposes. What is important is that in 1971, the decision was "on the books" and informed petitioner that a charitable organization could not qualify for a tax exemption if it had an illegal purpose or violated public policy.77. Petitioner introduced several disbursement vouchers for impeachment, all signed by John McLean, save one, which was signed simply with the name "Karen." The Court only credits the disbursement vouchers signed by John McLean. These show that following the incident which occurred on June 18, 1971, McLean was taken off the payroll until July 13, 1971. However, even if the voucher signed "Karen" were taken into account, John McLean at least went without pay for the week ending June 24, 1971.78. Petitioner also objects to the introduction of the OEC series on constitutional grounds claiming entanglement. We have treated this objection 413 U.S. 455">supra↩ at 462-464.79. On redirect examination, petitioner's witness Fran Harris said this index was not exhaustive. We do not believe this aspect of her testimony, since the statement contradicts her earlier testimony and was only elicited after repeated questioning by counsel.↩80. Although the Supreme Court in Emich Motors Corp. v. General Motors Corp., 340 U.S. 558">340 U.S. 558 (1951), was construing sec. 5 of the Clayton Act, 15 U.S.C. sec. 16(a)↩, the language of the decision suggests that the Court felt it was applying general principles regarding the estoppel effect of a prior criminal conviction. See 4 J. Weinstein, Evidence, par. 803(22)[01], at 803-274 nn. 19 & 20 (1981).81. The seal on Exhibit FX was lifted by the District Court for the District of Columbia by orders dated Oct. 25, 1979, and Oct. 30, 1980. It was reimposed by order of the District Court dated Nov. 5, 1980, on remand from the U.S. Court of Appeals for the District of Columbia. United States v. Hubbard, 650 F.2d 293">650 F.2d 293, 650 F.2d 293">295↩ n. 1, 332-333 (D.C. Cir. 1980).82. In his trial memorandum filed Oct. 3, 1980, respondent stated that petitioner's net earnings inured to the benefit of L. Ron Hubbard through "the diversion of large sums from petitioner to Hubbard utilizing sham entities known as O.T.C. and O.T.S. which were completely controlled and dominated by Hubbard." Respondent also said he would put on witnesses to show "petitioner * * [and] entities known as 'O.T.C.' and 'O.T.S.' constitute, in substance, a single organization under Hubbard's absolute and total control." Respondent's trial memorandum filed Oct. 3, 1980, at 6, 47.83. In some cases, even the Commissioner's attempt to raise a new legal theory comes so late in the day that it cannot be heard because of its prejudicial impact on petitioner. United States v. First Security Bank, 334 F.2d 120">334 F.2d 120, 334 F.2d 120">122 (9th Cir. 1964); Riss v. Commissioner, 56 T.C. 388">56 T.C. 388, 56 T.C. 388">400-401 (1971), affd. sub nom. Commissioner v. Transport Manufacturing & Equipment Co., 478 F.2d 731">478 F.2d 731 (8th Cir. 1973). See also cases collected 432 U.S. 464">supra↩ at 472.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621057/	Dean Babbitt and Estelle Babbitt, Petitioners, 1 v. Commissioner of Internal Revenue, RespondentBabbitt v. CommissionerDocket Nos. 41947, 51515, 51516, 51517, 51518United States Tax Court23 T.C. 850; 1955 U.S. Tax Ct. LEXIS 246; February 14, 1955, Filed 246 Decisions will be entered under Rule 50. 1. Petitioner, in 1936, as part of his contract of employment as president of a corporation, received an option to purchase 30,000 shares of the company's common stock at $ 2 per share during the term of his employment. The contract was renewed in 1939, at which time the option price was reduced to $ 1.50 per share. In 1944, the contract was again renewed, the option price remaining at $ 1.50 per share. The number of shares then subject to the option was not less than 20,000. At the time of the 1944 renewal, the option terms were modified to permit its execution by petitioner within the 5-year period of the contract regardless of petitioner's employment status with the company. In 1947, petitioner purchased 10,000 shares of the stock at the option price of $ 1.50 per share at which time the fair market value of the stock was $ 3.75 per share. Held, petitioner realized compensation upon his exercise of the option in 1947 in an amount equal to the excess of the fair market value of the stock acquired over the option price.2. Petitioner purchased a farm in 1940 and hired a farmer to operate it. He changed farmers twice, and the emphasis247 of the farm's operations was altered a number of times at petitioner's direction in repeated efforts to grow or produce profitable items. Petitioner did not use the farm as a hobby, or for recreation or entertainment. In 1953, a small net profit was realized. Prior to that year, it was operated at a loss. Held, that the farm was operated by petitioner as a business regularly carried on.3. The deficiency notice for the taxable year 1947 was not sent to petitioner within 3 years after his 1947 return was filed. Within 5 years, however, petitioner executed a consent to extend the period of time for assessment. The notice was sent to him within the period of that extension but beyond the 5-year period. Petitioner did not report in his 1947 return any income resulting from the exercise of his stock option in that year. The amount of such income exceeded 25 per centum of the gross income stated in the return for that year. Held, this proceeding with respect to the taxable year 1947 is not barred by limitations. Sec. 275 (c), I. R. C., 1939. J. Henry Landman, Esq., for the petitioners.James J. Quinn, Esq., for the respondent. Fisher, Judge. FISHER850 Respondent determined deficiencies against petitioner Dean Babbitt for 1947 and against both petitioners for subsequent years in the following amounts: 851 YearDeficiency1947$ 14,244.5619481,662.621949453.6819501,485.9019511,199.66Total$ 19,046.42The issues involved are (1) whether or not petitioner Dean Babbitt realized additional income in 1947 when he exercised an option249 granted to him by his employer in a prior taxable year to purchase its corporate stock; (2) whether or not losses incurred by petitioners attributable to the operation of a farm are deductible as trade or business expenses; and (3) whether or not proceedings with respect to 1947 are barred by limitations.FINDINGS OF FACT.Some of the facts were stipulated by the parties. Those so stipulated are found accordingly and incorporated herein by reference. Wherever the term "petitioner" appears herein in the singular, it refers to petitioner Dean Babbitt.Petitioners are husband and wife who filed joint income tax returns for the years 1948 through 1951. For 1947, petitioner Dean Babbitt filed a separate individual return.During most of 1947 and thereafter until October 15, 1949, petitioners resided in Westchester County, New York. Thereafter, they resided on petitioner's farm, Beech Hill Farm, Ashland, New Hampshire.In January 1933, petitioner was engaged by the Sonotone Corporation, a manufacturer of hearing aids, as sales manager for a territory encompassing New York and several neighboring States. Six months later, he became general sales manager of the company under a contract250 for a period to end on January 23, 1936.During the latter part of 1935, the then president of the company became ill and one of the directors indicated that an effort would be made by him to acquire control of the company in order to place a relative in the position of president. A spokesman for the board of directors and petitioner discussed the terms of a proposed contract to engage petitioner as chief executive officer of the company. Negotiations ensued concerning the amount of salary, a percentage of net earnings, and an option to purchase corporate stock. At this time, there was a possibility that petitioner could have become president of Dictograph Products Company, manufacturers of the Acousticon hearing aid, if he then left Sonotone. He had also received an offer 852 from the American Type Founders Company to become its vice president in charge of sales.The Sonotone Corporation acceded to petitioner's proposed terms and on January 30, 1936, he and the company entered into a contract whereby he was engaged as the "chief executive officer" of the company for a period of 3 years to begin on the 1st day of February 1936 and to end on the 31st day of January 1939. 251 Paragraph 3 of the agreement provides in part as follows:It is contemplated that Mr. Babbitt will be elected President of the Company from time to time but a failure to so elect him shall not invalidate this agreement. * * Paragraph 4 of the agreement provides in part as follows:Mr. Babbitt's compensation shall consist of (1) thirty thousand ($ 30,000.00) dollars per annum payable in semi-monthly installments, and (2) a sum equivalent to five percent (5%), payable annually, of the net earnings of the Corporation as certified, after the close of each fiscal year * ** * * In consideration of the execution and delivery of this agreement by Mr. Babbitt, the Company grants to Mr. Babbitt an option good until the close of business on January 31, 1939, to purchase any part or all, at any time and from time to time until said date, of thirty thousand (30,000) shares of the Company's Common Stock, as such stock is presently constituted, at a price of two dollars ($ 2.00) per share. * Paragraph 6 of the contract provides in part as follows:The Company shall have the right to terminate this agreement of employment upon three months' written notice served personally or by registered252 mail upon Mr. Babbitt, if Mr. Babbitt becomes so disabled as to be unable to carry on the duties for which he is employed, due to physical or mental illness which has continued for three months and the indications are that it will continue or if Mr. Babbitt consistently neglects the business of the Company. Mr. Babbitt shall have the right to terminate this agreement upon three months' written notice served personally or by registered mail on the Chairman of the Board of Directors at any time. In case of such termination by the Company or by Mr. Babbitt all of Mr. Babbitt's rights hereunder, including any unexercised portion of said option, shall terminate as of the effective date of such notice. If any termination takes effect during the course of a fiscal year, Mr. Babbitt's percentage compensation shall be computed for the expired portion thereof, and shall be computed and paid forthwith after such termination takes effect.Paragraph 9 of the agreement provides as follows:This agreement shall be binding upon and inure to the benefit of the Company and its successors and assigns and shall be personal and non-assignable as far as Mr. Babbitt is concerned and shall terminate in253 case of the death of Mr. Babbitt before the expiration thereof.On January 30, 1936, the option to purchase stock had no ascertainable fair market value. Petitioner did not exercise any part of his option prior to January 31, 1939, the expiration date of the 1936 employment agreement.853 On January 12, 1939, the company and petitioner entered into another agreement which, subject to certain modifications, extended and renewed the 1936 agreement for a period of 5 years to expire on January 31, 1944. Paragraphs 3 and 4 of the 1939 agreement are as follows:3. The option granted to Mr. Babbitt in the second paragraph of section 4 of said contract, not having been exercised by him, is extended until the close of business on January 31, 1944, subject to the same terms and conditions except that the price per share is reduced to one and one-half dollars ($ 1.50).4. There is attached hereto and made a part hereof an original copy of said contract of January 30, 1936, which said contract is hereby ratified, confirmed, extended and renewed as herein set forth.The list price of the common stock on the Curb was 1 1/2 on January 12, 1939, the date the 1939 agreement was executed. 254 The option price was reduced in the 1939 agreement from $ 2 to the then market price of $ 1.50 pursuant to petitioner's request. On January 12, 1939, the stock option had no ascertainable fair market value. Petitioner purchased 6,000 shares under his option at $ 1.50 per share. 2On January 19, 1944, the company and petitioner entered into another agreement which, subject to certain modifications, extended and renewed the 1936 contract as modified by the 1939 contract for a period of 5 years to expire on January 31, 1949. Paragraph 3 of that agreement provides in part as follows:The option granted to Mr. Babbitt in the unnumbered paragraph or section immediately following section 4 of said contract of January 30th, 1936, as modified and extended by section 3 of said contract of January 12th, 1939, is, to the extent that such option has not been heretofore and shall not have been up to the 255 31st day of January 1944, exercised by Mr. Babbitt, hereby extended until the close of business on January 31st, 1949, subject to the same terms and conditions as therein set forth; except that so much of section 6 of said contract of January 30th, 1936, as reads as follows; viz.: In case of such termination by the Company or by Mr. Babbitt all of Mr. Babbitt's rights hereunder, including any unexercised portion of said option, shall terminate as of the effective date of said noticeis hereby modified to read as follows: In case of such termination by the Company or by Mr. Babbitt all of Mr. Babbitt's rights hereunder shall terminate as of the effective date of such notice, with the exception that the unexercised portion of the option hereby granted shall nevertheless continue until the close of business on January 31st, 1949; and in the event of Mr. Babbitt's death or judically declared incompetency occurring prior to said expiration date may be exercised by his personal representatives in favor of his wife or next of kin or such thereof as Mr. Babbitt may designate by his last will and testament or other lawful power of appointment; provided that if death shall have occurred256 or incompetency proceedings been instituted prior to said expiration date his personal representatives or committee may exercise the option within thirty days after their appointment and qualification not occurring until after said expiration date.854 Paragraph 4 of the 1944 agreement provides as follows:There are attached hereto and made a part hereof original copies of said contracts of January 30, 1936 and January 12, 1939, which said contracts are hereby ratified, confirmed, extended and renewed as herein set forth.On January 19, 1944, the date of execution of the 1944 agreement, and on February 1, 1944, its effective date, the stock option had no ascertainable fair market value. Thereafter, petitioner purchased under his option 10,000 shares on February 28, 1944, and 10,000 shares on November 3, 1947. Subsequently, between December 2, 1948, and May 12, 1954, petitioner disposed of all of his stock in the Sonotone Corporation.In the Sonotone Corporation's original income tax returns for the years 1944 and 1947, the corporation claimed no deductions for additional compensation paid to petitioner attributable to the difference at any time in those years between the257 option price and the market price of its common stock. In 1952, however, the company retroactively claimed such differences as deductions for the 2 earlier years after its officials had been notified that petitioner had paid income tax deficiencies for 1944 based upon the difference between the option price and the market price on February 28, 1944 (the date petitioner first exercised a part of his option pursuant to the 1944 contract). 3Petitioner resigned as president of Sonotone at the end of 1946 but he was retained by the company until July 1953, in an advisory capacity for which he was substantially remunerated. Between October 1, 1947, and October 15, 1949, he was employed by the Carry-Cab Corporation, New York, New York, and thereafter by the Belmar Electric Corporation, Tilton, New Hampshire.The fair market258 value of 10,000 shares of Sonotone Corporation common stock on November 3, 1947, was $ 3.75 per share. The option granted to petitioner by the 1944 agreement was primarily intended as additional compensation for services rendered and to be rendered by him to the company. Such compensation was intended by the parties to be derived from the exercise of the option or portions thereof and to be equal to the excess of the fair market value of the stock so acquired over the option price paid therefor. In addition to the primary reason for insisting upon the option as a part of his employment contract, petitioner desired the option as some measure of protection from efforts on the part of one of the directors to install a relative in the position of president of the company.In 1940, petitioner purchased Beech Hill Farm at Ashland, New Hampshire, for $ 6,000. The farm consisted of about 235 acres and 855 farm buildings which were then in a dilapidated condition. These buildings were ahouse and storeroom which were connected with a barn, a large chicken house and a large shop a short distance from the main building. In addition, there was a dilapidated cottage on the property. 259 Also in 1940, petitioner purchased a 5-acre estate in Rye, New York, for about $ 70,000. This estate had formerly belonged to George Putnam and Amelia Earhart. The home on this estate contained 22 rooms and 7 baths, and petitioners resided therein with their daughter and 3 servants until 1946. Petitioner did considerable entertaining there. After 1946, petitioners resided in an apartment in Hartsdale, New York, until October 15, 1949, when they moved to Beech Hill Farm.Petitioner purchased the farm in order to provide for his future economic security. He felt that a piece of productive property would provide him food and shelter regardless of what economic events might take place in the future. He intended to live on the farm upon his retirement from industry. It was his objective that the farm be operated on a profitable basis. It was his opinion in 1940 that because of the war going on in Europe it was then an opportune time to acquire a farm which he believed could be operated for a profit.After purchasing the farm, petitioner hired a farmer to occupy and operate it. Petitioner himself had not had any previous farming experience, but he sought advice and counsel from260 sources such as the New Hampshire Department of Agriculture, the county farm agent, the Agricultural Department of the University of New Hampshire, and stockmen. He also studied various farm journals and bulletins to which he subscribed. At all times after 1940, petitioner focused the operations of the farm on products which he believed would produce a profit. As actual experience demonstrated the contrary from time to time, he shifted from product to product, placing emphasis at various times upon products such as pigs, dairy products, apples, and potatoes. Petitioner supplied tools, machinery, and equipment to be used by the farmer in whose charge the operation of the farm was placed.Until 1949, petitioner's supervision of farming operations was indirect because of his activities in New York with the Sonotone and Carry-Cab corporations, and he visited the farm only on occasional weekends and holidays. Between April 25, 1947, and September 8, 1947, however, petitioners resided on the farm, and on two occasions petitioner spent his vacation on the farm. At these times, he performed some labor on the farm. He did not use it for recreational purposes except in an incidental 261 way during the vacation periods above indicated, and he did not use it for entertaining.After purchasing the farm, petitioner remodeled the house, installed electricity, modernized the kitchen, prepared living quarters for the farmer in charge of its operation in the section between the house 856 and the barn, and repaired the farm buildings. The house was furnished with furniture, drapes, and other items brought from petitioner's house in Rye. In 1949, he remodeled the cottage on the property and offered it for rent. Petitioner spent the following amounts for the purposes indicated:PurposeDateAmountAdditions to farm buildings1941$ 8,405.35194217,577.5419431,728.33Cottage remodeling19498,365.38Garage1949196.48Garage additions1950397.20Cottage additions19501,035.44In the income tax returns filed for the years indicated, the following farm profits (loss) and rental income were reported:FarmcottagerentalFarm profitsYearincome(loss)1941($ 3,035.89)1942(6,311.82)1943(6,840.18)1944(6,905.46)1945(7,586.78)1946(6,723.15)1947(9,364.34)1948(4,672.45)1949$ 571.21(4,907.57)1950310.00(7,032.31)1951710.00(4,577.98)1952300.00(5,007.89)1953357.46 262 In 1945, petitioner hired a new farmer to replace the original one, who had proved himself to be inefficient and inadequate to manage the farm. The second one was in turn replaced in 1952. Under date of May 7, 1945, petitioner wrote a letter to the second farmer in which he set forth the points of agreement between them in part as follows:7. For your own table use, you will have available whatever produce is raised on the farm, such as vegetables, fruits, butter, milk, eggs, chickens and meats. All other items for your own table use will be supplied by yourself.8. You will be expected to have general supervision of the farm, running the same with the same interest to be shown by you as though it were owned by you personally. While under present conditions I doubt if the farm can be made to break even on expenses, I nevertheless have this as my objective and you should do all in your power to drive towards this end.9. You will, of course, be responsible for the proper care of livestock and poultry, the vegetable garden and fruit trees.10. With adequate assistance, you will get out what wood is necessary in the winter, and also, with adequate assistance, take care of the haying.263 11. You indicated to me last week, that you would prefer to work the farm with a tractor instead of a team of horses. I told you that this was agreeable to me and that I would take immediate steps to see if I could obtain the 857 necessary priority to get a tractor and if successful in doing so, would them [sic] dispose of the team. I have already written to Royal Smith, County Agent at Laconia, to see if I can get the priority for the tractor and if this can be done, the team will be put up for sale at once. Otherwise, for the time being, the team will have to be used by you.12. It will be necessary for you to maintain a daily cash book in which all receipt [sic] for money collected by you will be entered as well as all disbursements made by you. The first of each month this book is to be sent to me at my office address so that proper entries can be made by me in my farm ledger.13. Butter boxes and egg boxes will be supplied to you to be used in making express shipments to my home in Rye of approximately thirty pounds of butter per month and twenty-four dozen eggs per month, for which I am to be charged on the books. Any excess of butter and eggs (other than what264 is required for your own personal use) you should sell locally. The same, also, applies to vegetables and fruit. I have the feeling that the best way in which to get the farm to break even on expenses is by raising vegetables and fruits and selling such produce to the camps, and cottages located nearby, as well as possibly selling to the stores. In addition, I believe that we can churn and dispose of a certain amount of butter to neighbors and visitors who have cottages around the lakes.Petitioner maintained a separate set of books pertaining to the farm and its operations. He did not charge the farm books with the value of such labor thereon as he himself performed. He did, however, charge himself on the books for the produce supplied to himself and his household.Although the farm in fact suffered losses until 1953, it was bought and operated by petitioner during the years involved herein as a business regularly carried on for the purpose of profit. It was not operated as a hobby, or for purposes of entertainment or recreation except to a very minor and incidental degree.Petitioner filed a timely return for 1947 in which he reported a gross income of $ 16,613.72 for that265 year consisting of a salary of $ 12,003.98, dividends of $ 4,225.50, and interest of $ 384.24. Petitioner did not report in that return any income resulting from his acquisition of 10,000 shares of Sonotone Corporation common stock on November 3, 1947, at the option price of $ 1.50 per share.On January 27, 1953, petitioner executed a consent agreement (Form 872) with respondent to extend until June 30, 1954, the period in which taxes may be assessed for the taxable year 1947. The statutory notice of deficiency for the taxable year 1947 sent to petitioner was dated November 4, 1953.OPINION.The Stock Option Issue.The first issue involved in the instant case is whether or not petitioner realized additional income in 1947 upon his exercise of an option 858 previously granted to him by his employer to purchase its common stock. In 1936, the Sonotone Corporation as part of an employment contract between the company and petitioner granted him an option to purchase 30,000 shares of its common stock at $ 2 per share, the then listed price of the stock on the New York Curb Exchange. The contract, which was for a period of 3 years subject to termination by either party upon266 3 months' notice, provided that petitioner was to be the chief executive officer of the company and was to receive a salary of $ 30,000 per year plus 5 per cent of the certified annual net earnings of the company. The contract also provided that the stock option was good until the close of business on January 31, 1939, the expiration date of the contract, and that, in case of termination of the contract, petitioner's rights to any unexercised portion of the stock option would terminate as of the effective date of the termination notice. The contract was "personal and non-assignable" so far as petitioner was concerned.Petitioner did not exercise any part of the stock option during the term of the 1936 contract. In 1939, however, the parties entered into another agreement which extended and renewed the 1936 contract for 5 years until January 31, 1944, upon the same terms and conditions except that the option price was reduced to $ 1.50 per share which was the price listed on the Curb on the date the 1939 agreement was executed. Petitioner exercised only a portion of the option during the term of the 1939 contract.On January 19, 1944, the parties entered into another 5-year contract267 to extend and renew the 1936 agreement as modified by that of 1939, subject to certain other modifications. One of the modifications provided that the unexercised portion of the stock option should continue until January 31, 1949, even in the event of the sooner termination of the contract by either party, and that the option might be exercised by petitioner's personal representatives in the event of his death or incompetency prior to that date. Thereafter, petitioner exercised portions of the option by purchasing at a price of $ 1.50 per share 10,000 shares on February 28, 1944, when the price on the Curb was 2 3/8, and 10,000 shares on November 3, 1947, when the price on the Curb was 4 1/4. We are concerned in the instant case with the latter purchase which respondent has determined resulted in petitioner's realization of "taxable income by way of compensation for services in the amount of $ 27,500." Petitioner, on the other hand, contends that the option was not granted as compensation for services and that therefore no taxable income was realized by petitioner upon the exercise of a portion thereof in 1947.It should be noted at the outset that the option in the instant case268 was granted to petitioner prior to February 26, 1945, the effective date of 859 the amendments made to Regulations 111, section 29.22 (a)-1, by T. D. 5507, 1946-1 C. B. 18. T. D. 5507 expressly provides that in the case of property transferred by an employer to an employee pursuant to the exercise of an option granted before February 26, 1945, the regulations prior to such Treasury Decision shall apply. Accordingly, we are not concerned with the applicability of T. D. 5507 to the facts at hand. Cf. Philip J. LoBue, 22 T. C. 440. Nor are the provisions of section 130A of the 1939 Code, effective for taxable years beginning after 1949, applicable to the instant case.Regulations 111, section 29.22 (a)-1, prior to T. D. 5507 provided in part as follows:If property is transferred * * by an employer to an employee, for an amount substantially less than its fair market value, regardless of whether the transfer is in the guise of a sale or exchange, such * * * employee shall269 include in gross income the difference between the amount paid for the property and the amount of its fair market value to the extent that such difference is in the nature of (1) compensation for services rendered or to be rendered * These provisions were quoted with approval by the Supreme Court in Commissioner v. Smith, 324 U.S. 177 (1945).In the instant case, the option price paid by petitioner for the stock in 1947 was substantially less than its then fair market value (discussed infra). The problem presents an issue of fact as to whether or not the option was granted to petitioner as additional compensation for his services rendered or to be rendered to the Sonotone Corporation. Harold E. MacDonald, 23 T. C. 227; Charles E. Sorensen, 22 T. C. 321; Abraham Rosenberg, 20 T. C. 5. Upon consideration of all the facts in the instant case, we find that the excess of the fair market value in 1947 over the option price of the shares acquired in that year by the exercise of the option was compensatory for the reasons set forth below.The company 270 first granted petitioner a stock option in the 1936 employment contract, and unused portions of the option were carried over with certain modifications into the succeeding contracts of 1939 and 1944. Prior to its execution of the 1944 agreement, the company was not under any legal obligation to renew or extend the option beyond the expiration date of the 1939 contract. It agreed, however, as part of the bargain by which petitioner's services were retained for an additional term, to grant him the right to exercise the then unexercised portion of the original 30,000 share option at any time during the succeeding 5-year period. Under such circumstances, we believe that the terms of the 1944 contract grant an option which is legally separate and distinct from the prior options. In practical effect, however, the 1944 option is a continuation of the one which was granted in 1936. Accordingly, in our consideration of the nature of the 1944 option, we look first to its origin in 1936.860 It is apparent from the record that the original option, contained in the 1936 contract, was granted at petitioner's insistence. At the time of such insistence, he was in a strong bargaining position. 271 His prior services had been productive; he had offers from other companies; and the then president of the company was so ill that it was evident that it would be necessary for the company to elect a new president who would be its chief executive officer.It is clear that petitioner bargained for the option as an integral part of his requirements as a basis for accepting the terms of employment. When, during the negotiations for the 1936 contract, he was offered a 5,000-share option, he termed the offer "absolutely ridiculous." He testified further that "I was the one -- it wasn't offered to me -- I was the one that insisted on the 30,000 shares." When asked "Would you have accepted the employment if you didn't get a stock option?", he answered, "I don't think I would have."In essence, not only the 1936 contract but also the 1939 and 1944 contracts covered only the terms of employment. The references therein to the option were not couched in terms which were calculated to classify it in any different category. Neither the contracts nor the authorizing minutes of the board of directors characterized the option in any manner indicating that it was intended to be proprietary, rather272 than compensatory. The record contains no contemporaneous written statement on the part of the company that it desired or intended that the option be granted to permit petitioner to acquire a proprietary interest. While there is no legal requirement that such a contemporaneous record be made, in dealing with an issue of fact we think it appropriate to note the absence of any such record. This is in contrast with the facts in Philip J. LoBue, supra, where, in notifying petitioner and other key employees of the action by the stockholders and directors granting them stock options, the executive vice president wrote in part as follows:The purpose of this is to provide an incentive to key employees and especially to permit such men to participate in the success of the company. This is a method or plan which has been followed by many of the leading American corporations.We may add that there is no evidence in the record that any policy of granting the key men the opportunity to acquire proprietary (incentive) interests in the company was adopted, or that anyone except petitioner was granted such an option.Petitioner contends that the reason for the273 granting of the option in the 1936 contract was to give him the opportunity to acquire a proprietary interest in the company to protect him from the efforts of one of the directors to place a relative in the position of president. This may well have represented one factor in petitioner's desire to obtain the option. Nevertheless, we do not attach primary significance to this factor.861 The number of option shares initially suggested to petitioner was 5,000 and the number was increased to 30,000 as a result of bargaining in relation to the terms of employment. The record is bare of any factual background indicating that either 5,000 or 30,000 shares would have been a material factor in the control of the corporation. It is quite apparent that petitioner's acquisition of 30,000 shares out of a total of over 800,000 shares outstanding would not, of itself, have accomplished the objective which petitioner asserts was his purpose in acquiring the shares. There is no evidence in the record that others owning sufficient stock, which when added to the 30,000 shares subject to the option would have resulted in practical control of the company, had agreed to act in concert with 274 him. Moreover, as above indicated, there is no support for any suggestion that the company itself desired petitioner to have 30,000 shares as an incentive from the perspective of proprietorship. Nevertheless, the contention of petitioner centers around the element of control, with respect to which, as already indicated, essential information is lacking.We add that in carefully following the testimony of petitioner, we noted the repeated use by him of words in the nature of conclusions having a specialized tax significance. This, together with the absence of affirmative facts furnishing sound reasons for his conclusions, left us with the impression that the emphasis placed by him on the factor of combating the efforts of the antagonistic director was to some extent a reconstructed emphasis which had developed in petitioner's mind in the atmosphere of his obvious understanding of its importance from a tax standpoint.We are convinced, for the foregoing reasons, that the original option grant was primarily intended to be compensatory, and as such was a material part of the consideration upon which petitioner insisted as a part of his employment contract. Conceding that the acquisition275 of the option to purchase 30,000 shares might have strengthened petitioner's position in the company in some measure, it is our view that this was an intangible factor of secondary significance which can neither be isolated nor evaluated from the record. As we said in Harold E. MacDonald, supra (citing Delbert B. Geeseman, 38 B.T.A. 258">38 B.T.A. 258), "In the instant case, as in so many cases of this nature, 'both elements are present and decision is impossible if the absence of one or the other is essential thereto.'"The option was renewed in the 1939 employment agreement, but the option price was reduced to the then market price of $ 1.50 at petitioner's request as part of the terms of renewal. This supports the view that the option was compensatory in nature, being granted as part of the consideration to enable the company to further retain petitioner's services. It may be added that there is no evidence that the adverse 862 efforts of the antagonistic director had continued after the execution of the 1936 contract.Since we believe that the option was compensatory in nature prior to the execution of the 1944 contract, 276 we next consider the effect of that contract on the nature of the option. The 1944 contract modified the option to give petitioner the right to exercise the then unexercised portion of the 30,000-share option at any time during the succeeding 5 years regardless of whether or not he was employed by the corporation at the time of exercise. It also preserved the option to his personal representatives or committee in favor of his wife or next of kin in the event of his death or judicially declared incompetency within the period provided in the contract. The exercise of the option in 1947, here in issue, occurred after petitioner had resigned as president of the company but while he was serving in an advisory capacity for which he was receiving substantial compensation.Petitioner (although, of course, arguing that the option was proprietary) has vigorously maintained that the changes made with respect to the option in the 1944 contract did not in any way alter its nature. As already indicated, it is our view that the option was compensatory, but we agree that the 1944 contract did not change its nature.It should be noted that the option was renewed in 1944 as part of the contract 277 by which petitioner's services were retained for an additional term, and that the option price of $ 1.50 per share contained in the preceding contract was continued. In the light of the background of the previous contracts, and in the absence of any indication to the contrary, we think that the inference is again clear that the renewed option, including the terms expanded for petitioner's benefit, was granted in order to enable the company to retain for the future services which had proved valuable in the past.We are thus convinced upon consideration of all of the facts in the record that the option was granted to petitioner in 1944 as compensation, in addition to the salary and percentage of net earnings provided for in the contract of employment.We add that we attach no significance to the treatment by the corporation of petitioner's exercise of the option in 1944 and 1947 in its original returns for those years or its later reversal of that position in its amended returns. Harold E. MacDonald, supra;Philip J. LoBue, supra.Petitioner contends, however, that respondent is now estopped from asserting that the option is278 compensatory. He argues that respondent "acquiesced" in treating the option as proprietary in nature with respect to the exercises of portions of the option on August 9, 1940, and January 28, 1944. Although it appears from statements by petitioner's counsel that respondent did not challenge petitioner's failure to report income from those two exercises made during the 863 term of the 1939 contract, there is no evidence of this, or any other form of acquiescence, in the record. Accordingly, the issue raised by petitioner's contention is not actually before us. Assuming, however, that respondent did fail to challenge petitioner's omission of such gain in his 1940 and 1944 returns, we think it is clear his failure to take affirmative action does not give rise to an estoppel situation analogous to that present in either Stockstrom v. Commissioner (C. A., D. C. Cir., 1951) 190 F.2d 283">190 F. 2d 283, or Vestal v. Commissioner, (C. A., D. C. Cir., 1945) 152 F. 2d 132, relied on by petitioner, and therefore we are not called upon to determine whether these two cases will be followed by us. For completeness, we mention that279 the assertion made on petitioner's behalf that respondent had "conceded" that the option was proprietary under the 1936 and 1939 contracts is not supported by anything in the record, and is denied by respondent.As an alternative contention, petitioner argues that, if the 1944 option is compensatory in nature, it constituted additional compensation to petitioner on January 19, 1944, when it was granted to him, and not in 1947 when it was partly exercised. He advances the proposition that the additional compensation realized by him in 1944 was the option-day spread, that is, the difference between the option price and the fair market value of the number of shares of stock subject to the option on the day the option was granted.It is our view that, upon the record, the option itself had no fair market value at the time of the execution of the 1936 and 1939 contracts or on January 19 and February 1, 1944, being respectively the date of execution and the effective date of the 1944 contract. We think this is apparent upon the record without discussion insofar as the 1936 and 1939 contracts are concerned, since the market price and option price were the same when the respective agreements280 were made. Our view is less apparent as to 1944, and requires an analysis of the relevant facts.In determining the value, if any, of the option as of January 19 and February 1, 1944, we must recognize the fact that the option was exercisable but not then transferable. Petitioner received the option itself, not the stock which he might then have acquired by its exercise. While there is some confusion in the record as to the number of shares then subject to the option, it is clear that the number was not less than 20,000. Petitioner's expert witness testified that while the list price of the stock was 2 5/8, the number of shares subject to the option was so substantial, and the trading so light, that, applying the blockage principle, so large a number of shares would have brought $ 2 per share or possibly less. It should be noted, however, that all of his views were expressed in answer to questions assuming that only 10,000 shares were under consideration. In fact, the option then applied to not less 864 than 20,000 shares, and there can be no doubt from the supporting reasons offered by the witness that if he had had 20,000 shares in mind, he would have determined the 281 value to be materially less. Remembering that petitioner could not assign the option itself, and that if he desired to realize upon it, he would have been required first to invest not less than $ 30,000 in exercising the option, and then sell under conditions in which the application of blockage principles rendered the yield conjectural at best, we must hold that there is no basis in the record for assigning a fair market value to the option itself, or, for that matter, for assigning a fair market value in excess of the option price to the 20,000 shares then covered by it, as of either January 19 or February 1, 1944. See John C. Wahl, 19 T. C. 651, 658; Harold H. Kuchman, 18 T. C. 154, 163.It is our view, upon analyzing the circumstances surrounding the granting or extension of the option in January 1944 and the exercise of the option, that it was intended that petitioner should receive compensation, and that he did receive compensation, at the time of the exercise of the option rather than at the time it was granted. With respect to the issue before us, therefore, compensation was received upon the exercise of the option282 in 1947 as to the 10,000 shares then remaining subject to the option.In Commissioner v. Smith, supra, the Supreme Court said, in part (324 U.S. at p. 179):Since the Tax Court found that the market price of the stock on the date of the option did not exceed the option price, it is evident that its finding that the option was given as compensation for respondent's services, had reference to the compensation to be derived from exercise of the option after the anticipated advance in market price of the stock.Later (p. 181), the Court added the following:In certain aspects an option may be spoken of as "property" in the hands of the option holder. Cf. Helvering v. San Joaquin Fruit & Investment Co., 297 U.S. 496">297 U.S. 496, 498, 56 S. Ct. 569">56 S. Ct. 569, 570, 80 L. Ed. 824">80 L. Ed. 824; Shuster v. Helvering, 2 Cir., 121 F.2d 643">121 F. 2d 643, 645. When the option price is less than the market price of the property for the purchase of which the option is given, it may have present value and may be found to be itself compensation for services rendered. But it is plain that in the circumstances283 of the present case, the option when given did not operate to transfer any of the shares of stock from the employer to the employee within the meaning of § 22 (a) and Art. 22 (a)-1. Cf. Palmer v. Commissioner, 302 U.S. 63">302 U.S. 63, 71, 58 S. Ct. 67">58 S. Ct. 67, 70, 82 L. Ed. 50">82 L. Ed. 50. And as the option was not found to have any market value when given, it could not itself operate to compensate respondent. [Emphasis supplied.]We think that the principles so announced by the Supreme Court in analyzing the issues in Commissioner v. Smith, supra, support the inferences which we have drawn from the circumstances surrounding the granting or extension of the option in the instant case under all three contracts, together with the circumstances of the final exercise 865 of the option in 1947. See John C. Wahl, supra, 19 T. C. at pp. 657, 658. In the resolution of the problem presented by this case we are not called upon to consider whether the reversal of Harley V. McNamara, 19 T. C. 1001, by the Court of Appeals for the Seventh Circuit, 210 F. 2d 505,284 will be followed by this Court, since the facts taken by the Court of Appeals in that case to be controlling and assumed by that court to have been established by the record differ materially from the facts in the instant proceeding. In that case the Court of Appeals took the facts to be that the option was "an assignable right to buy the stock at a bargain price," which could have been "promptly sold for a substantial profit," that the value of the option at the time it was granted was substantial and ascertainable, and that the value of the option when granted was intended by the parties to be compensation at that time. Here the option was specifically non-assignable, its value at the time when it was granted was unsubstantial and not readily ascertainable, and we have concluded on the entire record here presented that the parties did not intend that the option when granted was to be compensation at that time.Respondent determined that petitioner realized compensation upon his exercise of the option in 1947 in the amount of $ 27,500. This figure is equal to the difference on 10,000 shares between the option price of $ 1.50 per share and $ 4.25 per share, the price on the New285 York Curb Exchange on the date of exercise. Petitioner, on the other hand, contends that blockage principles must be applied in determining the fair market value of the stock on the date of exercise, and that the fair market value of 10,000 shares of the Sonotone Corporation common stock on November 3, 1947, was only 2 7/8. Petitioner introduced expert testimony to the effect that if 10,000 shares of this stock were offered for sale "at the market" on that day they would have been sold at an average price of 2 7/8. We find ourselves unable to accept this testimony as conclusive.The market situation as to Sonotone Corporation common stock was quite different in 1947 than it was in 1944. The stock was in greater demand, trading in it was more active, and daily sales in excess of 2,000 shares were absorbed on two occasions without any drastic adverse effect. During the period from October 24, 1947, through November 13, 1947, 11,300 shares of Sonotone Corporation common stock were traded on the New York Curb Exchange. The last sale price on both the opening and closing days of that period was 4 1/4. The high sale price during that period was 4 3/8 on October 27, 1947, when 2,100286 shares were traded. The low sale price during that period was 4 on October 29, 1947, when 2,500 shares were traded.We agree with the expert witness that an offering of 10,000 shares of the stock within a limited period would have had an adverse effect 866 on the price, but the actual performance of the stock convinces us that the witness was too pessimistic. Applying our own judgment to the evidence in the record, we hold that 10,000 shares of Sonotone Corporation common stock could have been sold within a reasonable time, at about November 3, 1947, for $ 3.75 per share. See Harley V. McNamara, supra, 19 T. C. at p. 1012, reversed on other grounds 210 F.2d 505">210 F. 2d 505.Petitioner therefore realized compensation upon his exercise of the option in 1947 in an amount equal to the excess of the fair market value of the stock over the option price, or $ 22,500. Commissioner v. Smith, supra.The Farm Issue.Petitioner purchased Beech Hill Farm, at Ashland, New Hampshire, in 1940 for $ 6,000. The farm consisted of about 235 acres of land and a farmhouse and storeroom which were connected 287 to a barn. In addition, there were a large chicken house and a large shop both of which were located a short distance from the main building. The structures were all in a dilapidated condition at the time of the purchase, and petitioner expended over $ 35,000 during the following 2 years to reconstruct and remodel them.Farming operations were conducted on the farm at all times after 1940, and for each taxable year thereafter through 1952, the farm suffered losses. For 1953, however, farming operations resulted in a profit of $ 357.46. The years involved in the instant case are 1947 through 1951, and respondent has determined that the losses reported for those years are not deductible under the provisions of the Internal Revenue Code. He contends that the farm was acquired as a country place for pleasure and later for petitioner's personal residence. We disagree with respondent's determination, and we have found as a fact that the petitioner's farming operation during the years here involved was a business regularly carried on by him for profit. Upon the facts presented, the losses in question are therefore deductible for income tax purposes. The reasons for our view are set288 out below.Petitioner and his family did not reside permanently on the farm until October 15, 1949. Prior thereto, except during two vacations and the summer of 1947 when petitioner lived on the farm, he visited it only on occasional holidays and weekends. At these times, petitioner did not use it for entertainment, recreational purposes, or as a hobby. The few occasions on which he took guests with him to the farm were for his convenience in the discussion of business affairs. He had no facilities for the entertainment of guests, business associates, or customers. Until 1946, petitioner resided on his estate in Rye, New York, which he used for extensive entertainment. After 1946, 867 until he moved to the farm in 1949, he and his family lived in a large apartment in Hartsdale, New York.When asked at the hearing of the instant case why he acquired the farm, petitioner testified as follows:I had the idea that sometime I wanted to retire, and I wanted to build up something in the way of security for the future. And I believed the method to do that was by a farm.And in 1940 when the war situation was on, it looked to me like that would be an opportune time to acquire 289 a farm and build it up over a period of the years and have it on a profitable basis for the time I wished to retire.Petitioner subsequently clarified these statements by testifying that he had expected the farm to make a profit from the beginning and that he had expected profits to increase until the time he was ready to retire. He also testified that he believed that a piece of productive farm property would provide him with economic security regardless of future changes in the economic situation. While eventualities demonstrated that he was overoptimistic, we are convinced that petitioner operated the farm with a profit motive. Furthermore, as already indicated, the elements of hobby and recreation were not a part of his objectives.Petitioner himself had not had any previous farming experience, but after purchasing the farm he sought advice and counsel from neighboring farmers and official agencies. He also subscribed to various farm publications. Since he was completely occupied by his duties in New York with the Sonotone Corporation until the end of 1946 and thereafter until 1949 with the Carry-Cab Corporation, petitioner was unable directly to supervise the farming operations. 290 After buying the farm, however, he hired a farmer, whom he then believed was able and experienced, to live on the farm and operate it. Petitioner supplied the tools, machinery, and equipment for use on the farm. By 1945, petitioner had become dissatisfied with the first farmer and he replaced him with another who he felt was better qualified. In his effort to raise a profitable crop, petitioner shifted emphasis during the years from one to another of various products including pigs, dairy products, apples, and potatoes, although in fact, despite his shifting of objectives, each such venture proved financially unsuccessful until 1953 when the farm produced a net profit for the first time. (During 1952 the second farmer was replaced by a third in whom petitioner evinced great confidence.) It may be added that he at no time indicated that he was attempting, as a hobby, to raise prize cattle or other prize products.After October 15, 1949, petitioner and his family resided on the farm. He subsequently devoted much of his time to theBelmar Electric Corporation located in nearby Tilton, New Hampshire. Petitioner 868 is the president of this company which makes incandescent291 lamp sockets. Although his household was supplied with some of the farm's produce both before and after the family moved there, petitioner charged himself for that produce on the books maintained for the farm.Upon consideration of all of the facts, we believe that the farm was operated on a commercial basis and not for petitioner's recreation or pleasure or as an outlet of any desire for a hobby. Respondent, however, argues that the long series of losses sustained by petitioner on the farm indicate that he had no actual intention of making a profit. We have held that such circumstances are not controlling "if other evidence shows there is a true intention of eventually making a profit." Norton L. Smith, 9 T. C. 1150, 1155 (1947). In the instant case, the evidence before us convinces us that the farm was operated by petitioner during the years here involved as a business regularly carried on by him for profit, although there was no net profit until 1953.The notices of deficiency issued by respondent in the instant case make the general determination that the farm losses292 for the years 1947 through 1951 "are not deductible under the provisions of the Internal Revenue Code." There is no determination by respondent that any of the expenses which were factors in computing the farm loss for any of the years in question were not ordinary and necessary in carrying on the farming business. Our examination of the record discloses no basis for disallowing any of the farm expenses deducted by petitioners in the returns as filed.Statute of Limitations.Petitioner contends that this proceeding is barred with respect to the year 1947 by the provisions of section 275 (a) of the 1939 Code because the notice of deficiency dated November 4, 1953, was not sent to him within 3 years after the return for that year was filed. He concedes, however, that his execution on January 27, 1953, of a consent to extend the period of time for assessment to June 30, 1954, removes the bar of the statute if section 275 (c) of the 1939 Code is applicable in the instant case to permit determination of a deficiency within 5 years of the filing of the return. That section is applicable "if the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 per centum of the amount of gross income stated in the return, * ." 293 The record fully substantiates an affirmative finding that taxpayer omitted from his 1947 return gross income in excess of 25 per centum of gross income as reported. Petitioner reported gross income of $ 16,613.72 for the year in question. Since we have found that petitioner received taxable income in the amount of $ 22,500 in that year 869 upon the exercise of his option to purchase 10,000 shares of Sonotone stock at $ 1.50 per share, and since this income was omitted from and exceeded 25 per centum of his reported gross income, section 275 (c) is applicable to the instant case. Accordingly, we hold that the proceeding is not barred by limitations for the year in question.Petitioner argues, however, that he did not omit the above amount from his gross income within the meaning of that section because he "had completely disclosed his Sonotone stock option transactions on his tax returns." He cites in this respect Uptegrove Lumber Co. v. Commissioner, (C. A. 3, 1953) 204 F. 2d 570. In that case, the court held that the phrase "omits from gross income" in section 275 (c) is limited in effect to a failure to include some receipt or accrual294 in the computation of gross income rather than to an understatement of gross income due, for example, to an overstatement of cost of goods sold. It did not hold, however, that a general disclosure that transactions had occurred was sufficient compliance with the statute where the income or gain from such transactions was not included in gross income. Petitioner's 1947 return does not include in the computation of gross income any part of the taxable income received by petitioner in that year as a result of the exercise of his option. There is no direct mention of the exercise of the option or the purchase of the stock in the 1947 return. While the stock option transactions are factors in returns for later years in which gains arose from subsequent sales of the stock acquired in 1947, there is nowhere any act or disclosure which could be deemed an inclusion in gross income under the rule of the Uptegrove case or any other authority which has come to our attention.While our own construction of section 275 (c) has not, in all respects, been in accord with that set forth in the Uptegrove opinion, the area of difference has not been on the issue raised by petitioner in the*295 instant case. We therefore have no occasion here to enter into any discussion of the differing perspectives.Decisions will be entered under Rule 50. Footnotes1. Following proceedings are consolidated herewith: Dean Babbitt, Docket No. 51515; Dean Babbitt and Estelle Babbitt (husband and wife), Docket Nos. 51516, 51517, and 51518.↩2. Petitioners' counsel states in the brief that petitioner also acquired 4,000 shares under this option on August 9, 1940.↩3. Petitioners' counsel stated at the hearing of the instant case that petitioner paid the 1944 deficiency under protest and that suit for refund is now pending in the United States Court of Claims.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621059/	Leonard T. Fielding and Lois C. Fielding, Petitioners v. Commissioner of Internal Revenue, RespondentFielding v. CommissionerDocket No. 2557-69United States Tax Court57 T.C. 761; 1972 U.S. Tax Ct. LEXIS 169; March 13, 1972, Filed 169 Decision will be entered for the respondent. After completing medical school and his internship petitioner entered into an agreement with the Department of Public Welfare of the State of Minnesota which provided him with educational allowances while he undertook a 3-year residency in psychiatry. In order to receive the allowances, petitioner had to promise the Department that he would enroll in an accredited residency program and that he would become an employee of the Department for a 2-year period following completion of his residency. Held, petitioner cannot exclude the allowances as a scholarship or fellowship under sec. 117. Held, further, petitioner cannot deduct tuition expenses as a trade or business expense under sec. 162 during the years in question. Edward M. Cohen, for the petitioners.Richard J. Hunter, for the respondent. Irwin, Judge. IRWIN761 Respondent determined the following deficiencies in the income taxes of petitioners: 762 YearDeficiency1963$ 455.4019641,693.3119651,572.54The deficiencies stem from respondent's inclusion in gross income of amounts that petitioners excluded as a fellowship under section 117, and from respondent's disallowance of deductions for tuition expense and his recomputation of petitioners' medical expense deductions.FINDINGS OF FACTSome of the facts have been stipulated and they are found accordingly.Leonard T. Fielding and Lois C. Fielding are husband and wife, who at the time of filing their petition maintained their legal residence in Minneapolis, Minn. They filed joint Federal income tax returns for the years 1963, 1964, and 1965 with the district director of internal revenue, St. Paul, Minn.Lois C. Fielding is a party to this action solely by reason of her having filed a joint Federal income tax return with Leonard T. Fielding for each of the taxable171 years 1963, 1964, and 1965. Leonard T. Fielding will be hereinafter referred to as the petitioner.Petitioner received his bachelor of science degree in 1958 from the University of Minnesota and his doctor of medicine degree from the University of Minnesota Medical School in 1962. Following the completion of medical school in 1962, petitioner applied for and was accepted as an intern at the Hennepin County General Hospital, Minneapolis, Minn. Petitioner's internship terminated in June 1963.At all times material herein the Department of Public Welfare for the State of Minnesota, hereinafter called Department, had an established professional training program known as the Psychiatric Residency Training Program, which it maintained for the purpose of alleviating the scarcity of applicants for the positions as psychiatrists in State mental hospitals.On or about May 20, 1963, petitioner applied to Department seeking admission to Department's residency program. On May 23, 1963, petitioner entered into an agreement with Department, part of the terms of which were the following:Whereas, the Department desires to have LEONARD T. FIELDING, M.D., educated and trained as a psychiatrist 172 to fill a position as a psychiatrist in the State Mental Hospitals when such education and training is completed;Now, Therefore, It Is Hereby Agreed by and between the parties as follows:1. The psychiatric resident hereby applies to the Department for an educational allowance to be used in training as a psychiatrist and agrees to enter an accredited training program with inpatients and outpatients at the University of 763 Minnesota, Minneapolis, Minnesota, commencing July 1, 1963, pursuing such courses, training and education as is directed by the Department for a period of three (3) years, hereinafter referred to as the first, the second, and the third years. The psychiatric resident further agrees that at some time after the conclusion of such education and training, he will accept a position as a psychiatrist with the State of Minnesota in a State Hospital or in some other professional capacity for which he has been trained, as determined by the Department, for a period of not less than two (2) years.2. The Department hereby grants to the psychiatric resident the sum of Eight Thousand Dollars ($ 8,000) for the first year, Eight Thousand Five Hundred Dollars ($ 8,500) for173 the second year, and Nine Thousand Dollars ($ 9,000) for the third year, payable in monthly installments.3. The Department reserves the right to cancel this Agreement at any time if it appears the program and training of the psychiatric resident is not satisfactory.4. Failure of the psychiatric resident to satisfactorily make progress in his training as determined by the Department or his failure to complete the five (5) year program as herein provided shall constitute a breach of this Agreement.5. In the event of any breach of this Agreement, the psychiatric resident agrees to refund to the Department all moneys received by him as an education allowance under this Agreement.Pursuant to the terms of the agreement, in July 1963 petitioner enrolled at the University of Minnesota Medical School, Department of Psychiatry and Neurology, as a degree candidate for the academic degree of master of science in psychiatry.While a resident in Department's psychiatric residency training program, petitioner was paid an educational allowance for each of the taxable years 1963, 1964, and 1965 by Department in the amounts of $ 4,000.02, $ 8,000, and $ 8,500, respectively. The educational allowances174 bore no relationship whatsoever to the need or marital status of petitioner at any material time and the allowance was not peculiar to petitioner. At no time did Department deduct or withhold income taxes, social security taxes, or State employees' retirement funds from the allowances paid to petitioner while enrolled in the psychiatric residency training program, nor did petitioner accrue vacation or sick leave, participate in the employee group health and life insurance plan or any other programs for which employees of Department were eligible during the period of residency.Throughout his residency petitioner made no reports at all to Department. Petitioner had no visits and no direct or indirect supervision from Department for the same period although under the agreement Department had the right to exercise such supervision.Petitioner was not an employee of Department prior to the execution of the agreement, nor did he become an employee of Department during his residency training program which ended on June 30, 1966. On July 1, 1966, petitioner was employed by Department as a senior staff physician at the Anoka State Hospital and remained there 764 through December 175 29, 1966. On January 9, 1967, Department employed petitioner as the senior staff physician at the Willmar State Hospital. Petitioner remained at Willmar State Hospital through May 5, 1967, when he resigned and moved to the State of Delaware, where he was employed by the State of Delaware as a senior staff physician until June 1, 1968, when he returned to the State of Minnesota.The State of Minnesota has taken no legal action, nor has the State of Minnesota attempted to legally enforce the provisions of the agreement with regard to the reimbursement of any funds received by petitioner in the event of a breach of the agreement. A majority of the students who had participated in the psychiatric residency program fulfilled their obligation of 2 years of work for the State after completion of the residency, and the State had never taken any legal action against any student who breached his agreement.Upon his return to Minnesota in June 1968, petitioner began to engage in the private practice of psychiatry; however, he did perform work for the State as a consultant for various institutions. Petitioner was paid on a daily or hourly basis under contracts with the State for each institution. 176 The director of personnel for Department indicated that Department considered the consulting work performed by petitioner to be in partial fulfillment of his obligation to the State. In all instances petitioner was paid the same amount of wages or fees for his services to the State that would have been paid to any other doctor with the same training and experience who had not received educational allowances from the State.OPINIONThis case is yet another involving a physician who has excluded grants received during his residency as a scholarship under section 117 of the Internal Revenue Code of 1954 and has been challenged by respondent. This case differs both from other section 117 cases that we have found in that petitioner performed no services for the grantor prior to receiving his purported fellowship and from other cases involving resident physicians in that petitioner performed no services for the grantor while receiving the purported fellowship. Bingler v. Johnson, 394 U.S. 741 (1969); Ussery v. United States, 296 F. 2d 582 (C.A. 5, 1961); and Aloysius J. Proskey, 51 T.C. 918">51 T.C. 918 (1969).177 The only string attached to the grants in addition to enrollment in an accredited program was that petitioner had to work for the grantor for 2 years at some time after completing his residency. For this work he was to be paid the same salary that any other doctor with similar training would receive for performing similar services for the State.Despite these differences, we believe that respondent properly included 765 the fellowship grants in petitioner's income for the years in issue.With limitations in the case of nondegree students section 117 permits an individual to exclude from gross income any amount received as a scholarship or fellowship. The terms scholarship and fellowship are not defined by the statute; however, section 1.117-4, Income Tax Regs., defines them in a negative manner:Sec. 1.117-4 Items not considered as scholarships or fellowship grants.The following payments or allowances shall not be considered to be amounts received as a scholarship or a fellowship grant for the purpose of section 117: * * (c) Amounts paid as compensation for services or primarily for the benefit of the grantor. (1) Except as provided in paragraph (a) of § 1.117-2, 178 any amount paid or allowed to, or on behalf of, an individual to enable him to pursue studies or research, if such amount represents either compensation for past, present, or future employment services or represents payment for services which are subject to the direction or supervision of the grantor.(2) Any amount paid or allowed to, or on behalf of, an individual to enable him to pursue studies or research primarily for the benefit of the grantor.However, amounts paid or allowed to, or on behalf of, an individual to enable him to pursue studies or research are considered to be amounts received as a scholarship or fellowship grant for the purpose of section 117 if the primary purpose of the studies or research is to further the education and training of the recipient in his individual capacity and the amount provided by the grantor for such purpose does not represent compensation or payment for the services described in subparagraph (1) of this paragraph. * * Any doubt concerning the propriety of the definitions contained in the regulation was eliminated by the Supreme Court in Bingler v. Johnson, supra, which stated:Here, the definitions179 supplied by the Regulation clearly are prima facie proper, comporting as they do with the ordinary understanding of "scholarships" and "fellowships" as relatively disinterested, "no-strings" educational grants, with no requirement of any substantial quid pro quo from the recipients. [394 U.S. at 751.]Upon the record in this case we believe that the State granted petitioner the educational allowance in consideration of his promise of 2 years' future work for the State. Petitioner has not argued that his agreement with the State was not enforceable, nor do we think it material that the State failed to take legal action against him when he breached his agreement. We believe that petitioner owed an enforceable obligation to the State which constituted a sufficient string upon the grants under the regulation and Bingler v. Johnson, supra, to disqualify them for exclusion under section 117.Notwithstanding the regulation and Bingler v. Johnson, petitioner contends that our decision in Aileene Evans, 34 T.C. 720 (1960), controls in this case. In Lowell D. Ward, 55 T.C. 308 (1970),180 affd. 449 766 F. 2d 766 (C.A. 8, 1971), this Court held that we would no longer follow Aileene Evans, supra. See also Robert W. Willie, 57 T.C. 383">57 T.C. 383 (1971). Even if Evans remained sound precedent, our former case can be distinguished from the present one. The petitioner in Evans was a registered nurse who accepted a grant from the State of Tennessee which enabled her to enroll in a psychiatric nursing program. The petitioner agreed to work for the State for a certain time after completing her course of study. Though these facts appear to resemble those of the present controversy, Evans can be distinguished because the amount of the grant that the petitioner there received was determined solely by her financial needs. That fact led us to find on the record that the primary purpose of the grant was to further petitioner's education and that the promise of future services was only an incidental benefit to the State. Aileene Evans, supra at 726. In this case the amount of the grant bore no relation to petitioner's financial needs and was set at 181 a figure that Department felt would attract students into the program. The primary purpose of the Minnesota program was to recruit new psychiatrists; the grants to petitioner were primarily for the benefit of the grantor.Accordingly, we hold that petitioner may not exclude any part of the educational allowances received from Department during the years in issue as a scholarship under section 117.In addition to excluding the amounts received from the State, petitioner also deducted as a business expense his payments for tuition during the years in issue. He now argues for these deductions only as an alternative to the scholarship exclusion. Petitioner contends that, if the educational grants are considered to be compensation for future employment paid by Department, his training in psychiatry was a requirement of this employment.First, in denying petitioner the benefits of section 117, we have not held that he was an employee of Department, but we have found that the educational allowances simply did not constitute a scholarship. Second, even if the allowances were compensation, we can find no moral or legal reason for giving petitioner tax benefits not enjoyed by other students182 in professional training who work to defray the cost of their education.After finishing his internship petitioner did not engage in a profession but could have engaged in the general practice of medicine without further education or training. He did not undertake his residency to improve his skill as a general practitioner but to attain a new profession. Compare John S. Watson, 31 T.C. 1014">31 T.C. 1014 (1959). Petitioner's tuition expenses were clearly not an incident of any profession that he practiced and are not deductible under section 162. See sec. 1.162-5, Income Tax Regs. (1958), and sec. 1.162-5, Income Tax Regs. (1967).*767 Our disallowance of petitioner's exclusions under section 117 and deductions under section 162 will require the adjustments to petitioner's medical expense deduction set forth in the statutory notice.Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621060/	APPEAL OF KANSAS MILLING CO.Kansas Milling Co. v. CommissionerDocket No. 2835.United States Board of Tax Appeals3 B.T.A. 709; 1926 BTA LEXIS 2581; February 13, 1926, Decided Submitted July 15, 1925. 2581 The taxpayer's books of account showed payments for additions and improvements as expenses. By reason thereof the reserve set up for depreciation was less than the amount of depreciation actually sustained. Held, that, upon all the evidence, the invested capital shown by the taxpayer on its books should not be adjusted either for capital additions or depreciation in prior years. Appeal of Cleveland Home Brewing Co.,1 B.T.A. 87">1 B.T.A. 87. P. J. Barnes, C.P.A., and O. R. Abel, C.P.A., for the taxpayer. Arthur H. Fast, Esq., for the Commissioner. SMITH 709 Before LITTLETON, SMITH, and TRUSSELL. This appeal is from the determination of a deficiency in income and profits tax for the year 1917 in the amount of $63,080.82. FINDINGS OF FACT. The taxpayer is a Kansas corporation, with its principal office at Wichita. It was organized in 1907 and is engaged in the manufacture of flour and grist mill products. It is a close corporation, its stock having always been held by a small group of individuals. Two flour and grist milling plants are operated by the taxpayer, one of which is located at St. John, Kans., and the other2582 at Wichita. During the period 1907 to and including the year 1916, certain sums expended for additions, betterments, renewals, and replacements, but not all such expenditures, were charged to current opperating expenses rather than to capital accounts. However, depreciation, specifically as such, was not charged off on the books uniformly at stated periods, it being the opinion of the directors and officers that the additions, betterments, renewals, and replacements, which were annually being charged to current operating expenses, were sufficient to offset any depreciation which was taking place. On December 31, 1916, the plant and all other fixed assets, exclusive of land, appeared on the taxpayer's books at an aggregate value of $364,894.87. Against this value there appeared a reserve for depreciation in the total sum of $19,324.19. As the result of an examination of the taxpayer's books of account by a revenue agent and the recommendations of that officer, the Commissioner, for the purpose of computing the taxpayer's invested capital, increased the book values of the plant and fixed assets by the aggregate amount of $47,172.69. This latter sum represented the aggregate2583 cost of additions, betterments, renewals, and replacements, which the revenue agent was able to identify as such, which 710 had been charged to current operating expenses from 1907 to 1916, inclusive. At the same time and for the same purpose, the Commissioner increased the reserve for depreciation, as it appeared on the books, from $19,324.19 to $98,681.59, an increase of $79,357.40. Thus the Commissioner has reduced the surplus as shown by the books, for the purpose of computing invested capital, by the net amount of $32,184.71. The reserve for depreciation as computed by the Commissioner, in the sum of $98,681.59, results from an application of the straight-line theory of depreciation from 1907 to the end of 1916. In computing the deduction from gross income to which this taxpayer is entitled on account of depreciation of physical assets, the Commissioner failed to provide for any depreciation sustained with respect to the physical properties comprising the plant at Saint John, Kans. This appears to be an inadvertence, brought about by the fact that the properties comprising this plant are not carried in the regular property accounts, but are carried in a separate2584 account on taxpayer's books denominated "St. John Investment Account." The nature of this account was not made known to the revenue agent whose depreciation schedules were made the basis for the Commissioner's allowance for depreciation. The property comprising this plant and the cost thereof are as follows: Ice plant$11,000Manager's residence3,000Machinery46,000Building15,000Total$75,000The ice plant had a useful life of 10 years; the manager's residence, 20 years; the machinery 10 years, and the building 20 years. DECISION. The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 15 days' notice, in accordance with Rule 50. OPINION. SMITH: In its petition the taxpayer alleges that the deficiency is predicated, in part, upon the following errors: (a) That the Commissioner has arbitrarily reduced the invested capital shown on the taxpayer's books of account, without adducing 711 affirmative evidence that such books of account overstated the amount of invested capital within the meaning of the tax statutes. (b) That the Commissioner has not allowed the2585 taxpayer a reasonable allowance for the exhaustion, wear and tear of property arising out of its use or employment in the business. (c) That the Commissioner erred in computing its excess-profits-tax liability for the year 1917 under the provisions of section 201 of the Revenue Act of 1917, whereas, in view of existing circumstances, such determination should have been made under the provisions of section 210. The first allegation of error is directed toward the Commissioner's action in rejecting, for invested capital purposes, the reserve for depreciation as shown by the taxpayer's books and substituting therefor a reserve of a considerably greater amount, thereby materially reducing taxpayer's invested capital. The evidence before us indicates that at January 1, 1917, the taxpayer had accrued on its books a reserve for depreciation in the sum of $19,324.19; that, in addition to this reserve, the taxpayer from 1907 to the close of 1916, had charged as current operating expense certain capital expenditures in lieu of charging off depreciation, specifically as such, annually at uniform rates; that of the capital expenditures charged to operating expense the revenue agent2586 was able to identify items totaling $47,172.69, and this amount the Commissioner restored to the asset accounts and to invested capital; and that, by the application of a mathematical formula to property costs, based upon the straight-line theory of depreciation, going back to the date of taxpayer's organization, the Commissioner has determined that the reserve for depreciation at the beginning of the taxable year 1917 should be stated in the sum of $98,681.59. We can not approve the Commissioner's action in this respect. It appears from the facts that, from 1907 to the end of 1916, the taxpayer took depreciation upon its books as such in the amount of $19,324.19, and in addition thereto expended at least the amount of $47,172.69 in betterments and additions which were not capitalized. The question here involved is the determination of the invested capital of this taxpayer as of January 1, 1917. For that purpose the Commissioner has, on the one hand, added the above amount of $47,172.69 to capital items, and, on the other hand, has applied straight-line depreciation to the taxpayer's assets from 1907 to 1917. The facts are thus not substantially different from the facts in the2587 . In that appeal we said (p. 91): Depreciation, we have already said, is a question of fact. Congress has allowed taxpayers "a reasonable allowance for * * * wear and tear of 712 property used in the trade or business" as a deduction from income, to make whole their capital investments before levying a tax upon that income. The Commissioner in this case asks us to accept a readjustment of taxpayer's invested capital upon a mere assumption that the property of this taxpayer was reasonably depreciable at certain arbitrary rates and in equal annual amounts over a period of 11 completed years. No evidence is offered that the alleged depreciation has actually occurred. None is even offered that property of the kind here in question usually deteriorates at approximately the rates used in the computations of the examining agent. Upon the record so made, we must sustain the position of the taxpayer. The evidence before us discloses that the amount charged off its books by the taxpayer against its physical assets, both in the reserve and in capital expenditures charged to expense, was substantial. 2588 There is no evidence before us that such assets suffered any greater depreciation than the amount so charged off, or that the Commissioner's computation is more nearly correct than the taxpayer's. In these circumstances, we are of the opinion that no change should be made either in the asset accounts or in the depreciation reserve as they stand in the taxpayer's books as of January 1, 1917. ;; ; . As pointed out in our findings of fact, the deduction for depreciation which the Commissioner has allowed the taxpayer for the year 1917 does not include any allowance for depreciation of the physical properties comprising the plant located at St. John, Kans. Any part of the deficiency occasioned by the failure of the Commissioner to make such an allowance is in error. The costs of the properties comprising this plant are set out in our findings of fact. We conclude that those costs should form the basis for the determination of a reasonable allowance*2589 for depreciation, computed at the following rates: Ice plant, 10 per cent; manager's residence, 5 per cent; machinery, 10 per cent; building, 5 per cent. In support of its allegation of error, that the Commissioner erred in determining its excess-profits tax under the provisions of section 201 of the Revenue Act of 1917, when, under the existing circumstances, such determination should have been made under the provisions of section 210, the taxpayer contends that its invested capital can not be satisfactorily determined. We are unable to find, from any evidence which has been presented to us, that the invested capital is not susceptible of accurate ascertainment, or that the invested capital as determined by the Commissioner, subject to adjustment in accordance with this opinion, is not correct.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621061/	BERNARD LEON GOLDENBERG, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentGoldenberg v. CommissionerDocket No. 13262-78.United States Tax CourtT.C. Memo 1981-589; 1981 Tax Ct. Memo LEXIS 156; 42 T.C.M. (CCH) 1397; T.C.M. (RIA) 81589; October 8, 1981. Bernard Leon Goldenberg, pro se. Bernard S. Mark, for the respondent. FORRESTERMEMORANDUM FINDINGS OF FACT AND OPINION FORRESTER, Judge: Respondent has determined a deficiency in petitioner's Federal income tax and additions to tax pursuant to section 6653(b) 1 as follows: 157 Taxable YearDeficiencyAddition to tax (sec. 6653(b))1968$ 400,046$ 200,023The issues for decision are: (1) whether petitioner understated his taxable income for 1968 in the amount of $ 518,414 with respect to certain stock dealings; (2) whether petitioner properly reported gains and losses from sales or exchanges of certain property on his joint income tax return for 1968; (3) whether petitioner is entitled to a deduction for various business expenses for 1968 in excess of amounts allowed by respondent; and (4) whether petitioner is liable for an addition to tax for fraud pursuant to section 6653(b) for 1968. FINDINGS OF FACT Some of the facts have been stipulated and are so found. Petitioner resided in New York, New York, at the time the petition herein was filed. He and his wife, Bridgette Goldenberg, timely filed their 1968 joint Federal income tax return with the appropriate office of the Internal Revenue Service. 2During the mid-1960's petitioner was a merger and acquisition specialist employed by First Standard Corporation (hereinafter First Standard), of which158 he was also a shareholder. First Standard was a publicly held corporate shell which engaged in no business. Its only assets were cash and a patent for a prototype video tape machine. In 1967 petitioner arranged a merger of First Standard and Mastercraft Electronics Corporation (hereinafter Old Mastercraft), which was engaged in the business of importing consumer electronic products and possessed the wherewithal to manufacture and distribute First Standard's video tape recorder. H. John Gluskin (hereinafter Gluskin) was secretary of Old Mastercraft and its "house counsel." Pursuant to the merger, which was completed in December 1967, First Standard acquired all of the assets of Old Mastercraft in exchange for 4,200,000 shares of the former's stock. First standard then changed its name to Mastercraft Electronics Corporation (hereinafter New Mastercraft). The officers and directors of Old Mastercraft held similar positions at New Mastercraft, and petitioner was regularly employed by the new corporation as a merger and acquisition specialist. During discussions in connection with the merger it was determined that New Mastercraft would need approximately $ 200,000 to finance and159 market the video tape recorder. Petitioner suggested a plan (hereinafter the Plan) whereby, pursuant to the merger, stock would be distributed to certain individuals as nominees of petitioner, Gluskin and Al Dayon, the president and principal stockholder of New Mastercraft. These shares would then be sold by the nominees to the public without registration under the Federal securities laws. Petitioner arranged, managed and controlled the sales of New Mastercraft stock according to the Plan. Under the Plan the proceeds of these sales of stock were to be divided as follows: $ 2 per share to New Mastercraft; 33 percent of the net amount realized to petitioner; and the balance to Gluskin. Gluskin secured an opinion letter from Simeon Brinberg, an attorney, which stated that the stock issued to the nominees was salable without registration. New Mastercraft stock was issued to the nominees and pursuant to the Plan they endorsed the stock certificates in blank, had their names guaranteed by their respective banks, signed blank stock powers and returned the stock certificates to Gluskin. On petitioner's advice Gluskin delivered a certain number of shares to recommended brokers for160 sale at a particular price. As the nominees received proceeds of the sales of New Mastercraft stock from the brokers they transferred them (less their fee plus an amount sufficient to pay their Federal income taxes) to Gluskin who in turn deposited them in his special account at the Chemical Bank. Said proceeds so received by Gluskin totaled $ 1,372,785.24. Gluskin refused petitioner's request to receive his share of the proceeds in cash. Thus, a scheme was agreed upon whereby a corporation called Superior Plans, Inc. (hereinafter Superior), was formed on March 7, 1968, with petitioner as its sole shareholder. Gluskin was to issue checks to Superior in the amount due petitioner, receiving in exchange convertible debentures of Superior. Gluskin, in fact, did not intend to invest in Superior. The scheme was merely devised as a method to transfer petitioner's percentage of the proceeds derived from New Mastercraft stock sales to him. Gluskin agreed to exercise his right to convert the debentures to stock of Superior so that the corporation would not have to repay the alleged loan. On March 7, 1968 and June 5, 1968, petitioner opened checking accounts for Superior, naming161 himself as the only person authorized to sign checks with respect thereto. Between March 8, 1968 and September 5, 1968, Gluskin transferred 23 checks payable to Superior in the aggregate amount of $ 540,000. In exchange Gluskin received $ 250,000 in Superior debentures. He also provided petitioner with an undated letter electing to convert all of his debentures to stock. Gluskin never received either interest on the debentures or stock certificates after conversion. Superior did not conduct any business activity during 1968, and its tax returns for 1968, 1969, and 1970 did not disclose loans to it or investments in it. Almost immediately after petitioner deposited Gluskin's checks into the Superior accounts he withdrew the funds: converting $ 407,190 into cash; depositing $ 8,800 into his personal bank accounts; purchasing cashier's checks payable to himself but endorsed over to other individuals in the amount of $ 61,000; and in checks payable to others (including bank charges and checks not located) in the aggregate amount of $ 78,045.51. Petitioner testified that the above funds were, for the most part, invested on behalf of Superior with Arnold Kimmes by handing him cash162 for the purpose of building a hotel and casino in Las Vegas. At the trial herein petitioner introduced small handwritten scraps of paper which he alleges are receipts for his cash investment with Arnold Kimmes. These represent the only documentary evidence petitioner has ever claimed to have had of this investment. This alleged investment was not reflected as an asset on Superior's 1968, 1969, or 1970 income tax returns. During the examination of petitioner's 1968 tax liability he stated to the examiner that he had borrowed the funds from Superior and then loaned them (individually) to Kimmes. Petitioner testified herein that he is unaware of what happened to these funds, and that he undertook no legal action and made no efforts outside of inquiry to secure their return. On October 6, 1966, petitioner was indicted on three counts of purgery; count one relating to his testimony before the Securities and Exchange Commission, and counts two and three relating to his testimony before the grand jury. On July 14, 1971, petitioner was found guilty as charged in counts one and three of the indictment and convicted. He served a prison sentence with respect to this conviction from163 November 8, 1971 through February 3, 1972. 3On April 14, 1975, petitioner was indicted for willfully attempting to evade his income taxes for the taxable year 1968 in violation of section 7201, and for willfully making and subscribing to a joint U.S. Individual Income Tax Return for the taxable year 1968 which he did not believe to be true and correct as to every material matter, in violation of section 7206(1). Petitioner pleaded not guilty and on April 12, 1976, he was convicted of violating sections 7201 and 7206(1) by a jury after a trial on the merits (U.S. District Court for the Southern District of New York). This conviction was affirmed by the U.S. Court of Appeals for the Second Circuit. On his return for 1968 petitioner reported taxable income of negative $ 3,244. On Schedule D of his return he claimed a bad debt deduction of $ 21,000 and he claimed various business expense deductions on his Schedule164 C totaling $ 51,286. By his notice of deficiency respondent determined that petitioner realized taxable income of $ 518,414 from his part in the sale of New Mastercraft stock and that he had an additional shortterm capital gain of $ 485 on the sale of Southern Realty Utility Company stock. Further, respondent disallowed the claimed bad debt deduction and $ 51,086 of petitioner's business expenses for lack of substantiation. Finally, respondent determined that all or part of petitioner's underpayment of tax for 1968 was due to fraud. OPINION Petitioner contends that the funds received by Superior represented an investment in that corporation by Gluskin and that these funds were in turn invested on behalf of Superior, in a Las Vegas hotel and casino through Arnold Kimmes. Respondent asserts that the funds transferred to Superior by Gluskin represent petitioner's agreed share of the proceeds derived from the sale of New Mastercraft stock, and that Superior was no more than a sham organized solely as a conduit through which petitioner would receive the money. As to the underpayment of tax, the petitioner bears the burden of proving all of those facts necessary to support the165 theory upon which he relies. ; Rule 142(a). 4 This, the petitioner has plainly failed to do. Petitioner does not dispute that Superior received $ 540,000 from Gluskin. However, he would have this Court believe that Gluskin, an attorney, invested this money in exchange for only $ 250,000 of Superior's debentures even though that corporation had no assets and no business. Moreover, petitioner maintains that these funds were invested in a Law Vegas hotel through Arnold Kimmes. The petitioner is an educated man, having attended several universities and having studied business administration (including business law and contract law). He told the story that Arnold Kimmes would only deal in cash; that there were no written contracts or other documents evidencing Superior's investment of over one-half million dollars; that Kimmes, his accountant, or his chauffeur would fly into New York to collect up to $ 50,000 at a time in cash; and that these individuals refused to give receipts except166 upon petitioner's vehement insistence. Petitioner also testified that he was and is unaware of what happened to the money given to Kimmes and states that he never made any serious effort to recover it. Coming from anyone else, petitioner's testimony would be doubtful at best but, given petitioner's conviction for purgery before the Securities and Exchange Commission and the grand jury in 1971, it is entirely incredulous. Moreover, the other evidence presented in the record herein weighs heavily in support of respondent's position. Three officers of New Mastercraft, including Gluskin and Al Dayon, testified as to petitioner's role in the Plan and the scheme, stating that he received percentages of the proceeds from the sale of New Mastercraft stock. Furthermore, notwithstanding petitioner's explanation of how the funds were acquired by Superior (as debt or equity investment and subsequently "invested" with Kimmes) petitioner, as treasurer of Superior, did not report any of these transactions on its 1968, 1969, or 1970 Federal income tax returns which reflected that Superior had no assets and no liabilities. We believe the evidence overwhelmingly establishes that Superior167 was a mere conduit for the receipt of income earned by petitioner for his part in the promotion and sale of New Mastercraft stock. Thus,we agree with respondent that receipts from these transactions were income to petitioner for 1968. Sec. 61; ; ; cf. . In his notice of deficiency respondent also determined that petitioner underreported his income from capital transactions by $ 485. Further, respondent has disallowed a claimed bad debt deduction of $ 21,000, and various claimed business expenses totaling $ 51,086 on the basis that petitioner has failed to substantiate his entitlement to them. Again, the petitioner bears the burden of proving his claim. Rule 142(a). The record herein is devoid of any credible evidence whatsoever which would tend to rebut the statutory notice with respect to these items. Petitioner's only explanation for the absence of documentation is that with the passage of time and his stay in jail his records have been lost or destroyed. On this record, we hold that petitioner has failed168 to meet his burden to prove that the respondent's determination is incorrect. The final matter presented herein is whether all or part of petitioner's underpayment of tax in 1968 was due to fraud pursuant to section 6653(b). With respect to fraud the burden of proof is on the respondent and must be met by clear and convincing evidence. ; Rule 142(b). Respondent has chosen to rely entirely upon the doctrine of collateral estoppel to support his determination that the petitioner is liable for the addition to tax for fraud. It is well settled in this Court that once having been convicted of willfully attempting to evade taxes for a given year, pursuant to section 7201, the taxpayer is collaterally estopped to deny that an underpayment of tax for the same year was due to fraud pursuant to section 6653(b). ; . Similarly, we have held that a conviction under section 7206(1) collaterally estops the taxpayer so convicted from denying that he filed a fraudulent Federal income tax return from*169 which was omitted income for the year involved. ; In 1975 petitioner was indicted for violating both sections 7201 and 7206(1) for 1968. He pleaded not guilty to both violations. After a trial on the merits before a jury in 1976 petitioner was convicted of violating sections 7201 and 7206(1). These convictions were affirmed by the U.S. Court of Appeals for the Second Circuit. Thus, in accord with the precedent of this Court, we hold that petitioner is estopped by his convictions in the prior criminal case from denying that his underpayment of tax in 1968 was due to fraud pursuant to section 6653(b). 5Accordingly, Decision will be entered for the respondent. Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable year in issue.↩2. Bridgette Goldenberg is not a party in the instant litigation.↩3. On January 21, 1971, petitioner was indicted on 15 counts of unlawfully using the mails to sell unregistered shares of New Mastercraft, and 1 count of conspiracy to do the same. He was subsequently acquitted with respect to each count of this indictment.↩4. Unless otherwise indicated, any reference to the "Rules" shall be deemed to refer to the Tax Court Rules of Practice and Procedure.↩5. Notwithstanding the doctrine of collateral estoppel, we note that it is obvious from the facts presented herein that respondent has independently proved by clear, convincing and overwhelming evidence that petitioner's underpayment of tax for 1968 was due to fraud.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621062/	BENJAMIN E. MAY, PETITIONER, ET AL., 1v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. May v. CommissionerDocket Nos. 76785, 76880, 76881, 76882, 76883.United States Board of Tax Appeals35 B.T.A. 84; 1936 BTA LEXIS 564; November 18, 1936, Promulgated 564 A corporation exchanged most of its assets for cash and stock of another corporation and pursuant to a plan of complete liquidation distributed assets to its stockholders in liquidation of its capital stock. A fund left for the payment of creditors was dissipated so that the Federal income tax liability was never paid. Held, that all stockholders receiving distributions in complete liquidation of their stock are liable as transferees of the corporation, since a stockholder is not entitled to receive in such complete liquidation any assets of a corporation until all of its obligations to creditors are discharged. Herbert J. Haas, Esq., Joseph F. Haas, Esq., and Bertram S. Boley, Esq., for the petitioners. Ralph E. Smith, Esq., for the respondent. ARUNDELL84 The respondent has determined deficiencies in income tax for the year 1928 in the amount of $12,299.11 against Benjamin E. May (of Mobile, Alabama), Arthur I. May, Joseph May, and Benjamin F. May (of Atlanta, Georgia), each, and against Alvin H. Fuller in the amount of $2,640. The issues involved are whether or not the petitioners are liable as transferees of the French Dry565 Cleaning Co., and the fair market value of the preferred stock of the Atlanta Laundries, Inc., distributed to them in 1928. FINDINGS OF FACT. 1. All of the assets and business of the French Dry Cleaning Co. except cash and certain accounts and bills receivable were transferred to the Atlanta Laundries, Inc., as of January 1, 1928, and the French Dry Cleaning Co. conducted no business subsequent to that date for its own account except such as was incidental to its liquidation. 2. The collector of internal revenue has made due effort to collect the income tax due from the French Dry Cleaning Co., the transferor in these proceedings, and the tax and interest thereon as provided by law remains unpaid. Warrant of distraint was issued November 15, 1933, and returned unsatisfied. 85 3. On May 28, 1928, there was outstanding common and preferred stock of the French Dry Cleaning Co. in amounts as follows: 800 shares of preferred stock, par value $100$80,000949 shares of common stock, par value $10094,900Total174,9004. On May 29, 1928, by virtue of a valid resolution adopted by the board of directors of the French Dry Cleaning Co. of Atlanta, 566 Georgia, at a special meeting, duly called and held on the 26th day of May 1928, there were distributed to the common stockholders of that company, in proportion to their stockholdings, 3,025 shares of the preferred stock and 7,562 1/2 shares of common stock of the Atlanta Laundries, Inc., of Atlanta, Georgia, as a liquidating dividend upon surrender of their common stock in the French Dry Cleaning Co. This stock was distributed as follows: PreferredCommonBen F. May6911,737Joseph May6851,682Arthur I. May6751,698Ben E. May6751,698C. D. Heidler255637 1/2A. H. Fuller441105. The same resolution of May 26, 1928, provided that: Whereas, this corporation has in hands funds sufficient to liquidate in cash the eight hundred (800) shares of preferred stock; * * Now, THEREFORE, BE IT RESOLVED AS FOLLOWS: * * * (3) That the preferred stock of the French Dry Cleaning Company be redeemed at par. 6. The directors who passed the resolution referred to above were Arthur I. May, Joseph May, and Benjamin F. May, who constituted all of the directors of the French Dry Cleaning Co. Joseph May is the father of Arthur I. May and567 Benjamin F. May. 7. It was understood and agreed as at May 29, 1928, that the outstanding personal accounts of certain of the stockholders of the company due the company on account of advances to or for them should be offset against the amounts due these stockholders on their preferred stock. 8. The solvent assets of the French Dry Cleaning Co. as of May 29, 1928, after the distribution of Atlanta Laundries, Inc., stock were as follows: Cash$37,855.58Reserve a/c cash4,869.10O. M. Huie cash815.15Bills receivable:Huie1,850.00Albert's1,168.79United Manufacturing Co5,145.75Massell Realty Co10,000.00Overdrafts and advances:Joseph May14,662.41B. F. May20,506.82A. I. May8,071.68C. D. Heidler8,931.41A/c reserve, Citizens & Southern National Bank4,795.33Do , Atlanta Title & Trust Co2,000.00Cash advanced to employees1,003.91Robert Fulton Hotel2,000.00Cecil Hotel1,939.38Accounts receivable240.06Total125,855.3786 The liabilities of French Dry Cleaning Co. as of May 29, 1928, including the tax subsequently assessed and here sought to be collected, were as follows: U.S. Federal tax 1928$12,299.11U.S. Federal tax 19241,838.73U.S. Federal tax 19251,714.03U.S. Federal tax 19272,000.00U.S. Federal tax 1927574.91D. J. Gantt$200.00Revenue stamps122.19Preferred stock80,000.0098,748.97568 9. No part of the cash or other assets listed above and owned by the French Dry Cleaning Co. on May 29, 1928, or thereafter acquired by it, was ever paid to Benjamin E. May or Alvin H. Fuller, and the sole assets received on or after May 29, 1928, by them were the common and preferred stock of the Atlanta Laundries, Inc., issued as hereinabove stated. 10. Subsequent to the meeting of the directors of the French Dry Cleaning Co. of May 26, 1928, there were no directors' or stockholders' meetings of the French Dry Cleaning Co., and no further corporate action was taken for any further distribution of the remaining undistributed assets of the company, and such further distributions as took place were made without the knowledge of Benjamin E. May of Mobile and Alvin H. Fuller. 11. The disposition of the assets listed in the balance sheet of May 29, 1928, was as follows: The assets of French Dry Cleaning Co. as of May 29, 1928, included $14,662.41 due from Joseph May, and subsequent to that date Joseph May received of the assets of that company $49,009.56, consisting of the following payments: June 8, 1928$4,500.00June 19, 19285,350.00June 20, 19285,040.83June 21, 19284,900.00June 23, 1928603.09June 23, 192810,000.00July 13, 19285,040.90July 20, 1928$2,000.00Oct. 26, 19284,855.64Date unknown but subsequent to May 28, 19281,850.00Date unknown but subsequent to May 28, 19284,869.10569 87 The assets of the French Dry Cleaning Co. as of May 29, 1928, included $20,506.82 due from Benjamin F. May (of Atlanta), and subsequent to that date Benjamin F. May received of the assets of that company $11,750.16, consisting of the following payments: June 5, 1928$1,500.00June 5, 1928157.91June 6, 192892.25In the years 1930-193110,000.00The last item represents the note of the Massell Realty Co., which was transferred to Benjamin F. May after July 1928 and was subsequently collected by him in 1930 and 1931. The assets of the French Dry Cleaning Co. as of May 29, 1928, included $8,071.48 due from Arthur I. May, and subsequent to that date Arthur I. May received of the assets of the company $200, consisting of payment to him on June 1, 1928. The assets of the French Dry Cleaning Co. as of May 29, 1928, included $8,931.41 due from C. D. Heidler, which debt was never collected from him. From the remaining assets of the French Dry Cleaning Co. as of May 29, 1928, the following payments were made: Date of paymentPayeeAmountJune 18, 1928Mrs. Boozer$19.00June 11, 1928Transfer tax211.76June 25, 1928Oberdorfes Ins33.50Aug. 1, 1928Mrs. Broadus6.00Aug. 1, 1928Citizens & Sou. Bank25.00Aug. 1, 1928Met. Ref. Co15.00Dec. 31, 1928Collector of internal revenue$1,838.73Dec. 31, 1928do1,714.03Mar. 21, 1929do2,000.00April 30, 1929do574.91Aug. 24, 1929Revenue stamps122.19Jan. 15, 1930D. J. Gantt200.00570 The assets of the French Dry Cleaning Co. as of May 29, 1928, included $1,168.79 owed by Albert's and $5,145.75 owed by the United Manufacturing Co., from which assets there was collected only $668.79 from Albert's and $2,500 from the United Manufacturing Co., leaving an uncollected balance of $500 due from Albert's and $2,645.75 due from the United Manufacturing Co. It is not known what disposition was made of the assets of the French Dry Cleaning Co. remaining as of May 29, 1928, amounting to $2,817.68. 12. The $80,000 of preferred stock of the French Dry Cleaning Co. was owned as follows: Joseph May owned 510 shares of par value of $100 each; Benjamin F. May owned 200 shares of par value of $100 each; and Arthur I. May owned 90 shares of par value of $100 each. 13. The amounts shown as due to the French Dry Cleaning Co. on May 29, 1928, from Joseph May in the sum of $14,662.41; Benjamin 88 F. May in the sum of $20,506.82, and Arthur I. May in the sum of $8,071.48 were either valid debts owed to the company, in which event the liability of the company to its preferred stockholders would be $80,000, or those sums were advances to the preferred stockholders, in571 which event the liability of the company to its preferred stockholders would be reduced from $80,000 to $36,759.29. 14. On July 31, 1928, Joseph May had drawn from the French Dry Cleaning Co. the sum of $52,097.23, which completely liquidated the liability to him for his preferred stock in the French Dry Cleaning Co.; and on that date Benjamin F. May had drawn from the French Dry Cleaning Co. the sum of $22,256.98, which completely liquidated the liability to him for his preferred stock in the French Dry Cleaning Co.; and on that date Arthur I. May had drawn $8,271.48 from the French Dry Cleaning Co., which left a balance due to him on his preferred stock in the French Dry Cleaning Co. of $728.52. On that date the solvent assets of the French Dry Cleaning Co., not including the $10,000 note of the Massell Realty Co. hereinabove referred to and not including the advances to Joseph May and Benjamin F. May in excess of their preferred stockholdings, were as follows: ItemAmountCash in First National Bank$843.25Employees' accounts1,003.91Cash in Huie account939.25Huie notes with accrued interest1,909.80Cash in Atlanta Title & Trust Co. and interest2,044.20Due from Atlanta Laundries4,796.33Hotel accounts3,939.38Due from Albert's$500.00Due from United Manufacturing Co2,645.75Cash reserve in Atlanta National Bank1,327.90Cash reserve in Atlanta Trust Co723.1220,672.89572 On that date the total liabilities owed by the French Dry Cleaning Co. including the tax here sought to be collected, were as follows: ItemAmountU.S. Federal tax for 1928$12,299.11Mrs. J. C. Broadus6.50Citizens & Southern National Bank25.00Met. Refining Co15.00Collector of internal revenue1,838.73Collector of internal revenue1,714.03Collector of internal revenue2,000.00Collector of internal revenue$574.91Internal revenue stamps122.19Balance due Arthur I. May on his preferred stock in FrenchDry Cleaning Co728.5219,323.4915. The fair market value of the Atlanta Laundries, Inc., preferred stock on the date of its distribution to the stockholders of the French Dry Cleaning Co. was $60 per share. It was distributed pursuant to a plan of complete liquidation of all the outstanding stock of the French Dry Cleaning Co. 89 OPINION. ARUNDELL: The two issues involved here are (1) whether the petitioners are liable as transferees of the French Dry Cleaning Co. under section 311 of the Revenue Act of 1928, and (2) the value of the stock of the Atlanta Laundries, Inc., which was distributed to petitioners as stockholders573 of the French Dry Cleaning Co. In a prior proceeding before this Board a deficiency in income tax for the year 1928 was determined against the French Dry Cleaning Co. in the amount of $12,299.11, arising out of its profit from the exchange of almost all of its assets for cash and stock in the Atlanta Laundries, Inc. Our determination was affirmed on appeal by the Circuit Court of Appeals for the Fifth Circuit. French Dry Cleaning Co. v. Commissioner, 72 Fed.(2d) 167. The collector of internal revenue made due effort to collect this deficiency from the French Dry Cleaning Co. and on November 15, 1933, issued a warrant of distraint which was returned unsatisfied. Deficiencies were then proposed against each of the petitioners as transferees of the assets of the French Dry Cleaning Co. The first issue is whether the petitioners are liable as transferees. Each of them received assets from the French Dry Cleaning Co. after its tax liability arose, but it is the petitioners' position that none of the distributions were made while the company was insolvent or served to render the company insolvent and therefore no transferee liability was incurred. The company574 ceased to do business as of January 1, 1928, when most of its assets were transferred to the Atlanta Laundries, Inc., and thereafter it conducted no business except such as was incidental to its liquidation. There was a series of distributions to stockholders, beginning on May 29, 1928, when the stock of the Atlanta Laundries, Inc., held by the French Dry Cleaning Co. was distributed to its common stockholders in exchange for all of the outstanding common stock, of a par value of $94,900. Successive payments in cash and distribution of personal overdrafts were made after that date to the preferred stockholders of the French Dry Cleaning Co. and by July 31, 1928, the entire outstanding preferred stock of the corporation, having a par value of $80,000, was liquidated except for an amount of $728.52 held by Arthur I. May. After July 31, 1928, additional payments were made to Joseph May and Benjamin F. May (of Atlanta) in excess of $14,000. The petitioners present balance sheets to show that at successive stages in the distribution the French Dry Cleaning Co. remained solvent, with an excess of assets over liabilities, including its tax liability for 1928, which had not then been determined. 575 On May 29, 1928, after all of its common stock had been redeemed, the French Dry Cleaning Co. retained assets of $125,855.37 against liabilities of $98,748.97. 90 On July 31, 1928, after all of its preferred stock except the amount of $728.52 had been liquidated, the company retained assets of $30,672.89 against liabilities of $19,323.49. No balance sheet later than July 31, 1928, is in evidence, but it is apparent from the stipulation that the distributions made to Joseph May and Benjamin F. May after that date wiped out the margin of solvency existing as of July 31 and rendered the company insolvent, and it was found to be without assets when a distraint warrant was issued in 1933. Benjamin F. May would therefore be liable to the extent of the $10,000 he received after July 31, 1928, and Joseph May would be liable for the $4,855.64 he received on October 26, 1928, plus any part of two undated distributions listed in the stipulation which were made after July 31, 1928. But the petitioners claim there is no liability on the part of any of the stockholders for distributions made prior to July 31, 1928, because the corporation remained solvent on that date, and three of576 the five petitioners here received all of their distributions prior to July 31, 1928, namely, Benjamin E. May (of Mobile, Alabama), Alvin H. Fuller, and Arthur I. May. The petitioners' position, we think, overlooks the controlling fact that the distributions in liquidation of their stock were all made in pursuance of a plan of complete liquidation of the French Dry Cleaning Co. The petitioners do not deny the existence of a plan of liquidation; in fact, they admit in their pleadings the respondent's allegation that a large part of the assets of the French Dry Cleaning Co. was distributed pursuant to a plan of liquidation. In the French Dry Cleaning Co. case we found the fact to be as stipulated that: The plan under which the assets of the French Dry were transferred to Atlanta Laundries, Inc., contemplated that the holders of the French Dry common stock should receive pro rata the preferred and common stock of Atlanta Laundries, Inc., and that the cash should first be used in liquidating the indebtedness of the French Dry and then for retiring the outstanding preferred stock of the French Dry. In order to insure that the indebtedness would be paid, it was agreed that577 the cash consideration paid by the Atlanta Laundries, Inc., would be deposited in an Atlanta bank in the name of the French Dry Cleaning Co., and that checks issued thereon should be countersigned by Herbert J. Haas, attorney for the Atlanta Laundries, Inc., until an affidavit should be made on behalf of the French Dry Cleaning Co. that all the indebtedness had been fully paid, "it being the understanding that said funds shall be used insofar as they are necessary to the discharge of said indebtedness, and for no other purpose." The corporate resolution of May 26, 1928, recited the plan of complete liquidation of all the capital stock of the French Dry Cleaning Co. It provided for the distribution of all of the stock received from the Atlanta Laundries, Inc., as a liquidating dividend to the 91 common shareholders of French Dry, to be delivered upon the surrender of their shares of common stock in the corporation; and it provided for the redemption of preferred stock of French Dry at par for cash. The part of the plan calling for the redemption of the entire capital stock was carried out, and by July 31, 1928, it had all been liquidated except for $728.52 due to Arthur I. 578 May on his preferred stock; but that part calling for payment of all debts of the corporation was not carried out, and the tax liability here in question was never paid. In such circumstances, where a corporation sets out to retire all its capital stock, even though it may plan to leave enough assets to discharge its obligations to creditors, we have no doubt that the stockholders are not free from liability as transferees until the debts are finally paid. The courts have repeatedly held, as did the Circuit Court of Appeals for the Fifth Circuit in Robinson v. Wangeman, 75 Fed.(2d) 756 (1935), that: "The assets of a corporation are the common pledge of its creditors, and stockholders are not entitled to receive any part of them unless creditors are paid in full." This doctrine dates back as far as Justice Story's famous formulation in Woods v. Dummer, 3 Mason 308, and it was stated by the Supreme Court in these words in Sanger v. Upton,91 U.S. 56">91 U.S. 56: The capital stock of an incorporated company is a fund set apart for the payment of its debts. It is a substitute for the personal liability which subsists in private copartnerships. 579 When debts are incurred, a contract arises with the creditors that it shall not be withdrawn or applied, otherwise than upon their demands, until such demands are satisfied. The creditors have a lien upon it in equity. If diverted, they may follow it as far as it can be traced, and subject it to the payment of their claims, except as against holders who have taken it bona fide for a valuable consideration and without notice. It is publicly pledged to those who deal with the corporation, for their security. Whatever may be the present status of the trust fund doctrine as applied to some situations (see McDonald v. Williams,174 U.S.397; United States v. Fairall, 16 Fed.(2d) 328), we think that certainly this much of it remains - that a corporation must pay its debts before it liquidates its entire capital stock. Even those cases which have pointed out limitations on the trust fund doctrine recognize this as fundamental. In the case of Hospes v. Northwestern Manufacturing & Car Co.,48 Minn. 174">48 Minn. 174, the Supreme Court of Minnesota, in discussing Woods v. Dummer, Supra, said: Evidently all that the eminent jurist [Justice580 Story] meant by the doctrine was that corporate property must be first appropriated to the payment of the debts of the company before there can be any distribution of it among its stockholders - a proposition that is sound upon the plainest principles of common honesty. Another court has said that the trust fund theory "is not obsolete and will not become obsolete anywhere until honesty shall become 92 obsolete." Witt v. Nelson (Tex. Civ. App.), 169 S.W. 381">169 S.W. 381. The courts of Georgia where this case arises have adhered to the trust fund doctrine from Hightower v. Thornton (1850), 8 Ga. 486">8 Ga. 486, and Reid v. Eatonton Manufacturing Co. (1869), 40 Ga. 98">40 Ga. 98, to Fitzpatrick v. McGregor (1909), 133 Ga. 332">133 Ga. 332; 65 S.E. 859">65 S.E. 859; and Williams v. Clemons (1934), 178 Ga. 619">178 Ga. 619; 173 S.E. 718">173 S.E. 718. 2 In this state of the authorities we must hold that all the stockholders in the case at bar who received distributions pursuant to the plan of complete liquidation are liable as transferees to the extent of the value of the assets received. We do not think the cases relied on by the581 petitioners hold to the contrary. McDonald v. Williams, supra, involved dividends paid by a corporation out of capital but received by the stockholders in good faith, believing them to be out of earnings and profits. In such a situation the stockholders were not chargeable with knowledge of the wrong of the directors and the dividends were not recoverable by creditors on subsequent insolvency. Here, however, we have a totally different situation. The assets of the French Dry Cleaning Co. were sold to the Atlanta Laundries, Inc., pursuant to a plan that the proceeds of the sale would be used first to pay the debts of the French Dry Cleaning Co. and then the remaining assets would be distributed to the stockholders in liquidation of their stock. The Atlanta Laundries, Inc., made certain requirements to insure that the debts would indeed be paid first. But the plan was not carried out; the distributions to stockholders were made first and the debt to the United States was never paid. In such a case there can be no question of notice to the stockholders that capital is being impaired or that a complete liquidation is being effected, for they were required to surrender their582 capital stock in order to participate in the distribution. Thus, as the stockholders participated in the complete liquidation of the entire capital stock before all debts were paid, we think their liability persists and that the creditors can follow the funds distributed to them. The responsibility of stockholders who receive a return of their capital in complete liquidation does not cease with their merely setting aside a fund which at its then value is sufficient to pay debts, but continues until the debts are actually paid. The equity of the creditors is superior to that of the stockholders. Eliza J. Wray,24 B.T.A. 94">24 B.T.A. 94, invoked by the petitioners, was a case where the Commissioner failed to establish the ultimate insolvency of the company, and we held that he had not proved that the corporation583 itself was unable to pay the tax or that he had exhausted 93 his remedies against the corporation. M. H. Graham,26 B.T.A. 301">26 B.T.A. 301, did not, properly speaking, involve a liquidating dividend at all since it does not appear that any stock in the transferor was surrendered upon the distribution in question; also the distribution did not impair the capital of the corporation, but left the assets representing the capital stock completely intact to meet the claims of creditors; finally, there was no evidence there of the existence of any plan of complete liquidation of all of the capital stock, or, indeed, any of the capital stock of the corporation at the time when the dividend in question was paid. On the other hand, a case which is very closely in point is W. S. Scamehorn,27 B.T.A. 155">27 B.T.A. 155. There a corporation sold its assets for $100,000, liquidated the minority stockholdings for $125 a share, paid all the debts of the corporation except the Federal tax liability, and still had on hand sufficient assets to cover that liability. The corporation was subsequently made insolvent by distributions to certain of its shareholders and the tax liability was584 never paid. It was held that the minority stockholders whose interests were first liquidated, as well as those receiving the final distributions, were liable as transferees. It seems to us that the particular order of distribution is immaterial where all the distributions are made in pursuance of a single plan of complete liquidation. We think it is unimportant in the case at bar that certain of the holders of common stock were not apprised of the distributions made after July 31, 1928, in violation of the plan. By surrendering their stock in return for the distribution of May 29 they subscribed to the plan of reversing the normal order of liquidation by making distributions to stockholders before debts were paid. This, we think, makes them liable along with the rest of the stockholders if the fund remaining for creditors should for any reason prove inadequate. As stockholders receiving distributions in complete liquidation, we think they became guarantors that the fund left for creditors should actually prove sufficient to discharge their obligations. In view of the imminent possibility of dissipation or depreciation of assets left for creditors in such a case as this, it585 might even be held, if it were deemed necessary to go so far, that as a matter of law the retirement of a corporation's entire capital stock is made in contemplation of insolvency and therefore is in fraud of creditors. The courts have been zealous in transferee cases to protect the revenues from any misuse of the corporate entity theory. See Helvering v. Wheeling Mold & Foundry Co., 71 Fed.(2d) 749; Concrete Industries Co.,19 B.T.A. 655">19 B.T.A. 655. The second issue is the value of Atlanta Laundries, Inc., preferred stock which was distributed to the petitioners on May 29, 1928; the respondent concedes that the common stock distributed was without 94 value. In the transferor case, French Dry Cleaning Co. v. Commissioner, supra, we found the value of the preferred stock of Atlanta Laundries, Inc., on the day of its receipt by the French Dry Cleaning Co., January 16, 1929, to be $60 per share, and this finding was affirmed by the Circuit Court of Appeals for the Fifth Circuit, which pointed out: It appears from the record that in July, 1932, Atlanta Laundries, Inc., defaulted on the payment of interest on its bonds. It586 is probable that thereafter the stock had little or no value. That, however, is immaterial as we are dealing with the situation existing in January, 1928, when the reorganization was effected. It further appears that for the twelve months ending November 15, 1927, petitioner's volume of business was approximately $505,000. The basis of cost of the tangible property transferred was, in round figures, $384,000. Since petitioner received only about $305,000 in cash, this left a considerable amount of the purchase price of tangibles to be represented by stock. In addition, the going business value was represented by stock. This must have been a large percentage of the value considered in effecting the consolidation. It appears in evidence that the book value of the preferred stock of Atlanta Laundries, Inc., considering the common stock as having no value, was more than $100 a share from January 16, 1928, when the books of the Atlanta Laundries, Inc., were first opened, through December 31, 1931. Furthermore, and more important, the net earnings available for dividends in both 1928 and 1929 were well in excess of the $7 per share which was required to pay dividends on the preferred587 stock, and regular semiannual dividends were paid on the preferred stock throughout those two years. The earnings for 1925 through 1927 of the respective companies which were consolidated support the earning power indicated for the preferred stock of the new company, Atlanta Laundries, Inc. This would indicate a value in the neighborhood of its $100 par for the year 1928, when the distribution occurred. The respondent claims a value of only $60 per share for the preferred stock, and we have no doubt that such a valuation is justified on the basis of the earning power of the stock and its book value. The petitioners do not challenge the correctness of the figures put in evidence by the Commissioner, but only their materiality, claiming that, in the absence of evidence of any sales of the stock, fair market value can not be established from book value and earning power alone. Where there is no evidence that the figures are unreliable, we think it is well settled that book value and earning power are sufficient to establish fair market value. *588 Wessel v. United States, 49 Fed.(2d) 137; Commissioner v. Brier Hill Collieries, 50 Fed.(2d) 777; Shanley & Furness, Inc.,21 B.T.A. 146">21 B.T.A. 146. We have found as a fact that the preferred stock of the Atlanta Laundries, Inc., on May 29, 1928, had a fair market value of $60 per share. Judgment will be entered under Rule 50.Footnotes1. The following cases were submitted on the same stipulation of facts and were consolidated for hearing: Benjamin E. May, Docket No. 76785; Alvin H. Fuller, Docket No. 76880; Joseph May, Docket No. 76881; Arthur I. May, Docket No. 76882; Benjamin F May, Docket No. 76883. ↩2. See also Bank of Morgan v. Reid,107 S.E. 555">107 S.E. 555 (Ga. App., 1921); for the effect of the municipal law in transferee cases see Harwood v. Eaton, 68 Fed.(2d) 12; for a further limitation on the power of a Georgia corporation to liquidate its entire capital stock see Kaminsky v. Phinizy,↩ 54 Fed.(2d) 16.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621064/	APPEAL OF THE NATIONAL CITY BANK OF NEW YORK AND HENRY G. GRAY, EXECUTORS OF THE ESTATE OF JULIAN H. BARCLAY, DECEASED.National City Bank v. CommissionerDocket No. 2243.United States Board of Tax Appeals2 B.T.A. 696; 1925 BTA LEXIS 2279; September 30, 1925, Decided Submitted April 16, 1925. 2279 Value of fractional interests in real estate determined. Matthew J. Shevlin, Esq., for the taxpayer. W. Hall Trigg, Esq., for the Commissioner. GREEN 696 Before GRAUPNER, TRAMMELL, and GREEN. This is an appeal from the determination of a deficiency in estate tax in the amount of $1,104.61. The deficiency arose from the difference in valuation placed on certain real estate by the executors and the Commissioner. FINDINGS OF FACT. The petitioners are the duly appointed, qualified, and acting executors of the estate of Julian H. Barclay, who died October 6, 1923. At the time of his death he was a resident of the County and State of New York and the owner of an undivided one-half interest in 10 parcels of real estate located in New York City. The value of the undivided one-half interest of these parcels of real estate, as returned by the executors and as valued by the Commissioner, is as follows: ItemLocationAs returned by executorsAs valued by the Commissioner120 Wooster Street$14,400$15,0002268-270 Washington Street56,25062,5003385 Grand Street29,25032,5004345 Canal Street11,25012,5005195 Hester Street15,75017,5006471 Greenwich Street10,80012,000729 Suffolk Street10,35011,5008144 Spring Street7,2008,1259100 Orchard Street15,75017,5001047 Ann Street40,50045,000211,500234,1252280 The executors and the Commissioner agreed upon the market value of each parcel of real estate, but the executors, in arriving at the undivided one-half interest, deducted 10 per cent of this value. Thus, the executors' valuations of the one-half interest are 10 per cent less than the mathematical one-half interest. The market value of items (1) and (8), above set forth, was determined from the price at which the property was sold several months later. For many years the transfer tax authorities of the State of New York have accepted as correct appraisals of undivided fractional 697 interests in New York real estate which were at least 10 per cent less than aliquot portions of the value of the entire parcel. The transfer tax authorities accepted the value of $211,500 for the decedent's interest in the properties listed above, and the tax upon that amount was duly paid by the executors to the State of New York. For appraisal purposes it is the practice in the New York realestate market to deduct a percentage for fractional undivided interests. The reason given for this deduction is the additional inconvenience of dealing with several owners, the possibility of minor2281 heirs, partition suits, and disagreements of the owners. Selling only a fractional undivided interest in the market is a rare occurrence and is only done under exceptional circumstances. In the common and ordinary sales all the owners join together in one conveyance or one common owner sells to the other. In the few instances of actual sale testified to, the fractional interests brought in the market a value equal to or in excess of the mathematical or aliquot proportion of the value of the entire parcel. DECISION. The determination of the Commissioner is approved. OPINION. GREEN: In this appeal there is no dispute as to the market value of the parcels of real estate. The issue is whether the value of an undivided one-half interest in real estate is 50 per cent of the market value of the whole or is 45 per cent thereof, as is contended by the executors. On behalf of the executors, it is pointed out that it is the common practice in the New York real estate market, in appraising real estate, to deduct a percentage because of undivided fractional interests. It is further pointed out that this is also the practice of the transfer tax authorities of the State of New2282 York, and that they in fact did deduct 10 per cent in this particular estate. The reason given for this deduction is the additional inconvenience of dealing with several owners, the possibility of minor heirs, partition suits, and disagreement of several owners. While this appraisal practice may be followed to a great extent, the testimony in this case discloses that in cases of actual sales undivided fractional interests brought in the market a value equal to or in excess of the aliquot portion of the value of the entire parcel. The executors have offered no actual evidence of value other than the practice of the New York real estate dealers and the New York transfer tax authorities. There is no evidence to sustain the values *698 placed by the executors upon these particular parcels of land such as would warrant us in disturbing the values fixed by the Commissioner. ARUNDELL not participating.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/748938/	131 F.3d 144 NOTICE: Eighth Circuit Rule 28A(k) governs citation of unpublished opinions and provides that they are not precedent and generally should not be cited unless relevant to establishing the doctrines of res judicata, collateral estoppel, the law of the case, or if the opinion has persuasive value on a material issue and no published opinion would serve as well.UNITED STATES of America, Appellee,v.Jewell Leroy Chatman, Appellant. No. 97-2319. United States Court of Appeals, Eighth Circuit. Submitted: November 19, 1997.Filed: December 2, 1997. Appeal from the United States District Court for the District of Minnesota. Before McMILLIAN, BEAM, and MORRIS SHEPPARD ARNOLD, Circuit Judges. PER CURIAM. 1 Jewell Leroy Chatman pleaded guilty to robbing a federally-insured Minneapolis, Minnesota bank, in violation of 18 U.S.C. § 2113(a). Based on a total offense level of 22 and a Category IV criminal history, the presentence report (PSR) recommended a Guidelines imprisonment range of 63 to 78 months. Chatman sought a downward departure from this Guidelines range pursuant to U.S. Sentencing Guidelines Manual § 4A1.3, p.s. (1995), arguing that Category IV overstated his criminal history and Category II would be more appropriate. The district court1 refused to depart downward. Noting that, in addition to the five countable convictions underlying his criminal history score, Chatman had been charged with criminal conduct in five other instances, the district court concluded Category IV overstated neither the seriousness of the defendant's criminal history nor his likelihood of recidivism. The court, however, granted the government's motion for downward departure pursuant to U.S. Sentencing Guidelines Manual § 5K1.1, p.s. (1995), and sentenced Chatman to 46 months imprisonment and three years supervised release. Chatman appeals, and we affirm. 2 We conclude that, because the district court was aware of its authority to depart, Chatman's sentence is unreviewable. See United States v. Hall, 7 F.3d 1394, 1396 (8th Cir.1993). 3 Accordingly, we affirm. 1 The Honorable David S. Doty, United States District Judge for the District of Minnesota	01-04-2023	04-17-2012
https://www.courtlistener.com/api/rest/v3/opinions/4340352/	CHRISTOPHER MICHAEL HAAG AND CHRISTINE ANN HAAG, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentHaag v. Comm'rDocket No. 27956-14S.United States Tax CourtT.C. Summary Opinion 2016-29; 2016 Tax Ct. Summary LEXIS 29; June 22, 2016, FiledDecision will be entered under Rule 155.29 Andrew J. VanSingel and Lawrence C. Letkewicz, for petitioners.Michael T. Shelton and Elizabeth A. Carlson, for respondent.GUY, Special Trial Judge.GUYSUMMARY OPINIONGUY, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect when the petition was filed.1 Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case.Respondent determined a deficiency of $6,204 in petitioners' Federal income tax for 2012 and an accuracy-related penalty of $1,241 pursuant to section 6662(a). Petitioners, husband and wife during the year in issue, filed a timely petition for redetermination with the Court pursuant to section 6213(a). At the time the petition was filed, petitioners resided in Illinois.After concessions,2 the issues remaining for decision are whether petitioners are: (1) entitled to deductions for various unreimbursed employee business expenses30 in excess of amounts respondent allowed; (2) entitled to deductions for cash and noncash charitable contributions in excess of amounts respondent allowed; and (3) liable for an accuracy-related penalty under section 6662(a).BackgroundSome of the facts have been stipulated and are so found. The stipulation of facts and the accompanying exhibits are incorporated herein by this reference.Petitioners were married in 2006 and were legally separated in 2014.I. Petitioners' EmploymentPetitioners are both electricians and members of the International Brotherhood of Electrical Workers (IBEW Local 150 or union).A. Mr. HaagIn 2012 Mr. Haag worked for several employers on short-term work assignments. In the first half of the year he worked for Aldridge Electric, Inc. (Aldridge), at several station stops on the Chicago Transit Authority (CTA) Green Line. Mr. Haag described his work primarily as "pulling communications cable".In addition to his work at CTA31 Green Line stations, Mr. Haag performed work for Aldridge at the University of Illinois in Champaign, Illinois, and in Daytona Beach, Florida. He also worked for approximately one month at Chicagoland Speedway in Joliet, Illinois, for Applied Communications Group.B. Ms. HaagMs. Haag was employed by Aldridge throughout 2012 as a project engineer responsible for a wide range of tasks, including managing project worksites, bidding on projects, and field work. Ms. Haag testified that she did have a permanent office space at Aldridge's headquarters and that she completed her assignments in the field, at home, or in office space that she borrowed from another employee at Aldridge.II. Petitioners' ExpensesA. Vehicle ExpensesMr. and Ms. Haag both drove their personal vehicles to and from work. Mr. Haag drove a 2003 Chevrolet Trailblazer, and Ms. Haag drove a 2011 Dodge Journey.1. Mr. Haag's Vehicle ExpensesMr. Haag recorded his vehicle mileage in a notebook that he kept in his Trailblazer. He updated the notebook daily or weekly, listing the date, the worksite location, and the number of miles that he drove. He testified that he recorded only the miles that he drove from the county line (petitioners'32 residence was in Lake County, Illinois) to each worksite and back in accordance with conversations that he had with other union electricians.Mr. Haag normally was allowed to park at no charge on CTA property near his assigned Green Line worksites. He testified, however, that he paid between $150 and $250 to park at two CTA stations (the Garfield and Roosevelt stations) when free parking was not available.2. Ms. Haag's Vehicle ExpensesMs. Haag recorded her vehicle mileage in a pocket calendar that she kept in her vehicle. Like Mr. Haag, she worked at several CTA Green Line stations in Chicago, and she recorded the date, the worksite location, and the number of miles she drove from the Lake County line to each worksite and back.Ms. Haag testified that she paid to park at the Garfield and the Roosevelt CTA Green Line stations while working for Aldridge. Petitioners produced five receipts showing that they paid $89 for parking in 2012.B. Work ClothingIn an effort to enhance employee safety, IBEW Local 150 requires its member electricians to wear safety boots, denim jeans, and long-sleeve cotton shirts. Petitioners testified that they normally replace their work boots twice a year and that33 in 2012 they purchased two pairs of composite-toed boots during a two-for-one sale. They produced a receipt from Rogan's Shoes for work boots totaling $239. Petitioners also testified that they each purchased an insulated Carhartt bib that included a "built-in" tool belt for $100. Ms. Haag testified that she purchased new work clothing in 2012 because it had been some time since Aldridge had assigned her to perform field work.C. ToolsIBEW Local 150 requires its member electricians to maintain a basic set of tools including a screwdriver, pliers, meters, and testers. Mr. Haag testified that he often dropped tools onto the CTA Green Line tracks (where they could not be retrieved) as he climbed up and down ladders to perform electrical work. Consequently, he was required to purchase replacement tools about once a month in 2012. Ms. Haag also purchased tools to perform work in the field. Petitioners produced receipts from Home Depot showing that they paid a total of $371 for various tools in 2012.D. Ms. Haag's ComputerAldridge provided Ms. Haag with a laptop computer to enable her to test network connections at worksites. In 2012 Ms. Haag brought her personal laptop to a worksite to test34 network connections while her Aldridge laptop was being repaired. Ms. Haag's personal laptop was destroyed after it was inadvertently knocked to the ground by another employee. As a result, Ms. Haag purchased a new personal laptop computer and submitted to Aldridge a request for reimbursement. Aldridge denied Ms. Haag's reimbursement request because she had not been directed to take her personal laptop to work. Aldridge had earlier denied Ms. Haag's request to be reimbursed for the cost of a new printer that she had purchased.E. MealsMs. Haag testified that in 2012 she bought dinner for several union employees to lift their spirits when they were required to work late. The record shows that Mr. Haag purchased meals while working for Aldridge in Champaign, Illinois, and Daytona Beach, Florida.III. Aldridge's Employee Reimbursement PolicyPetitioners testified that they did not believe that Aldridge maintained a formal employee expense reimbursement policy. In his 10 years of employment as a union electrician, Mr. Haag rarely requested or received reimbursement for any work-related expenses. Ms. Haag also testified that she generally was not reimbursed for work-related expenses. Aldridge35 typically reimbursed her, however, for office supplies and materials that she purchased in her capacity as a project manager. To request reimbursement, Ms. Haag submitted receipts to her division manager, and she would receive the reimbursement in her next paycheck.IV. Petitioners' Office SpacePetitioners maintained a 60-square-foot office in the basement of their home which included a desk, a desktop computer, and filing cabinets. The filing cabinets held both personal and work-related documents. Petitioners used the office for both personal and work-related purposes, including checking work-related emails, maintaining tax-related documents, and preparing their personal income tax returns.V. Charitable ContributionsA. Cash ContributionsPetitioners attended and made donations to separate churches in 2012. Petitioners testified that they each donated approximately $20 per week at their respective churches in 2012. Petitioners did not provide any documentation to substantiate their cash contributions.B. Noncash ContributionsDuring the early months of 2012 Ms. Haag moved out of the couple's home. She testified that she made two sizable donations of various household items to the Salvation36 Army, including clothing, furniture, and kitchenware.VI. Petitioners' 2012 Tax ReturnMs. Haag began to prepare the couple's joint Federal income tax return for 2012 in early January 2013 using TurboTax software. Petitioners' vehicle mileage logs were destroyed when their basement office flooded on January 30, 2013. Ms. Haag testified that she had substantially completed the couple's tax return before the flooding occurred.Petitioners reported total income of $141,657 comprising wages of $86,110, taxable refunds of $349, taxable pensions of $29,095, and unemployment compensation of $26,103. Petitioners attached a Schedule A, Itemized Deductions, to their tax return and claimed, in pertinent part, deductions for charitable gifts of $5,427 ($2,000 of cash gifts and $3,427 of gifts other than by cash or check) and unreimbursed employee business expenses of $40,783 (before application of the 2% limitation prescribed in section 67(a)).Petitioners attached Form 8283, Noncash Charitable Contributions, to their tax return and reported donations of various items to the Salvation Army and a veterans charity. Petitioners reported that they used "Comparative sales" to determine the fair market37 value of the items they donated. On a supplemental schedule Ms. Haag assigned a value of $2,082 to donated clothing and $1,087 to donated furniture and kitchenware.Petitioners also attached to their tax return two Forms 2106-EZ, Unreimbursed Employee Business Expenses. Specifically, they reported driving 55,000 miles for business purposes (19,000 and 36,000 miles for Mr. Hagg and Ms. Haag, respectively) and claimed a deduction of $30,525 for their combined vehicle expenses using the standard mileage rate of 55.5 cents per mile.3 In addition, they reported parking fees, tolls, and transportation expenses of $1,002 ($177 and $825 for Mr. Haag and Ms. Haag, respectively), other business expenses of $9,203 ($2,195 and $7,008 for Mr. Haag and Ms. Haag, respectively),438 and meals and entertainment expenditures attributed to Ms. Haag of $53 (after application of the 50% limitation prescribed in section 274(n)(1)).Ms. Haag also completed a worksheet to determine the amount of a deduction that they might be entitled to for the business use of their home. Because petitioners had claimed other unreimbursed employee business expenses in excess of the wages they attributed to the business use of their home, they did not claim a home office deduction on their 2012 tax return.5VII. Pretrial DevelopmentsAs previously mentioned, petitioners' vehicle mileage logs were destroyed when their basement flooded in late January 2013. Shortly before trial petitioners and their attorneys attempted to reconstruct the number of miles that they drove for business purposes using their employment time cards and vehicle service records. They estimated that Mr. Haag and Ms. Haag drove 13,705 and 24,631 miles for business purposes in 2012, respectively.DiscussionThe Commissioner's determination of a taxpayer's liability in a notice of deficiency normally is presumed correct, and the taxpayer bears the39 burden of proving that the determination is incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115 (1933). Although petitioners assert that the burden of proof should shift to respondent as to certain factual issues, they have failed to show that they satisfied all of the relevant requirements prescribed in section 7491(a)(2). Therefore, the burden of proof as to any relevant factual issue does not shift to respondent under section 7491(a). See sec. 7491(a)(1) and (2); Higbee v. Commissioner, 116 T.C. 438">116 T.C. 438, 442-443 (2001).Deductions are a matter of legislative grace, and the taxpayer generally bears the burden of proving entitlement to any deduction claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79">503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 440 (1934). A taxpayer must substantiate deductions claimed by keeping and producing adequate records that enable the Commissioner to determine the taxpayer's correct tax liability. Sec. 6001; Hradesky v. Commissioner, 65 T.C. 87">65 T.C. 87, 89-90 (1975), aff'd per curiam, 540 F.2d 821">540 F.2d 821 (5th Cir. 1976); Meneguzzo v. Commissioner, 43 T.C. 824">43 T.C. 824, 831-832 (1965). A taxpayer claiming a deduction on a Federal income tax return must demonstrate that the deduction is allowable pursuant to a statutory provision and must further substantiate that the expense to which the deduction relates has been paid or incurred. Sec. 6001; Hradesky v. Commissioner, 65 T.C. at 89-90.When a taxpayer establishes that he or she paid or incurred a deductible expense but fails to establish the amount of the deduction, the Court40 normally may estimate the amount allowable as a deduction. Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731">85 T.C. 731, 742-743 (1985). There must be sufficient evidence in the record, however, to permit the Court to conclude that a deductible expense was paid or incurred in at least the amount allowed. Williams v. United States, 245 F.2d 559">245 F.2d 559, 560 (5th Cir. 1957).The Court may permit a taxpayer to substantiate expenses through secondary evidence where the underlying documents have been unintentionally lost or destroyed. Boyd v. Commissioner, 122 T.C. 305">122 T.C. 305, 320 (2004); Davis v. Commissioner, T.C. Memo. 2006-272. A taxpayer is required, however, to reconstruct pertinent records to the fullest extent possible. See Roumi v. Commissioner, T.C. Memo. 2012-2; Chong v. Commissioner, T.C. Memo 2007-12">T.C. Memo. 2007-12. In deciding whether a taxpayer has satisfied his or her burden of substantiating an expense, we are not required to accept the taxpayer's self-serving, undocumented testimony. Niedringhaus v. Commissioner, 99 T.C. 202">99 T.C. 202, 219-220 (1992); Tokarski v. Commissioner, 87 T.C. 74">87 T.C. 74, 77 (1986).I. Unreimbursed Employee Business ExpensesUnder section 162(a), a deduction is allowed for ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. The determination of whether an expenditure satisfies the requirements for deductibility under section 162 is a question of fact. See Commissioner v. Heininger, 320 U.S. 467">320 U.S. 467, 475 (1943). The term "trade or business" includes performing services as an employee. Primuth v. Commissioner, 54 T.C. 374">54 T.C. 374, 377-378 (1970). However, expenses for which an employee could claim reimbursement from his or her employer, but does not,41 are not ordinary and necessary expenses. See Podems v. Commissioner, 24 T.C. 21">24 T.C. 21, 22-23 (1955).A deduction normally is not available for personal, living, or family expenses. Sec. 262(a). The Court is not obliged to accept testimony that is self-serving and uncorroborated by objective evidence. See Cluck v. Commissioner, 105 T.C. 324">105 T.C. 324, 338 (1995).As a preliminary matter, the record shows that Aldridge reimbursed Ms. Haag for some expenses that she incurred in her capacity as a project manager. It also appears that Mr. Haag was reimbursed for some extraordinary work-related expenses. We are convinced, however, that petitioners generally were not eligible to be reimbursed for routine work-related expenses such as transportation, work clothing, and tools.Section 274(d) prescribes stringent substantiation requirements to be met before a taxpayer may deduct certain categories of expenses, including meals and entertainment expenditures and expenses related to the use of listed property as defined in section 280F(d)(4)(A). See Sanford v. Commissioner, 50 T.C. 823">50 T.C. 823, 827 (1968), aff'd, 412 F.2d 201">412 F.2d 201 (2d Cir. 1969). As relevant here, the term "listed property" includes, inter alia, automobiles. Sec. 280F(d)(4)(A)(i). To satisfy the requirements of section 274(d), a taxpayer generally must maintain records and documentary evidence which, in combination, are sufficient42 to establish the amount, date, and business purpose for a covered expenditure or business use of listed property. Sec. 1.274-5T(b)(6), (c)(1), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).A. Vehicle and Parking ExpensesPetitioners claimed a deduction of $30,525 for vehicle expenses on their 2012 tax return. At trial, however, Mr. Haag and Ms. Haag significantly reduced the number of estimated miles they had driven for business purposes in 2012 to 13,705 and 24,631 miles, respectively. They offered scant objective evidence to support their testimony regarding parking expenses.Respondent concedes that petitioners are entitled to a deduction of $183 for Mr. Haag's vehicle expenses. Specifically, respondent agrees that Mr. Haag drove 330 miles for business purposes in 2012--round trip mileage from petitioners' residence to Champaign, Illinois, where he performed work for Aldridge. The deduction of $183 is the product of 330 miles multiplied by the standard mileage rate of 55.5 cents per mile.Mr. Haag's reconstructed mileage records also indicate that he drove 76 miles round trip to Chicago Midway International Airport in connection with a trip to Daytona, Florida, to perform work for Aldridge. We conclude that petitioners are entitled to a further deduction43 of $42 (i.e., 76 miles multiplied by the standard mileage rate of 55.5 cents per mile) to account for these vehicles expenses.Respondent otherwise maintains that petitioners' vehicle and parking expenses constitute nondeductible personal commuting expenses. As a general rule, a taxpayer's costs of commuting between his or her residence and place of business or employment are nondeductible personal expenses. See Fausner v. Commissioner, 413 U.S. 838">413 U.S. 838, 839 (1973); Commissioner v. Flowers, 326 U.S. 465">326 U.S. 465, 473-474 (1946); sec. 1.262-1(b)(5), Income Tax Regs. There are various exceptions to this general rule. In accordance with Rev. Rul. 99-7, 1 C.B. 361">1999-1 C.B. 361, 362, a taxpayer may deduct travel expenses "incurred in going between the taxpayer's residence and a temporary work location outside the metropolitan area where the taxpayer lives and normally works." As another exception to the general rule, a taxpayer may deduct travel expenses for commuting between the taxpayer's residence and his or her work locations if the residence is the taxpayer's principal place of business. See Strohmaier v. Commissioner, 113 T.C. 106">113 T.C. 106, 113-114 (1999); Rev. Rul. 99-7, supra.Petitioners contend that they are entitled to a deduction for vehicle expenses because their various worksites were both temporary and outside the metropolitan area where they lived. Specifically, petitioners argue that, because the jurisdiction of IBEW Local 150 was limited to44 Lake County, Illinois, work that they performed beyond the Lake County line should be considered outside the metropolitan area. We disagree.The Court considers all the facts and circumstances in deciding whether particular transportation expenses were incurred in traveling to a worksite unusually distant from the area where the taxpayer lives and normally works. See, e.g., Bogue v. Commissioner, T.C. Memo 2011-164">T.C. Memo. 2011-164, aff'd, 522 F. App'x 169 (3d Cir. 2013). In 2012 petitioners resided in Lake County, and neither of them had a place of business to which he or she regularly reported for work. Instead, the vehicle and parking expenses remaining in dispute related to routine round trips from their residence to various temporary worksites up to approximately 65 miles away in either Chicago or Joliet, Illinois. The record reflects that petitioners normally worked in or near Chicago. Without suggesting the adoption of any rigid definition of the term "metropolitan area" for this purpose, we conclude that Lake County and petitioners' work sites in Chicago and Joliet fall within the Chicago metropolitan area. The distances that petitioners routinely traveled to work were not so unusually long as to justify an exception to the general rule that commuting expenses are45 nondeductible personal expenses.Petitioners aver in the alternative that Ms. Haag is eligible to deduct her vehicle expenses because she maintained an office at home. They rely on Rev. Rul. 99-7, 1999-1 C.B. at 362, which states in pertinent part: "If an office in the taxpayer's residence satisfies the principal place of business requirements of * * [section] 280A(c)(1)(A), then the residence is considered a business location * * * [and] the daily transportation expenses incurred in going between the residence and other work locations in the same trade or business are ordinary and necessary business expenses (deductible under * * * [section] 162(a))."A taxpayer generally is not entitled to deduct any expenses related to a dwelling unit used as a residence during the taxable year. Sec. 280A(a). Expenses attributable to a home office are excepted from this general rule, however, if the expenses are allocable to a portion of the dwelling unit which is exclusively used on a regular basis as the principal place of business for the taxpayer's trade or business. Sec. 280A(c)(1); Lofstrom v. Commissioner, 125 T.C. 271">125 T.C. 271, 277 (2005).If the taxpayer is an employee, the exception under section 280A(c)(1) will apply only if the exclusive use of the office space is for the convenience46 of the taxpayer's employer. Section 280A(c)(1) further provides that in this context the term "principal place of business" includes a place of business which is used by the taxpayer for the administrative or management activities of any trade or business of the taxpayer if there is no other fixed location of the trade or business where the taxpayer conducts substantial administrative or management activities of the trade or business. See Hamacher v. Commissioner, 94 T.C. 348">94 T.C. 348, 353-354 (1990).Petitioners admitted that they routinely used their basement office space for both business and personal purposes, including checking work-related emails, storing their personal tax records, and preparing personal tax returns. Petitioners did not use the office space exclusively as a principal place of business within the meaning of section 280A(c)(1), nor did they show that the space was used for the convenience of their employers (as opposed to their personal convenience). It follows that petitioners are not entitled to a deduction for the business use of their home under section 280A(c)(1). Because petitioners' residence does not satisfy the principal place of business requirements of section 280A(c)(1)(A), it follows that Ms. Haag was not eligible47 for the exception to the general rule barring a deduction for what are otherwise personal commuting expenses. See, e.g., Walker v. Commissioner, 101 T.C. 537">101 T.C. 537, 545-546 (1993) (citing and discussing Curphey v. Commissioner, 766">73 T.C. 766 (1980)).In sum, petitioners are not entitled to a deduction for vehicle expenses (including the deduction that Ms. Haag claimed for the depreciation of her vehicle) in excess of $225 as discussed above.6B. "Other" Expenses1. Work ClothingPetitioners claim that they are entitled to a deduction of $1,500 for work clothing and boots. The cost of clothes that are "required or essential in an employment, and which are not suitable for general or personal wear and are not so worn" is a deductible expense. Yeomans v. Commissioner, 30 T.C. 757">30 T.C. 757, 767-769 (1958); see Wasik v. Commissioner, T.C. Memo. 2007-148; Beckey v. Commissioner, T.C. Memo 1994-514">T.C. Memo. 1994-514.As previously mentioned, respondent concedes that petitioners are entitled to a deduction of $239 for work clothing (i.e., the cost of two pairs of composite-toe boots). Petitioners testified that they each paid48 $100 for a Carhartt bib that included a "built-in" tool belt. Considering petitioners' line of work and the harsh weather conditions they worked in, we are convinced these items were required for their employment and were not generally suitable for personal wear. Accordingly, we conclude that petitioners are entitled to a total deduction of $439 for work boots and clothing, subject to the 2% limit of section 67(a).2. ToolsPetitioners claim they are entitled to a deduction of $1,000 for work tools. The record includes Home Depot receipts showing that petitioners purchased various tools at a cost of $371. Petitioners' testimony that union electricians are required to purchase and maintain a basic set of tools was forthright and credible. We conclude on this record that petitioners are entitled to a deduction of $371 for tools, subject to the 2% limit of section 67(a).3. Computer EquipmentPetitioners claim they are entitled to a deduction of $850 related to the purchase of a personal laptop computer and a printer. Ms. Haag purchased the laptop after her personal laptop computer was damaged at an Aldridge worksite. Aldridge declined to reimburse Ms. Haag for the cost of the damaged computer49 because she had not informed the company in advance of her plan to take the device to the worksite.Ms. Haag acknowledged at trial that she used her personal laptop computer at the worksite by choice and not as directed by Aldridge. We are not persuaded that the replacement cost of Ms. Haag's computer and the cost of a new printer constitute ordinary and necessary employee business expenses. Moreover, it is unclear whether Aldridge might have reimbursed Ms. Haag had she notified the company in advance of her plan to take the laptop computer to a worksite. Accordingly, we sustain respondent's determination disallowing a deduction for the combined cost of the laptop computer and printer.C. Meals and EntertainmentPetitioners claimed a deduction of $53 (after the 50% limit of section 274(n)) for unreimbursed meals and entertainment expenses.Although Ms. Haag testified that she bought meals for persons under her supervision in order to maintain morale, those expenditures were not ordinary and necessary employee business expenditures. In short, Ms. Haag did not establish that she was required or expected by her employer to incur such expenses as a condition of her employment. See, e.g., Fountain v. Commissioner, 59 T.C. 696">59 T.C. 696, 708 (1973)50 .The record shows, however, that Mr. Haag purchased meals at a cost of $153 while traveling to perform work for Aldridge in Champaign, Illinois, and Daytona Beach, Florida. We conclude on this record that Mr. Haag was not eligible to be reimbursed by Aldridge for these meals and that he may deduct the cost of the meals under section 162(a) inasmuch as he was traveling while away from home. See, e.g., Bissonnette v. Commissioner, 127 T.C. 124">127 T.C. 124, 134-135 (2006). Because the deduction for meals and entertainment expenses is subject to the 50% limitation of section 274(n)(1), see Bissonnette v. Commissioner, 127 T.C. at 136-137, we conclude that petitioners are entitled to a deduction for meals and entertainment expenses of $77.II. Charitable ContributionsCharitable contributions are deductible only if verified in accordance with regulations prescribed by the Secretary. Sec. 170(a)(1); see Van Dusen v. Commissioner, 136 T.C. 515">136 T.C. 515, 530 (2011). No deduction for a contribution of cash, a check, or a monetary gift in any amount is allowed unless the donor maintains a bank record or a written communication from the donee showing the name of the donee organization, the date of the contribution, and the amount of the contribution. Sec. 170(f)(17). In the case of a charitable contribution deduction of $250 or more, section 170(f)(8)(A) provides that the taxpayer must obtain a contemporaneous written51 acknowledgment from the donee. Section 170(f)(8)(B) provides in relevant part that the contemporaneous written acknowledgment must include the amount of cash and a description of any property other than cash contributed, whether the donee organization provided any goods or services in consideration, in whole or in part, for any cash or property contributed, and, if so, a description and good-faith estimate of the value of any goods or services provided by the donee. Seesec. 1.170A-13(b), (f), Income Tax Regs. Section 170(f)(8)(C) provides that a written acknowledgment is contemporaneous when the taxpayer obtains it on or before the earlier of (1) the date the taxpayer files a tax return for the year of contribution; or (2) the due date, including extensions, for filing that tax return.7In addition to the written acknowledgment requirement, section 170(f)(11) and related regulations establish more detailed requirements for substantiation of contributions of property other than money. For noncash contributions52 of $500 or less, the taxpayer must substantiate the contribution with a receipt from the donee indicating the donee's name, the date and location of the contribution, and "[a] description of the property in detail reasonably sufficient under the circumstances." Sec. 1.170A-13(b)(1), Income Tax Regs. For noncash contributions in excess of $500, the taxpayer normally must also maintain written records showing the manner in which the item was acquired, the approximate date of acquisition, and the cost or adjusted basis of the property. Id. subpara. (3); see Lattin v. Commissioner, T.C. Memo 1995-233">T.C. Memo. 1995-233.8For noncash contributions, the value of the contribution generally is the fair market value of the property at the time of contribution. Hewitt v. Commissioner, 109 T.C. 258">109 T.C. 258, 261 (1997), aff'd without published opinion, 166 F.3d 332">166 F.3d 332 (4th Cir. 1998); sec. 1.170A-1(c)(1), Income Tax Regs. The fair market value of contributed property is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to53 buy or sell and both having reasonable knowledge of relevant facts. Sec. 1.170A-1(c)(2), Income Tax Regs.For purposes of determining whether a taxpayer's donation of property exceeds the $500 threshold prescribed in section 170(f)(11), all similar items of property donated to one or more donees are treated as one property (i.e., the values of all similar items of property contributed to one or more donees are considered in the aggregate). Seesec. 170(f)(11)(F); sec. 1.170A-13(c)(1)(i), (7)(iii), Income Tax Regs.A. Cash ContributionsPetitioners claimed a deduction of $2,000 for cash donations made to their respective churches. Petitioners did not produce a written acknowledgment of the contributions from either church, nor did they produce any other records to substantiate the amounts and dates of their reported cash contributions. In the absence of additional corroborating evidence supporting petitioners' trial testimony, respondent's determination disallowing a deduction for cash contributions is sustained.B. Noncash ContributionsPetitioners claimed a deduction of $3,427 for noncash donations of various items including clothing, furniture, and kitchenware to the Salvation Army and a veterans charity. Petitioners produced a list of donated items that Ms. Haag created when she prepared the couple's tax54 return, and she purportedly estimated the value of each donated item using "Comparative sales". Ms. Haag assigned a value of $2,082 to donated clothing and $1,087 to furniture and kitchenware.Petitioners failed to offer any contemporary written acknowledgments from the donee organizations stating whether they were provided any goods or services in return for the donations as required by section 170(f)(8)(A) or receipts or written records as required by section 170(f)(11) and the related regulations. Accordingly, we sustain respondent's determination limiting petitioners' deduction for noncash charitable contributions to $250.III. Accuracy-Related PenaltySection 6662(a) and (b)(1) and (2) imposes a penalty equal to 20% of the amount of any underpayment of tax that is attributable to, among other things: (1) negligence or disregard of rules or regulations or (2) any substantial understatement of income tax. The term "negligence" includes any failure to make a reasonable attempt to comply with tax laws, and "disregard" includes any careless, reckless, or intentional disregard of rules or regulations. Sec. 6662(c). An understatement means the excess of the amount of the tax required to be shown on the tax return over the amount55 of the tax imposed which is shown on the tax return, reduced by any rebate. Sec. 6662(d)(2)(A). An understatement is substantial in the case of an individual if the amount of the understatement for the taxable year exceeds the greater of 10% of the tax required to be shown on the tax return or $5,000. Sec. 6662(d)(1)(A).With respect to an individual taxpayer's liability for any penalty, section 7491(c) places on the Commissioner the burden of production, thereby requiring the Commissioner to come forward with sufficient evidence indicating that it is appropriate to impose the penalty. Higbee v. Commissioner, 116 T.C. at 446-447. Once the Commissioner meets his burden of production, the taxpayer must come forward with persuasive evidence that the Commissioner's determination is incorrect. Id. at 447; see Rule 142(a); Welch v. Helvering, 290 U.S. at 115.Section 6664(c)(1) provides an exception to the imposition of the accuracy-related penalty if the taxpayer establishes that there was reasonable cause for, and the taxpayer acted in good faith with respect to, the underpayment. Sec. 1.6664-4(a), Income Tax Regs. The determination of whether the taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account the pertinent facts and circumstances. Id. para. (b)(1).*56 Respondent discharged his burden of production as to negligence under section 7491(c) by showing that petitioners failed to keep adequate records or properly substantiate expenses underlying many of their claimed deductions. Seesec. 1.6662-3(b)(1), Income Tax Regs. Moreover, it appears that Rule 155 computations will show that petitioners substantially understated their income tax liability for the year in issue.Petitioners did not offer a meaningful defense to the imposition of an accuracy-related penalty other than to assert that respondent erred in determining a deficiency and that they are not well versed in tax matters. On this record, we cannot say that petitioners had reasonable cause with respect to their negligence or any understatement, and, therefore, respondent's determination that they are liable for an accuracy-related penalty under section 6662(a) is sustained.To reflect the foregoing,Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, section references are to the Internal Revenue Code, as amended and in effect for 2012, and Rule references are to the Tax Court Rules of Practice and Procedure. Monetary amounts are rounded to the nearest dollar.↩2. Respondent concedes that petitioners are entitled to deductions for vehicle expenses of $183, union dues of $2,993, clothing expenses of $239 (subject to the 2% limitation imposed under sec. 67(a)), and noncash charitable contributions of $250.↩3. The Commissioner generally updates the optional standard mileage rates annually. Seesec. 1.274-5(j)(2), Income Tax Regs. The standard mileage rate of 55.5 cents per mile for 2012 is set forth in Notice 2012-1, sec. 2, 2 I.R.B. 260">2012-2 I.R.B. 260↩, 260.4. Ms. Haag's other business expenses appear to include depreciation of approximately $6,000 attributable to her Dodge Journey.5. Petitioners maintain that if the Court sustains respondent's determination disallowing deductions for other unreimbursed employee business expenses, they would be entitled to a deduction for a home office for 2012.↩6. We note that Ms. Haag would not have been entitled to a deduction for vehicle depreciation in any event. She had elected to use the standard mileage rate method in computing the deductions she claimed for vehicle expenses, and that method includes an allowance for actual operating and fixed costs of a vehicle, including depreciation. See Campana v. Commissioner, T.C. Memo. 1990-395↩.7. Sec. 170(f)(8)(D)↩ provides an exception to the contemporaneous written acknowledgment requirement if the donee organization files a return containing the same information that is required in the contemporaneous written acknowledgment. Petitioners do not assert that this exception applies.8. If information regarding the acquisition date or cost basis of the property is not available and the taxpayer attaches a statement to his tax return setting forth reasonable cause for not being able to provide such information, the taxpayer's charitable contribution deduction shall not be disallowed on that account. Sec. 1.170A-13(b)(3)(ii), Income Tax Regs.↩	01-04-2023	11-14-2018
https://www.courtlistener.com/api/rest/v3/opinions/4537528/	If this opinion indicates that it is “FOR PUBLICATION,” it is subject to revision until final publication in the Michigan Appeals Reports. STATE OF MICHIGAN COURT OF APPEALS PEOPLE OF THE STATE OF MICHIGAN, UNPUBLISHED May 28, 2020 Plaintiff-Appellee, v No. 346888 Livingston Circuit Court BILLIE ERNEST FULKERSON, LC No. 15-022541-FC Defendant-Appellant. Before: RONAYNE KRAUSE, P.J., and SERVITTO and REDFORD, JJ. PER CURIAM. Defendant appeals as of right the sentences imposed upon him after his jury trial convictions of three counts of first-degree criminal sexual conduct (CSC-I), MCL 750.520b(1)(a) (sexual penetration with person under 13 years of age), and one count of second-degree criminal sexual conduct (CSC-II), MCL 750.520c(1)(a) (sexual contact with person under 13 years of age). We affirm. Defendant was convicted of sexually abusing his granddaughter. The trial court sentenced defendant to concurrent prison terms of 20 to 40 years for his CSC-I convictions and 10 to 15 years for his CSC-II conviction. Defendant appealed as of right, and this Court affirmed his convictions but vacated his sentences and remanded for resentencing on the basis of scoring error that altered the applicable guidelines range. People v Fulkerson, unpublished per curiam opinion of the Court of Appeals, issued December 26, 2017 (Docket No. 329887), p 1. On remand, the trial court resentenced defendant to a prison term of 18 years and nine months to 40 years for his CSC-I convictions and a prison term of 10 to 15 years for his CSC-II conviction. Defendant now appeals those sentences, asserting that they are disproportionate and unreasonably long in context of his age of 85 and his poor and declining health (defendant has congestive heart failure, diabetes, and prostate cancer, and has been hospitalized while incarcerated since September 2016). We disagree. We review the reasonableness of a sentence for an abuse of discretion. People v Steanhouse, 500 Mich 453, 471; 902 NW2d 327 (2017). However, this Court is required to review a defendant’s sentence for reasonableness only if the trial court imposed a departure sentence. People v Anderson, 322 Mich App 622, 636; 912 NW2d 607 (2018). A sentence within the -1- guidelines range is “presumptively proportionate.” People v Odom, 327 Mich App 297, 315; 933 NW2d 719 (2019). Defendant acknowledges that his minimum sentence of 18 years and nine months is within the applicable guidelines range. “If a minimum sentence is within the appropriate guidelines sentence range, the court of appeals shall affirm that sentence and shall not remand for resentencing absent an error in scoring the sentencing guidelines or inaccurate information relied upon in determining the defendant’s sentence.” MCL 769.34(10) (emphasis added). See also People v Schrauben, 314 Mich App 181, 196; 886 NW2d 173 (2016). Defendant does not argue that the trial court improperly scored the prior record or offense variables after this Court remanded for resentencing, nor does he contend that the trial court relied on any inaccurate information in determining defendant’s sentence. Accordingly, because defendant’s minimum sentence falls within the guidelines range, we must affirm the sentence. Anderson, 322 Mich App at 636. Affirmed. /s/ Amy Ronayne Krause /s/ Deborah A. Servitto /s/ James Robert Redford -2-	01-04-2023	05-29-2020
https://www.courtlistener.com/api/rest/v3/opinions/4474711/	OPINION Foley, Judge: The issues for decision are what portion of certain lump-sum payments made pursuant to a divorce decree qualifies as child support and what portion qualifies as alimony. Background Petitioner and Liza Holdman (Ms. Holdman), who were married in 1979, had two children, Dianne and Kimberly. On December 10, 1993, the Superior Court of Pulaski County, Georgia (superior court), entered a Final Judgment and Decree (divorce decree) terminating petitioner and Ms. Holdman’s marriage. The divorce decree required petitioner to pay $675 per month in child support, maintain medical and dental insurance for each child, and share equally with Ms. Holdman any medical and dental costs not covered by insurance. The divorce decree also required petitioner, who was an active member of the U.S. Navy at the time of the divorce, to pay Ms. Holdman, pursuant to the Uniformed Services Former Spouses’ Protection Act (USFSPA), 10 U.S.C. sec. 1408 (2000), 25 percent of his disposable retirement pay (retirement payments). On June 30, 2000, petitioner retired from the U.S. Navy. In August of the same year, petitioner began receiving his retirement pay, but he failed to make payments to Ms. Holdman as set forth in the divorce decree. On December 4, 2000, Ms. Holdman initiated a contempt proceeding against petitioner for his failure to comply with the divorce decree. The superior court, on June 26, 2001, ordered (the June 26 order) petitioner to pay $1,463 relating to the children’s past dental bills. The June 26 order also required petitioner to pay $68 a month relating to his portion of Kimberly’s then-current dental bills and $321 per month representing Ms. Holdman’s share of petitioner’s retirement pay. Petitioner failed to comply with the order. In response, Ms. Holdman initiated three additional contempt proceedings. On December 10, 2001, the superior court issued an order (the December 10 order) that required petitioner to comply with the June 26 order and decreased the retirement payments to $231 per month. Pursuant to the December 10 order, petitioner paid $2,774 on May 6, 2002, representing his first payment for his children’s uninsured dental expenses and Ms. Holdman’s share of his retirement pay. Petitioner followed that payment, in 2002, with six additional payments of $550 (i.e., totaling $3,300). Of the $6,074 paid by petitioner in 2002, $2,687 was for his children’s uninsured dental expenses. In July 2003, petitioner filed a Federal income tax return relating to 2002 and deducted, as alimony, $6,074. In a statutory notice of deficiency, dated November 9, 2005, and relating to 2002, respondent disallowed petitioner’s alimony deduction. On February 7, 2006, while residing in Eastman, Georgia, petitioner filed his petition with the Court. Discussion Petitioner deducted, as alimony, the entire $6,074 paid to Ms. Holdman in 2002. We must determine what portion, if any, of this amount was attributable to child support and what portion, if any, was attributable to alimony. Petitioner contends that the entire amount is alimony and is, therefore, deductible. Respondent contends that none of the amount is deductible because part of it is child support and the remaining portion, relating to Ms. Holdman’s share of petitioner’s retirement pay, is a division of marital property and does not qualify as alimony. I. Child Support An individual may generally deduct payments made to a spouse during the taxable year to the extent those payments are alimony includable in the spouse’s gross income. See sec. 215(a) and (b). Any payment which the terms of the divorce decree fix as a sum payable for the support of children is not alimony. See sec. 71(c)(1). If any payment is less than the amount specified in the divorce decree, to the extent the payment does not exceed the amount required to be paid for child support, such amount shall be considered support. See sec. 71(c)(3). Pursuant to the divorce decree, petitioner was required to pay Ms. Holdman $8,000 by the end of 2002 with respect to his children’s uninsured medical expenses and Ms. Holdman’s share of his retirement pay (i.e., $2,687 relating to his children’s uninsured medical expenses and $5,313 relating to Ms. Holdman’s share of his retirement pay). Petitioner started making payments in 2002. In that year, petitioner made lump-sum payments to Ms. Holdman totaling $6,074 (i.e., $1,926 less than the amount required pursuant to the divorce decree). Accordingly, $2,687 of the $6,074 paid by petitioner in 2002 is, pursuant to section 71(c)(3), child support and cannot be deducted as alimony. See Blyth v. Commissioner, 21 T.C. 275 (1953). We must determine whether the remaining $3,387 is alimony. II. Alimony Respondent contends that the retirement payments are part of a property settlement and do not qualify as alimony. An individual may generally deduct payments made to a spouse during the taxable year to the extent that those payments are alimony includable in the spouse’s gross income. See sec. 215(a) and (b). Section 71(a) requires amounts received as alimony to be included in gross income. In order to qualify as alimony, payments must meet the requirements of section 71(b)(1)(A) through (D). Ms. Holdman received the retirement payments pursuant to a divorce decree. Thus, such payments meet the requirements of section 71(b)(1)(A). In addition, petitioner and Ms. Holdman resided in separate households at the time the payments were made. Thus, such payments also meet the requirements of section 71(b)(1)(C). Respondent contends that the retirement payments do not, however, meet the requirements of section 71(b)(1)(B) and (D). Section 71(b)(1)(B) requires that the divorce instrument “not designate such payment as a payment which is not includible in gross income under this section and not allowed as a deduction under section 215”. Respondent contends that this prong is not met because the divorce decree refers to the payments as part of a division of the marital property. The classification of a payment as part of the division of marital property does not, however, preclude the payment from being alimony. See Benedict v. Commissioner, 82 T.C. 573, 577 (1984) (stating that “labels attached to payments mandated by a decree of divorce or marriage settlement agreement are not controlling”). While the designation need not mimic the statutory language of sections 71 and 215, the requirements of subparagraph (B) will generally be met if there is no “clear, explicit and express direction” in the divorce decree stating that the payment is not to be treated as alimony. See Estate of Goldman v. Commissioner, 112 T.C. 317, 323 (1999), affd. without published opinion sub nom. Schutter v. Commissioner, 242 F.3d 390 (10th Cir. 2000). The divorce decree does not contain such language. Accordingly, the retirement payments meet the requirements of section 71(b)(1)(B). Section 71(b)(1)(D) provides that there must be no liability for the payor to make such payments, or for the payor to make substitute payments, after the death of the payee spouse. Respondent contends that the retirement payments fail to meet the requirements of section 71(b)(1)(D) because the divorce decree does not state whether such payments will terminate upon the death of Ms. Holdman. In 1986, Congress amended section 71(b)(1)(D), specifically to remove the requirement that a divorce instrument expressly state that the liability terminates upon the death of the payee spouse. See Tax Reform Act of 1986, Pub. L. 99-514, sec. 1843(b), 100 Stat. 2853. Consequently, section 71(b)(1)(D) is satisfied if the liability ceases upon the death of the payee spouse by operation of law. Cf. Notice 87-9, 1987-1 C.B. 421. The divorce decree provides that the retirement payments were ordered pursuant to the USFSPA, which states that Payments from the disposable retired pay of a member pursuant to this section shall terminate in accordance with the terms of the applicable court order, but not later than the date of the death of the member or the date of the death of the spouse or former spouse to whom payments are being made, whichever occurs first. [10 U.S.C. sec. 1408(d)(4).] Accordingly, the retirement payments will terminate, by operation of law, on the date that either petitioner or Ms. Holdman dies, whichever occurs first.2 Moreover, the USFSPA provides that “Notwithstanding any other provision of law, this section does not create any right, title, or interest which can be sold, assigned, transferred, or otherwise disposed of (including by inheritance) by a spouse or former spouse”. 10 U.S.C. sec. 1408(c)(2). Petitioner has no liability to make such retirement payments after the death of Ms. Holdman. Thus, the retirement payments meet the requirements of section 71(b)(1)(D). The retirement payments meet the requirements of section 71(b)(1), and pursuant to section 215, petitioner is entitled to a deduction of $3,387 for alimony payments.3 Contentions we have not addressed are irrelevant, moot, or meritless. To reflect the foregoing, An appropriate decision will be entered. The USFSPA provides that a former spouse may serve upon the Secretary of Uniformed Services the divorce decree ordering payments pursuant to the USFSPA. After receipt of such service, the payments are made directly to the member’s spouse. See 10 U.S.C. sec. 1408(d)(1). While Ms. Holdman did not serve the Secretary of Uniformed Services with a copy of the divorce decree or receive payments directly from the Secretary, the payments were ordered “as authorized under the Uniformed Services Former Spouses’ Act”. Prior to enactment of the USFSPA, a former spouse had no right to receive a portion of a member’s military retirement pay. See McCarty v. McCarty, 453 U.S. 210 (1981). The USFSPA was enacted to allow courts to award spouses and former spouses an interest in a member’s military retirement pay. See S. Rept. 97-502 (1982). In Eatinger v. Commissioner, T.C. Memo. 1990-310, Witcher v. Commissioner, T.C. Memo. 2002-292, and Pfister v. Commissioner, 359 F.3d 352 (4th Cir. 2004), affg. T.C. Memo. 2002-198, the Court treated military retirement payments as property taxable to the former spouse. In those cases, the Court concluded that the payments were includable in the former spouses’ gross income pursuant to sec. 61(a)(ll) but did not address whether the payments qualified as alimony, pursuant to sec. 71. Conversely, in Baker v. Commissioner, T.C. Memo. 2000-164, the Court agreed with the Commissioner that the military retirement payments received by a former spouse qualified as alimony, pursuant to sec. 71.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4474712/	OPINION Cohen, Judge: This case is before us on respondent’s motion to dismiss for lack of jurisdiction on the ground the notice of deficiency is invalid and prohibited by section 6225. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue. Background The parties stipulated certain facts solely for our action on respondent’s motion to dismiss for lack of jurisdiction. Peter D. Adkison (petitioner) resided in Seattle, Washington, at the time that he filed his petition. Petitioner filed a joint Federal income tax return for 1999 with his spouse, Cathleen S. Adkison. The Adkisons claimed deductions and losses on their 1999 tax return in connection with their participation in a partnership known as Shavano Strategic Investment Fund, LLC (Shavano). Shavano engaged in a tax shelter transaction referred to as Bond Linked Issue Premium Structure or BLIPS. The Adkisons separated in December 1999 and were divorced in late 2001. In 2002, in response to an Internal Revenue Service (irs) announcement soliciting taxpayers to disclose their participation in certain tax shelter transactions, the Adkisons informed the IRS that they participated in the blips transaction through Shavano during 1999. During 2003, the IRS began an examination of the Adkisons’ 1999 tax return. In 2004, petitioner submitted to the IRS an election to participate in a settlement program pertaining to the Shavano tax shelter transaction. Although the parties attempted to draft a final closing agreement with regard to petitioner’s tax liability for 1999, the negotiations failed when petitioner requested that the closing agreement include language stating that petitioner was entitled to relief pursuant to section 6015(c), which provides that taxpayers filing a joint return may seek an allocation of the tax liability associated with the return. In October 2004, petitioner remitted to the irs $2.5 million to be posted as a cash bond against his tax liability for 1999. On December 21, 2004, respondent sent a notice of final partnership administrative adjustment (fpaa) to Shavano for its taxable year ended December 21, 1999. In May 2005, a partner other than the tax matters partner of Shavano filed a petition for readjustment with the U.S. District Court for the Northern District of California (District Court case). On June 9, 2005, petitioner submitted to the IRS a Form 8857, Request for Innocent Spouse Relief, seeking relief from joint and several liability on the joint return he filed for the taxable year 1999. Petitioner requested that the full amount of the tax due for 1999 be allocated in equal shares to him and to Cathleen Adkison pursuant to section 6015(c). Petitioner has not received a notice of determination from the IRS with regard to his Form 8857. On November 10, 2005, respondent sent a joint notice of deficiency for 1999 to petitioner and Cathleen Adkison. The deficiency of $5,837,482 set forth in the notice is attributable to the following adjustments related to the Adkisons’ participation in Shavano: (1) The disallowance of a capital loss of $27,213,056; (2) the disallowance of a partnership loss of $184,822; and (3) a reduction of itemized deductions (investment interest expense) of $812,327. The notice of deficiency includes an explanation that respondent made a number of alternative determinations including a determination that Shavano was a sham and/or Shavano was formed solely for the purposes of tax avoidance. On February 6, 2006, petitioner filed a petition with the Court. Petitioner asserted in the petition that he was invoking the Court’s jurisdiction (1) to redetermine the deficiency under section 6213(a) and (2) to review respondent’s failure to respond to petitioner’s request for an allocation of his tax liability for 1999 under section 6015(c). On December 15, 2006, respondent filed a motion to dismiss for lack of jurisdiction asserting that the notice of deficiency is invalid because the adjustments therein constitute “affected items” that are dependent upon the completion of partnership-level proceedings in the District Court case. See secs. 6221, 6225, 6230(a)(2). Respondent further asserts that petitioner submitted his claim for relief under section 6015(c) prematurely insofar as the partnership-level proceedings have not been completed, and, in any event, respondent did not “assert” a deficiency against petitioner within the meaning of section 6015(e)(1). Petitioner agrees that the Court lacks jurisdiction in this case to redetermine a deficiency pursuant to section 6213(a) because the notice of deficiency is invalid. Petitioner maintains, however, that he is an “individual against whom a deficiency has been asserted” within the meaning of section 6015(e)(1), and, therefore, he properly invoked the Court’s jurisdiction to review his claim for relief under section 6015(c). Discussion The Tax Court is a court of limited jurisdiction, and we may exercise our jurisdiction only to the extent provided by Congress. See sec. 7442; see also GAF Corp. & Subs. v. Commissioner, 114 T.C. 519, 521 (2000). The jurisdictional dispute in this case requires an examination of the interrelationship between the Court’s jurisdiction to review a claim for relief from joint and several liability on a joint return under section 6015 and the Court’s jurisdiction under the unified partnership audit and litigation procedures contained in sections 6221 through 6234. See Tax Equity and Fiscal Responsibility Act of 1982 (tefra), Pub. L. 97-248, sec. 402(a), 96 Stat. 648. Section 6015 Section 6013(d)(3) provides that, if a husband and wife file a joint Federal income tax return, “the tax shall be computed on the aggregate income and the liability with respect to the tax shall be joint and several.” However, section 6015(a) provides that, notwithstanding section 6013(d)(3), an individual who has made a joint return may elect to seek relief from joint and several liability on such return. For a detailed discussion of the legislative history of section 6015 (and its predecessor section 6013(e)), see Cheshire v. Commissioner, 115 T.C. 183, 188-189 (2000), affd. 282 F.3d 326 (5th Cir. 2002). Congress vested the Tax Court with jurisdiction to review a taxpayer’s election to claim relief from joint and several liability on a joint return under various circumstances. See King v. Commissioner, 115 T.C. 118, 121-122 (2000); Corson v. Commissioner, 114 T.C. 354, 363-364 (2000). A taxpayer may seek relief from joint and several liability on a joint return by raising the matter as an affirmative defense in a petition for redetermination filed in response to a notice of deficiency under section 6213(a). See Butler v. Commissioner, 114 T.C. 276, 287-288 (2000). In addition, a taxpayer may file with the Court a so-called stand-alone petition seeking relief from joint and several liability on a joint return if (1) the Commissioner issues a final determination letter denying the taxpayer’s claim for such relief or (2) the Commissioner has failed to rule on the taxpayer’s claim for relief within 6 months of its filing. See sec. 6015(e)(1); Mora v. Commissioner, 117 T.C. 279 (2001); Corson v. Commissioner, supra at 363. A taxpayer also may request relief from joint and several liability on a joint return in a petition for review of a lien or levy action. See secs. 6320(c), 6330(c)(2)(A)(i). TEFRA Partnership Provisions The proper tax treatment of any partnership item generally is determined at the partnership level pursuant to the TEFRA partnership provisions. The TEFRA procedures apply with respect to all taxable years of a partnership beginning after September 3, 1982. Sparks v. Commissioner, 87 T.C. 1279, 1284 (1986); Maxwell v. Commissioner, 87 T.C. 783, 789 (1986). A partnership item is any item required to be taken into account for the partnership’s taxable year under any provision of subtitle A to the extent regulations prescribed by the Secretary provide that, for purposes of subtitle A, such item is more appropriately determined at the partnership level than at the partner level. Sec. 6231(a)(3). Partnership items normally include each partner’s proportionate share of the partnership’s aggregate items of income, gain, loss, deduction, or credit. Sec. 301.6231(a)(3)-l(a)(l)(i), Proced. & Admin. Regs. Partnership items are distinguished from affected items, which are defined in section 6231(a)(5) as any item to the extent such item is affected by a partnership item. White v. Commissioner, 95 T.C. 209, 211 (1990). The first type of affected item is purely a computational adjustment made to record the change in a partner’s tax liability resulting from the proper treatment of partnership items. Sec. 6231(a)(6); White v. Commissioner, supra at 211. Once the decision in a partnership-level proceeding is final, the Commissioner is permitted to assess a computational adjustment against a partner without issuing a notice of deficiency. Secs. 6225, 6230(a)(1); N.C.F. Energy Partners v. Commissioner, 89 T.C. 741, 744 (1987); Maxwell v. Commissioner, supra at 792 n.7. The second type of affected item is an adjustment to a partner’s tax liability to reflect the proper treatment of a partnership item that is dependent upon factual determinations to be made at the individual partner level. N.C.F. Energy Partners v. Commissioner, supra at 744. Section 6230(a)(2)(A)(i) provides that the normal deficiency procedures apply to those affected items that require partner-level determinations. See N.C.F. Energy Partners v. Commissioner, supra at 743-744; see also Crowell v. Commissioner, 102 T.C. 683, 689 (1994). A valid notice of deficiency concerning an affected item generally is dependent upon a final decision in the underlying partnership-level proceeding. Sec. 6225(a); GAF Corp. & Subs. v. Commissioner, supra at 526 (citing Dubin v. Commissioner, 99 T.C. 325, 328 (1992)); see Crowell v. Commissioner, supra at 694-695. In 1997, Congress passed the Taxpayer Relief Act of 1997, Pub. L. 105-34, sec. 1237(a) and (b), 111 Stat. 1025, amending the TEFRA provisions to add specific rules that are applicable when the spouse of a partner seeks relief from joint and several liability on a joint tax return. As discussed in detail below, the new provisions, set forth in section 6230(a)(3) and (c)(5), prescribe the procedures under which a spouse of a partner seeking relief under section 6015 may raise such a claim either in a deficiency proceeding or in a refund suit. Section 6230(a)(3) and (c)(5) is effective as if included in TEFRA as originally enacted. See Taxpayer Relief Act of 1997, sec. 1237(d), 111 Stat. 1026. Section 6230(a)(3)(A) provides in part: SEC. 6230(a). Coordination With Deficiency Proceedings.— % if* ífc ‡ # ;f{ (3) Special rule in case of assertion by partner’s spouse of INNOCENT SPOUSE RELIEF.— (A) Notwithstanding section 6404(b), if the spouse of a partner asserts that section 6013(e) applies with respect to a liability that is attributable to any adjustment to a partnership item * * * then such spouse may file with the Secretary within 60 days after the notice of computational adjustment is mailed to the spouse a request for abatement of the assessment specified in such notice. Upon receipt of such request, the Secretary shall abate the assessment. Any reassessment of the tax with respect to which an abatement is made under this subparagraph shall be subject to the deficiency procedures prescribed by subchapter B. * * * To summarize, section 6230(a)(3)(A) provides that, after the Commissioner has issued to the spouse of a partner a notice of computational adjustment following the completion of a partnership-level proceeding, the Commissioner, upon the request of the spouse, must abate the underlying assessment to permit the spouse to assert a claim for relief from joint and several liability pursuant to the deficiency procedures of subchapter B. In addition to the deficiency procedures described above, section 6230(c)(5) provides in pertinent part: SEC. 6230(c). Claims Arising Out of Erroneous Computations, Etc.— % # % :Jt # ;ji % (5) Rules for seeking innocent spouse relief.— (A) In general. — The spouse of a partner may file a claim for refund on the ground that the Secretary failed to relieve the spouse under section 6015 from a liability that is attributable to an adjustment to a partnership item (including any liability for any penalties, additions to tax, or additional amounts relating to such adjustment). (B) Time for filing CLAIM. — Any claim under subparagraph (A) shall be filed within 6 months after the day on which the Secretary mails to the spouse the notice of computational adjustment referred to in subsection (a)(3)(A). In sum, section 6230(c)(5)(A) and (B) provides that the spouse of a partner may file a claim for relief from a tax liability attributable to an adjustment to a partnership item within 6 months after the Commissioner has mailed to the spouse a notice of computational adjustment. In connection with these provisions, section 6230(c)(5)(C) provides that, if the Commissioner disallows the spouse’s claim for relief under section 6015, the spouse may bring a refund suit within the period specified in section 6230(c)(3) (which in turn refers to section 6532 relating to periods of limitations on refund suits). Section 6015(g)(3) provides that no credit or refund shall be allowed in respect of a claim for relief under section 6015(c) — the provision on which petitioner relies. When section 6230(a)(3) and (c)(5) was originally enacted in 1997, both provisions contained express references to section 6013(e). One year later, however, Congress added new section 6015 to the Internal Revenue Code and made conforming amendments striking section 6013(e) and replacing the reference to section 6013(e) appearing in section 6230(c)(5)(A) with a reference to section 6015. See IRS Restructuring and Reform Act of 1998, Pub. L. 105-206, sec. 3201(a), (e)(1) and (2), 112 Stat. 740. To all appearances, Congress simply overlooked the reference to section 6013(e) contained in section 6230(a)(3)(A) and failed to make a conforming amendment to that section. In any event, both provisions reflect congressional intent that the spouse of a partner may initiate a claim for relief from joint and several liability attributable to an adjustment of a partnership item only after the Commissioner issues to the spouse a notice of computational adjustment following the completion of a partnership-level proceeding. With the foregoing as background, we return to the parties’ contentions. The Affected Items Notice of Deficiency The Court’s jurisdiction to redetermine a deficiency attributable to an affected item is dependent upon a valid (affected items) notice of deficiency and a timely filed petition. Crowell v. Commissioner, 102 T.C. at 694. The record reflects, and the parties agree, that the adjustments set forth in the notice of deficiency are attributable to adjustments to partnership items. Those partnership items are the subject of the partnership-level proceeding that is pending before the District Court. Under the circumstances, it follows that the notice of deficiency is invalid, and it is insufficient to permit petitioners to invoke the Court’s jurisdiction to redetermine a deficiency under section 6213(a). GAF Corp. & Subs. v. Commissioner, 114 T.C. at 528; Maxwell v. Commissioner, 87 T.C. at 788, 793. Section 6015 Although petitioner may not invoke the Court’s jurisdiction under section 6213(a), the petition includes allegations that petitioner is entitled to relief from joint and several liability on a joint return under section 6015. Respondent maintains that the Court lacks jurisdiction to review petitioner’s claim for relief under section 6015 because (1) the notice of deficiency upon which the petition is based is invalid and (2) petitioner’s entitlement to relief under section 6015 is an affected item that may be adjudicated only following a final decision in the related partnership-level proceeding. Respondent relies primarily on Life Care Cmtys. of Am. v. Commissioner, T.C. Memo. 1997-95, and Mann-Howard v. Commissioner, T.C. Memo. 1992-537, for the proposition that the spouse of a partner must prosecute a claim for relief under section 6015 in an affected items proceeding. Petitioner asserts that various developments in this case, including the parties’ attempt to settle petitioner’s tax liability for 1999, and eventually the issuance of both the FPAA and the invalid notice of deficiency, demonstrate that respondent “asserted” a deficiency against him within the meaning of section 6015(e)(1)(A). As petitioner sees it, his petition is a valid stand-alone petition for relief under section 6015(e). Taking into account the ongoing partnership-level proceeding, we conclude that respondent has not “asserted” a deficiency against petitioner within the meaning of section 6015(e)(1)(A). As explained below, petitioner’s claim for relief under section 6015 is premature and will not crystallize into a justiciable case or controversy until the underlying partnership-level proceeding is final and respondent has issued to petitioner a notice of computational adjustment. The question of when the Court may exercise jurisdiction to review a claim for relief from joint and several liability on a joint return in the context of a TEFRA partnership proceeding is not a new one. In cases such as Dynamic Energy, Inc. v. Commissioner, 98 T.C. 48 (1992), and Marthinuss v. Commissioner, T.C. Memo. 1995-58, the Court indicated that the spouse of a partner is not entitled to an adjudication of his or her entitlement to relief from joint and several liability on a joint return in a partnership-level proceeding. Further, in cases such as Life Care Cmtys. of Am. v. Commissioner, supra, and Mann-Howard v. Commissioner, supra, the Court indicated that the spouse of a partner normally would be able to prosecute a claim for relief from joint and several liability on a joint return in response to an affected items notice of deficiency issued after the completion of partnership-level proceedings. As previously discussed, Congress prescribed specific procedures for purposes of TEFRA partnership actions under which the spouse of a partner is permitted to obtain an adjudication of a claim for relief from joint and several liability on a joint return. Section 6230(a)(3), which refers to section 6013(e) (now stricken), provides a remedy in the form of a deficiency proceeding, whereas section 6230(c)(5) provides an alternative remedy in the form of a refund action. Significantly, in either case, the spouse of a partner may assert a claim for relief from joint and several liability only after the Commissioner has issued to the spouse a notice of computational adjustment. However, the Commissioner may issue a notice of computational adjustment to a partner (or the spouse of a partner) only following the completion of proceedings at the partnership level. Sec. 6225. Consistent with the foregoing, the Court has exercised its jurisdiction to review stand-alone petitions filed with the Court pursuant to section 6015 after the Commissioner issued to the spouse of a partner a notice of computational adjustment. See Mora v. Commissioner, 117 T.C. 279 (2001); Abelein v. Commissioner, T.C. Memo. 2004-274. Consistent with the preceding discussion, we conclude that petitioner is not a person against whom a deficiency has been asserted within the meaning of section 6015(e)(1). The related partnership-level proceedings have not been completed, and respondent has not had the occasion to issue to petitioner either a notice of computational adjustment or a valid affected items notice of deficiency. Until one of those events occurs, or respondent institutes a collection action under sections 6320 and/or 6330, petitioner’s claim for relief under section 6015 is premature, and the Court lacks jurisdiction to consider it. Because the Court lacks jurisdiction over the petition in this case, respondent’s motion to dismiss for lack of jurisdiction will be granted. To reflect the foregoing, An order of dismissal for lack of jurisdiction will be entered granting respondent’s motion to dismiss for lack of jurisdiction.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621007/	ALBERT W. BASSETT and MARY H. BASSETT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBassett v. CommissionerDocket No. 8166-73.United States Tax CourtT.C. Memo 1976-14; 1976 Tax Ct. Memo LEXIS 389; 35 T.C.M. 40; T.C.M. (RIA) 760014; January 20, 1976, Filed Jack W. Hawkins and Suzan E. Riddle, for the petitioners. Douglas R. Fortney, for the respondent. FAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: Respondent determined deficiencies in petitioners' Federal income taxes of $280.72 and1976 Tax Ct. Memo LEXIS 389">390 $10,701.61 for the years 1969 and 1970, respectively. Concessions having been made, it remains for us to decide: (1) Whether construction by petitioners of certain residential property was an activity engaged in for profit so as to entitle them to a deduction for a loss incurred on the sale of the property; and (2) whether petitioners are entitled to deduct amounts expended to insure and maintain the property during the years in issue. FINDINGS OF FACT The petitioners Albert W. (Albert) and Mary H. (Mary) Bassett, husband and wife, were residents of Pampa, Texas, when their petition was filed with this Court. They filed joint Federal income tax returns for 1969 and 1970 with the District Director of Internal Revenue, Dallas, Texas. At all times relevant, Albert was employed as publisher by Freedom Newspapers, Inc., a corporation which owned newspapers published in various cities throughout the country. Prior to 1969, Albert's post of employment was in Orange County, California. In July 1966, petitioners purchased a lot in Orange County for $17,500. In April 1968, they engaged the services of an architect to design and supervise construction of a personal residence on the1976 Tax Ct. Memo LEXIS 389">391 lot. The architect's fee was to be $3,500. Petitioners entered a construction agreement with a builder in October 1968 for a contract price of $76,100. Construction of the house began immediately but heavy rains in the winter of 1968 drastically impeded progress; by February 1969 only the foundation slab had been poured. Due to the magnitude of the project, construction of the new house caused such disharmony in petitioners' marital relationship that Albert departed from the home where they were then residing. During Albert's twelve-day absence, Mary ordered that construction of the new house be halted. Petitioners reconciled their differences following Albert's return home, but since it was the construction of the large new house that originally caused discord, they agreed it would be best to abandon plans to construct the house as their personal residence. At the time work ceased, petitioners had expended a total of $29,678.33 on the house, $17,500.00 representing the cost of the lot and the remaining $12,178.33 representing various amounts paid to the architects, appraisers, banks, and contractors. The fair market value of the lot, as improved, was at least equal to the1976 Tax Ct. Memo LEXIS 389">392 amount petitioners had expended. After conferring with his architect and builder Albert decided on March 7, 1969, to go forward with the construction of the home with the idea of eventually selling it for a profit. By eliminating certain custom features of the house, it was estimated that costs could be reduced as much as $10,000, thereby allowing for a substantial profit margin. The total cost of the completed house then contemplated would have been $87,200, comprised of $17,600 in land cost, $3,500 in architectural fees, and $66,100 in construction costs. Albert contemplated a $99,600 selling price for the house which, after deducting real estate commissions, would have yielded to him a profit of $6,500. On June 2, 1969, Albert ordered several modifications in the original design of the house in order to reduce the construction cost and, at the same time, give the house a broader appeal in the commercial real estate market. With the house well under construction, however, all of the changes originally anticipated could not be implemented. The resulting cost reduction was only $4,629, instead of the $10,000 reduction earlier projected by the builder and architect. In May1976 Tax Ct. Memo LEXIS 389">393 1969, Albert was transferred by his employer to Pampa, Texas, where he became publisher of a daily newspaper. Before he departed Orange County, Albert entered into a sales arrangement with an individual real estate agent who resided near the house. The asking price for the house was $99,750. Dissatisfied with the individual agent's efforts to sell the house, Albert terminated the arrangement and, on January 11, 1970, listed the house for sale with a large commercial real estate firm and reduced the asking price to $92,500. Extensive efforts to sell the house by advertisement and public showing met with little success. On March 23, 1970, Albert's realtors informed him that, in their opinion, the difficulty in selling the house was characteristic of the general downward economic trend then prevalent in Orange County. In fact, during the period from March 1969 through late 1970, economic conditions in Orange County, California, declined dramatically. Available mortgage funds were scarce; interest rates climbed steadily from 7 percent in 1968 to 9-3/4 percent in 1970. The aerospace industry, on which Orange County was greatly dependent, experienced severe setbacks. In March 19701976 Tax Ct. Memo LEXIS 389">394 the unemployment rate in Orange County rose to 5.4 percent; by June it had reached 7.1 percent. These deteriorating conditions had not yet begun at the time Albert made his decision to follow through with construction of the house, and decided upon his initial asking price. Prior to 1969, Orange County had enjoyed unprecedented prosperity. In an attempt to rent the house in April 1970, escrow proceedings were begun in anticipation of a proposed lease option agreement. The arrangement, however, was frustrated when the prospective purchaser withdrew. The house was finally sold on June 1, 1970, for a gross sales price of $80,000. Petitioners' basis in the completed house was $93,766.97. In addition, expenses of $5,401.50 were incurred in connection with the sale of the house along with various maintenance expenses not included in the basis of the house. On their joint Federal income tax returns for 1970 petitioners claimed deductions of $13,766.97 for the loss incurred on the sale of the property and $5,593.50 for amounts expended to insure, maintain, and sell the property. An insurance deduction of $364 was also claimed on their 1969 return. These deductions were disallowed and1976 Tax Ct. Memo LEXIS 389">395 a deficiency determined in a statutory notice mailed August 16, 1973. OPINION The issue to be decided is whether the residential property was held for the production of income within the meaning of section 212 1 so as to entitle petitioners to the loss sustained on the sale of the property. Respondent contends that the property was never converted from personal use and that, consequently, the incurred loss is not deductible. Petitioners' burden is to show that the property, initially purchased for personal reasons, was at some point appropriated to an income-producing purpose. Income Tax Regs. § 1.165-9(b)(1); 2Heiner v. Tindle,276 U.S. 582">276 U.S. 582 (1928); and Edward L. Parker,19 B.T.A. 171">19 B.T.A. 171 (1930). If this burden is to be sustained, the record must clearly evince a change in1976 Tax Ct. Memo LEXIS 389">396 attitude and intention toward the property. 276 U.S. 582">Heiner v. Tindle,supra.We feel that petitioners have sufficiently demonstrated such a departure. Albert and Mary acquired land and commenced construction of a personal dwelling in late 1968. In 1969, with construction barely under way, they decided not to occupy the house and ordered the work ceased. Albert then was confronted with a choice regarding the property--he could sell the land for fair market value in its improved condition and thereby recover his expenditures; or he could continue construction with the intention of deriving a profit from the sale of the improved property. Albert decided on the latter course and, endeavoring to maximize potential profits, increased substantially his investment in1976 Tax Ct. Memo LEXIS 389">397 the property. Albert was then transferred and moved his family from California to Texas, never having occupied the house at any time. 31976 Tax Ct. Memo LEXIS 389">398 Although the initial acquisition was personal, we are convinced that a conversion did occur and that construction of the dwelling was completed primarily as an investment. Helen Converse Thorpe,3 B.T.A. 1006">3 B.T.A. 1006 (1926); Sidney W. Sinsheimer,7 B.T.A. 1099">7 B.T.A. 1099 (1927); John N. Hughes,8 B.T.A. 206">8 B.T.A. 206 (1927); Henry J. Gordon,12 B.T.A. 1191">12 B.T.A. 1191 (1928); W. W. Holloway, Administrator,19 B.T.A. 378">19 B.T.A. 378 (1930); Marjorie G. Randall,27 B.T.A. 475">27 B.T.A. 475 (1932); Westmore Willcox,20 T.C. 305">20 T.C. 305 (1953); Cf. Harold K. Meyer,34 T.C. 528">34 T.C. 528 (1960); and James E. Austin,35 T.C. 221">35 T.C. 221 (1960), affd. 298 F.2d 583">298 F.2d 583 (C.A. 2, 1962). The evidence reveals that from the moment of his decision not to occupy but, nevertheless, to move forward with construction of the house, Albert treated the property not as his home but as a piece of property from which he expected to derive some financial benefit. Indeed his only reason for completing the structure was in furtherance of his intention to realize a profit. The conversion is further evidenced by Albert's alterations1976 Tax Ct. Memo LEXIS 389">399 in the design of the house which ultimately changed the nature of the property to that better suited to the commercial homebuyers' market. See 27 B.T.A. 475">Marjorie G. Randall,supra.The fact that Albert's expectations were frustrated by unforeseen decay of economic conditions does not alter the nature of the venture as one undertaken with a reasonable expectation of a profit. We therefore hold that petitioners' loss was incurred in a transaction entered into for profit within the meaning of section 165(c)(2). 47 B.T.A. 1099">Sidney W. Sinsheimer,supra.Having held that there existed such a transaction subsequent to February 1969, the expenditures incurred in insuring and maintaining the property were properly deducted. Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended. SEC 212. EXPENSES FOR PRODUCTION OF INCOME. In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year-- (1) for the production or collection of income; * * ↩2. Sec. 1.165-9(b)(1) provides: 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. Most of the decided residential "conversion" cases involve factual situations in which the taxpayer actually occupied the dwelling. See e.g., Helen Converse Thorpe,3 B.T.A. 1006">3 B.T.A. 1006 (1926); Sidney W. Sinsheimer,7 B.T.A. 1099">7 B.T.A. 1099 (1927); John N. Hughes,8 B.T.A. 206">8 B.T.A. 206 (1927); Henry J. Gordon,12 B.T.A. 1191">12 B.T.A. 1191 (1928); W. W. Holloway, Administrator,19 B.T.A. 378">19 B.T.A. 378 (1930); Marjorie G. Randall,27 B.T.A. 475">27 B.T.A. 475 (1932); Richard P. Koehn,16 T.C. 1378">16 T.C. 1378 (1951); Gilbert Wilkes,17 T.C. 865">17 T.C. 865 (1951); Westmore Willcox,20 T.C. 305">20 T.C. 305 (1953); Harold K. Meyer,34 T.C. 528">34 T.C. 528 (1960); James E. Austin,35 T.C. 221">35 T.C. 221 (1960), affd. 298 F.2d 583">298 F.2d 583 (C.A. 2 1962). We have noted that the presence of this element tends to bestow personal overtones on any expense or loss incurred. See Charles F. Neave,17 T.C. 1237">17 T.C. 1237 (1952); Warren Leslie, Sr.,6 T.C. 488">6 T.C. 488 (1946). Consequently, we regard the total absence of occupancy in this case as a factor weighing heavily in petitioners' favor. See Frank A. Newcombe,54 T.C. 1298">54 T.C. 1298, 54 T.C. 1298">1300 (1970). See also Income Tax Regs. § 1.165-9(a) which disallows losses "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 * ". (Emphasis supplied).4. SEC. 165. LOSSES. (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; * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621008/	Estate of Joseph A. Schmitt, Deceased, The First National Bank of Portland, Executor v. Commissioner.Estate of Schmitt v. CommissionerDocket No. 46749.United States Tax CourtT.C. Memo 1955-155; 1955 Tax Ct. Memo LEXIS 182; 14 T.C.M. 579; T.C.M. (RIA) 55155; June 16, 1955Frederick H. Torp, Esq., Yeon Building, Portland, Ore., for the petitioner. John D. Picco, Esq., for the respondent. RAUMMemorandum Findings of Fact and Opinion The respondent has determined a deficiency of $18,397.23 in the petitioner's estate tax liability. The deficiency results from the disallowance by the respondent of a charitable deduction of $67,118.99 claimed in the estate tax return. The issue is whether provisions of a testamentary trust giving the trustee power to invade the principal of the trust estate if, in his judgment, the income of the trust proved insufficient to provide for the "proper maintenance and support, or other necessity" of the income beneficiary rendered the value of a charitable remainder so uncertain1955 Tax Ct. Memo LEXIS 182">183 and unascertainable as to preclude its deduction under Section 812(d) of the Internal Revenue Code of 1939. Findings of Fact A stipulation of facts filed by the parties is hereby adopted and incorporated herein by reference. 1The decedent, Joseph A. Schmitt, died testate on September 25, 1948. At the time of his death, he was a resident of Oregon, and a citizen of the United States. He was survived by two brothers and three sisters. Decedent's will was admitted to probate on October 13, 1948. The First National Bank of Portland, the petitioner herein, was appointed executor. Petitioner had also been named trustee under decedent's will and since August 21, 1950, has been acting as such trustee. The will created a trust for the benefit of decedent's brother, Louis E. Schmitt, for life. The trust was to terminate upon his death, and the unexpended corpus then divided equally between a designated charity and named relatives. The trust was set up on August 21, 1950, the1955 Tax Ct. Memo LEXIS 182">184 principal thereof consisting largely of stock in Schmitt Bros. Lumber Company and S.H. & W. Lumber Company, Oregon corporations. Decedent's will provided in part as follows: "SECOND: I hereby give, devise and bequeath all the rest, residue and remainder of my estate and property, real and personal of which I shall be possessed at the time of my death, to my Trustee, THE FIRST NATIONAL BANK OF PORTLAND, (OREGON), in trust, to pay and apply to the use of my brother, LOUIS E. SCHMITT, (Otherwise known as L. E. Schmitt), for and during the term of his life, the net income of my Trust Estate during his life, in such sums of money from time to time as he may require; and if at any time or times such net income shall in the judgment of my Trustee, prove insufficient to provide for his proper maintenance and support, or other necessity, it shall be lawful for my Trustee at its sole discretion to invade the capital of my Trust Estate, and pay or apply for the benefit of my said brother such portion thereof as my Trustee in its discretion my see fit; and I hereby appoint said Bank Executor of my Estate; "THIRD: During the lifetime of my said brother, however, it is my wish and desire that1955 Tax Ct. Memo LEXIS 182">185 he shall have control of the management and operation of SCHMITT BROS. LUMBER CO., an Oregon corporation, and the business and affairs of said Corporation, and the income and profits therefrom, if any; and that said Corporation shall continue in existence during his lifetime, unless the same shall be dissolved and terminated, and the affairs thereof wound up by mutual agreement of my brother and my said Executor. "FOURTH: At the death of my said brother, LOUIS E. SCHMITT, my Trustee shall divide the unexpended residue of my trust estate remaining undisposed of, as follows: "Fifty (50%) per cent thereof, or an undivided one-half thereof I do hereby devise and bequeath unto the Board of Trustees of and for crippled children at Portland, Oregon, organized, maintained, and operated by and under the jurisdiction and authority of the Imperial Council of the Ancient and Arabic Order of the Nobles of the Mystic Shrine, for the use and benefit of the hospital of said Order for Crippled Children, at Portland, Oregon; and the remaining fifty (50%) per cent or undivided one-half thereof I do hereby devise and bequeath unto my sisters and brother surviving me at the time of my death, and to1955 Tax Ct. Memo LEXIS 182">186 my nieces, MAUDE HOGUE and LORENA WEISS, in accordance with their relationship to me, and the laws of descent and distribution of the State of Oregon now in force." The Imperial Council of the Ancient and Arabic Order of the Nobles of the Mystic Shrine for North America for the use and benefit of the charitable hospital for crippled children at Portland, Oregon, sometimes known as the Shriners Hospital for Crippled Children, is a qualified charitable organization within the meaning of Section 812 (d) of the Internal Revenue Code of 1939. On December 13, 1949, petitioner filed a Federal estate tax return with the then collector of internal revenue, Portland, Oregon. The return disclosed a net estate for basic tax and a net estate for additional tax in the respective amounts of $17,510.41 and $57,510.41, and reported a total estate tax of $8,737.52. The estate tax return disclosed a gross estate of $199,841.71, as follows: FairItemsMarket ValueStock and Bonds$177,634.03549 shares Schmitt Bros. Lumber Co., par value $100/share$135,279.09249 shares S.H. & W. Lumber Co., par value $100/share35,726.52Savings bonds6,628.42$177,634.03Mortgages, notes and cash20,787.68Miscellaneous (Auto & Personal effects)1,420.00$199,841.711955 Tax Ct. Memo LEXIS 182">187 The Schmitt Bros. Lumber Company stock was returned in the estate tax return at a total value of $135,279.09 or $246.41 per share. There were no sales of this stock near the date of decedent's death. In valuing the underlying assets, the appraisers for the estate appraised the assets at book value except for the following: BookAppraisedItemsValueValueTimber and timberiands$15,346.85$53,195.52Business Property(Garage): Land17,936.3122,000.00Building11,441.2525,840.00Ranch Property5,897.9514,860.00The S.H. & W. Lumber Company stock was returned in the estate tax return at a total value of $35,726.52 or $143.48 per share. There were no sales of this stock near the date of decedent's death. In valuing the underlying assets, the appraisers for the estate appraised the assets at book value except for the used operating equipment which was depreciated 42 per cent to reflect actual value. In schedule N of the estate tax return petitioner claimed a deduction of $67,118.99 for the remainder bequesthed to the Shriners Hospital for Crippled Children, as follows: Gross Estate$199,841.71Deductions15,212.31Net$184,629.40Less cash bequests5,002.00$179,627.40Net income per year at 4%$7,185.10Life tenant age: 70Present value of $1 for life at age 706,317.16Value of life estate45,389.42Remainder$134,237.98One-half of remainder bequeathed under Willto charity67,118.991955 Tax Ct. Memo LEXIS 182">188 The Commissioner of Internal Revenue did not change the value of the gross estate, but disallowed the deduction of $67,118.99 for charitable remainder. At decedent's death, Louis E. Schmitt, principal beneficiary of the trust, was 69 years and 7 months of age, and his life expectancy was approximately 8.48 years. He was in frail health, and lived with his wife, Loretta M. Schmitt. They had no children or dependents. Mrs. Schmitt was 65 years old, a housewife, and not employed. The customary living and personal expenses of Louis E. Schmitt and his wife, Loretta M. Schmitt, for the years before and after decedent's death averaged $9,000 a year, an amount which has always exceeded the trust income. Under Oregon law the net income of a testamentary trust is the property of the life beneficiary from the date of the decedent's death and as such is distributable to him upon establishment of the trust. The total net income of the estate and testamentary trust for the period September 25, 1948 to September 1, 1954 amounted to $9,475.82. During portions of this period losses were sustained. Louis E. Schmitt's distributable share of the income of the trust for 1951 was $8,558.23, for1955 Tax Ct. Memo LEXIS 182">189 1952 $1,936.73, and for 1953 $4.38 and he reported these amounts in his income tax returns for those years. By agreement with Louis E. Schmitt, the amounts of $8,558.23 and $1,936.73 (excepting $83.45 which was distributed to him on December 31, 1951) were used by petitioner to pay the expenses of administering the estate, which, in the absence of agreement, would otherwise have been charged against the trust corpus. At decedent's death, Schmitt Bros. Lumber Company was an Oregon corporation, formed on March 13, 1930, with its principal activity for many years being the manufacture and sale of lumber. In addition, it owned a ranch at Selma, Oregon, devoted to the raising and selling of cattle, sheep and hogs. It also leased a garage building in Grants Pass, Oregon, to Hannum and Kelt Chevrolet Agency. This company discontinued its lumber business in 1946 with the sale of its sawmill and other mill equipment to S.H. & W. Lumber Company for a consideration of $100,000, payable pursuant to deferred payment contract. It continued to engage in transactions involving the purchase and sale of timber. In 1953, it sold its ranch properties and closed down its farming business. Schmitt1955 Tax Ct. Memo LEXIS 182">190 Bros. Lumber Company was operated by decedent and Louis E. Schmitt as President and Vice-President, respectively, for many years prior to decedent's death. Louis E. Schmitt continued to be active thereafter as president. The stockholders on September 25, 1948, were: NameSharesJoseph A. Schmitt (Decedent)549Louis E. Schmitt549O. L. Hogan1L. H. Weiss1Total outstanding1,100No dividends were paid by Schmitt Bros. Lumber Company during at least five years prior to decedent's death. The following is a summary of its balance sheet on December 31, 1948: AssetsCash$ 5,362.70Other current assets31,863.45U.S. Government bonds64,072.00Contract receivable - sale of mill40,000.00Other investments27,346.85Garage and ranch property(less depreciation)22,434.68Total Assets$191,079.68LiabilitiesCurrent liabilities$ 7,785.35Unrealized profit - sale of mill31,977.52Net WorthCapital stock$110,000.00Surplus41,316.81Total Liabilities and Net Worth$191,079.68A summary of the sales and net income of Schmitt Bros. Lumber Company and the Federal income and excess profits taxes paid for the1955 Tax Ct. Memo LEXIS 182">191 years 1943 to 1948, inclusive, is as follows: YearSalesNet incomeTaxes1943$114,465.76$ 9,531.36$ 6,328.781944180,185.0714,793.9516,077.691945151,672.1210,012.774,239.41194643,978.3918,774.015,477.95194715,881.949,119.402,594.11194819,640.945,488.871,652.33The profits of Schmitt Bros. Lumber Company declined after discontinuance of the lumber business in 1946. The ranch was operated at a loss of $4,479.69, $1,407.68 and $6,560.02 in the years 1946, 1947 and 1948. The net rentals from leasing the garage building averaged $2,126.42 per year for the same years. The company was able to show a net income of $9,119.40 and $5,488.87 in 1947 and 1948 primarily as a result of receiving $20,000 each year in the form of installment payments from the sale of the mill property in 1946. At decedent's death, S.H. & W. Lumber Company was an Oregon corporation engaged in the manufacture and sale of lumber. It was incorporated on March 1, 1948. Prior to that time it was operated as a partnership from January 1, 1946 to February 29, 1948. The partnership was formed without any original capital contribution by the partners. 1955 Tax Ct. Memo LEXIS 182">192 As stated above, the partnership purchased its sawmill properties from Schmitt Bros. Lumber Company on a deferred payment contract. When the business was incorporated on March 1, 1948, all of the partnership assets were transferred to the new corporation. At decedent's death, Louis E. Schmitt was one of the managing officers of the S.H. & W. Lumber Company. Thereafter he remained active as vice-president until the liquidation of the corporation in 1954. The stockholders on September 25, 1948, were: NameSharesJoseph A. Schmitt (decedent)249Louis E. Schmitt249O. L. Hogan249L. H. Weiss249J. N. Walker4Total outstanding1,000A summary of the balance sheets of the S.H. & W. Lumber Company on March 1, 1948, date of incorporation, and February 28, 1949, at the close of its first year of operations, follows: Assets19481949Cash$ 6,748.54$ 23,321.90Inventory of lumber and logs21,193.0053,867.10Other current assets52,965.9632,061.79Timber and timberlands25,342.31118,283.77Sawmill and equipment (depreciated)93,605.06104,831.80Total Assets$199,854.87$332,366.36LiabilitiesContract payable - Purchase of sawmill$ 20,000.00$ 10,000.00Other current liabilities39,054.87115,422.12Long term liabilities40,000.0030,000.00Total Liabilities$ 99,054.87$155,422.12Net WorthCapital stock$100,000.00$100,000.00Surplus800.0076,944.24Total Net Worth$100,800.00$176,944.24Total Liabilities and Net Worth$199,854.87$332,366.361955 Tax Ct. Memo LEXIS 182">193 The S.H. & W. Lumber Company was nearing completion of the first year of its operations at the time of decedent's death. During that year, which ended on February 28, 1949, it had gross sales of $399,889.21, gross profit from sales of $283,757.05, and net income of $113,212.62. The company has never paid any dividends. Louis E. Schmitt was not dependent upon decedent and had no liabilities at the time of decedent's death. A summary of his net worth as of October 1, 1948, follows: Cash$ 6,420.00Residence9,500.00Buick auto2,000.00Receivables2,864.78549 shares of Schmitt Bros. LumberCo.135,279.09249 shares S.H. & W. Lumber Co.35,726.52Total Net Worth$191,790.39In his income tax returns for the years 1946, 1947 and 1948, Louis E. Schmitt reported the following gross income: Income fromS.H. & W.SalarySalaryLumber Co.,Schmitt Bros.S.H. & W.YearpartnershipLumber Co.Lumber Co.DividendsGross income1946$16,905.48$5,000.00None$21,905.48194712,256.705,000.00None17,256.7019487,258.215,000.00$4,166.60None16,424.81 The net income reported in these returns1955 Tax Ct. Memo LEXIS 182">194 was $20,426 for 1946, $16,256.70 for 1947, and $15,424.81 for 1948. This income exceeded the customary annual living expenses of Louis E. Schmitt and his wife. His income from the S.H. & W. Lumber Company partnership ceased on March 1, 1948, when the company was incorporated and he became the owner of approximately twenty-five per cent of its stock. Thereafter he received a salary for his services as an officer of the company. The petitioner and its predecessors have been in the business of trust administration since 1890. It was and is qualified to act as trustee and its administration of trusts is carried out in accordance with normally prudent and conservative corporate fiduciary practices. No invasion of the corpus of the trust created by decedent's will has been made for the benefit of Louis E. Schmitt nor has any request been made to the trustee that such an invasion be made. Opinion RAUM, Judge: The issue in this proceeding is not novel. This and other courts have on numerous occasions considered whether provisions of testamentary trusts permitting the invasion of principal rendered the value of charitable remainders so uncertain and unascertainable as to preclude deduction1955 Tax Ct. Memo LEXIS 182">195 under Section 812(d) of the Internal Revenue Code of 1939 or comparable statutory provisions. Deductions have been disallowed where the powers given in a will to fiduciaries to invade principal were regarded as not fixing a definite standard which would permit a reliable prediction as to the amount that might be diverted from the charitable remainderman, thus precluding the ascertainment of the value of the charitable bequest. Merchants Bank v. Commissioner, 320 U.S. 256">320 U.S. 256; Henslee v. Union Planters Nat. Bank & Trust Co., 335 U.S. 595">335 U.S. 595; Estate of Charles H. Wiggin, 3 T.C. 464">3 T.C. 464; Estate of John W. Holmes, 5 T.C. 1289">5 T.C. 1289; Estate of Nathan P. Cutler, Jr., 5 T.C. 1304">5 T.C. 1304, affirmed sub nom. Newton Trust Co. v. Commissioner, 160 Fed. (2d) 175 (C.A. 1); De Castro's Estate v. Commissioner, 155 Fed. (2d) 254 (C.A. 2). Deductions have been allowed, however, where the will sets up a definite and fixed standard for the exercise of the trustee's discretion to invade principal, thus making it possible to determine with reasonable accuracy the amount, if any, by which the charitable remainder might be depleted and its1955 Tax Ct. Memo LEXIS 182">196 value at the time of the decedent's death. Ithaca Trust Co. v. United States, 279 U.S. 151">279 U.S. 151; Blodget v. Delaney, 201 Fed. (2d) 589 (C.A. 1); Lincoln Rochester Trust Co. v. Commissioner, 181 Fed. (2d) 424 (C.A. 2); Berry v. Kuhl, 174 Fed. (2d) 565 (C.A. 7); Estate of Anna Finley Kenny, 11 T.C. 857">11 T.C. 857; Estate of Nellie H. Jennings, 10 T.C. 323">10 T.C. 323; Estate of Edwin E. Jack, 6 T.C. 241">6 T.C. 241; Estate of James M. Schoonmaker, Jr., 6 T.C. 404">6 T.C. 404; Estate of Lucius H. Elmer, 6 T.C. 944">6 T.C. 944; Estate of Horace G. Wetherill, 4 T.C. 678">4 T.C. 678, appeal dismissed, 150 Fed. (2d) 1019 (C.A. 9). In the instant proceeding the decedent's will, after directing the payment to Louis E. Schmitt of the net income of the trust estate during his life in such sums of money from time to time "as he may require", provided that if at any time such net income should in the judgment of the trustee prove insufficient to provide "for his proper maintenance and support, or other necessity" the trustee might "at its sole discretion" invade the capital of the trust estate and pay or apply for the benefit1955 Tax Ct. Memo LEXIS 182">197 of Louis E. Schmitt such portion thereof as the trustee in its discretion might see fit. The language used convinces us that it was the intention of the decedent to permit the invasion of the corpus of the trust to take care of the life tenant's needs and requirements for necessities and to maintain him according to the standard of living to which he had been accustomed. This constituted a sufficiently fixed and definite standard to permit ascertainment with reasonable certainty of the value, as of the date of decedent's death, of the bequest to the charitable remainderman, in accordance with the Ithaca Trust Co. line of decisions. See also Revenue Ruling 54-285, Internal Revenue Bulletin No. 29, July 19, 1954. 21955 Tax Ct. Memo LEXIS 182">198 The evidence convinces us that as of the date of decedent's death the likelihood that the corpus would be invaded to provide for the proper maintenance and support, or other necessity, of Louis E. Schmitt, was so remote as to be negligible. On that date he was 69 years and 7 months of age and had a life expectancy of approximately 8 1/2 years. Although he was in frail health, he was active in the operation of both the Schmitt Bros. Lumber Company and the S.H. & W. Lumber Company. His net worth was approximately $190,000. His net income for 1946, 1947 and 1948 exceeded his customary living expenses, and, in view of the salaries that he received from his two corporations, it was reasonable to assume that his income would continue to exceed his expenses even if those corporations maintained the practice of not paying dividends despite the existence of substantial earnings in at least one of them. Our conclusion, based upon the entire record, is that at the time of the decedent's death there was a reasonable certainty, ascertained from a fixed standard capable of measurement, that there would be no invasion of the trust corpus from which the charitable bequest is to be paid. In the circumstances, 1955 Tax Ct. Memo LEXIS 182">*199 we hold that the respondent erred in disallowing the charitable deduction claimed in the estate tax return. Decision will be entered for the petitioner. Footnotes1. Respondent objected to certain stipulated facts which were not known or reasonably foreseeable at the time of decedent's death. Such facts have not been taken into account in reaching the conclusions herein.↩2. It was stated in Revenue Ruling 54-285, supra, that "a charitable deduction under section 812(d) of the Internal Revenue Code↩ may be allowed on account of bequests or gifts of remainder interests to charity in cases where the will or instrument authorizes invasion of corpus for the comfortable maintenance and support of life beneficiaries if (1) there is an ascertainable standard covering comfort and support which may be either express or implied, and (2) the probability of invasion is remote or the extent of the invasion is calculable in accordance with some ascertainable standard."	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621010/	APPEAL OF MATHER PAPER CO.Mather Paper Co. v. CommissionerDocket No. 1378.United States Board of Tax Appeals3 B.T.A. 1; 1925 BTA LEXIS 2063; November 12, 1925, Decided Submitted April 30, 1925. 1925 BTA LEXIS 2063">2063 The taxpayer was one of a group of corporations which filed a consolidated return for the year 1920. Theretofore, Commissioner Williams had held the taxpayer to be affiliated with other corporations for the year 1919, and the conditions respecting affiliation were identical as to the year 1920. The taxpayer advanced the funds with which to pay its share of the tax, which amount was more than its pro rata share of the consolidated tax. The parent corporation thereafter became insolvent. Commissioner Blair, thereafter, determined correctly that the taxpayer was not affiliated with the parent corporation in the year 1920. Held, that the determination by Commissioner Blair was not an overruling of Commissioner Williams with respect to the year 1920. Held, further, that in the computation of the deficiency against the taxpayer, credit should be given for the pro rata portion of the tax paid by the parent corporation theretofore advanced by the taxpayer. Joseph M. Dohan, Esq., for the taxpayer. Percy S. Crewe, Esq., for the Commissioner. JAMES3 B.T.A. 1">1 Before JAMES, LITTLETON, SMITH, and TRUSSELL. This is an appeal from the determination1925 BTA LEXIS 2063">2064 of a deficiency in income and profits taxes for the calendar year 1920 in the amount of $20,231.05. FINDINGS OF FACT. The taxpayer is a Pennsylvania corporation organized in 1917 under the name of Shuttleworth, Hogg & Mather, Inc., and, after its incorporation, including the year in question, was engaged in business in Philadelphia as a wholesale and retail dealer in paper and paper bags. Shuttleworth, Keiller & Co., hereinafter referred to as the Shuttleworth Co., was, during the taxable year in question, a New York corporation engaged in business in New York City as a wholesale and retail dealer in paper and paper bags and as a jobber distributing paper products to other dealers in the same business. That company, through its stockholders, controlled a majority of the stock of a number of other corporations, including the taxpayer, 3 B.T.A. 1">2 engaged in the same line of business in various cities, operated the group of corporations substantially as one unit and, through the medium of said corporations, effected a large sale or distribution of its merchandise. On the organization of the taxpayer, its stock, consisting of 1,400 shares, was subscribed to in the amount of1925 BTA LEXIS 2063">2065 50.14 per cent by the Shuttleworth Co., and distributed among its stockholders. The remaining 49.86 per cent was acquired by H. J. Hogg, Charles W. Mather, James J. Gallen, and William S. Graham, in the amounts, respectively, of 279 shares each by Hogg and Mather, 100 shares by Gallen, and 40 shares by Graham. During the year 1920, Hogg sold 128 shares of his stock to the stockholders of the Shuttleworth Co., increasing its percentage of control, some time during that year, to 59.28 per cent. Under an agreement dated January 17, 1919, in order to assure uniformity of control by the Shuttleworth Co. and to prevent the sale of the stock of the associated companies, except with the knowledge and consent of the Shuttleworth Co., the stockholders of that company transferred to it, as trustee for the respective depositors, all of the shares in the associated companies, including Shuttleworth, Hogg & Mather, Inc., except 28 shares in the last-named company. This agreement, after reciting that, by virtue of the stock controlled by the Shuttleworth Co., all of the associated companies were managed and directed as to their policies and methods of operation to the advantage of the depositing1925 BTA LEXIS 2063">2066 stockholders and that the depositors desired to prevent division of their holdings and to assure a permanent policy in the management, provided hat the Shuttleworth Co. should have the exclusive right to vote all the deposited shares and to control, in so far as that was possible through the control of the majority of the stock, all of the business activities of the said associated companies. This agreement remained in effect throughout the taxable year here in question. To the 674 shares of the taxpayer originally deposited under this agreement were added 80 shares of the 128 shares disposed of by Hogg in that year. The remaining 48 shares were held by stockholders of the Shuttleworth Co. without deposit. The 28 shares not originally deposited were owned and held by one Tompkins at the time of the execution of the agreement and, upon his death, were acquired by other stockholders, who deposited them under the terms of the agreement. During the year 1920, four of the seven directors of the taxpayer were selected by the Shuttleworth Co., Mather, Hogg, and Gallen comprising the other three directors. During that year Shuttleworth was president, Mather vice president, and Gallen1925 BTA LEXIS 2063">2067 and Graham secretary and treasurer, respectively. 3 B.T.A. 1">3 From and after its organization the taxpayer made total purchases on account of its business and purchases from the Shuttleworth Co. at set forth below: YearTotal purchasesPurchases from Shuttleworth Co.3 months1917$40,924.37$25,125.0812 months1918632,141.91299,360.18Do1919691,342.57249,342.41Do1920957,539.94315,731.65In general, the method of doing business between the taxpayer and the Shuttleworth Co. was as follows: The Shuttleworth Co. acted as agent of the Union Paper Bag Co., purchased from them and sold the taxpayer. In so far as requirements could be supplied by the Shuttleworth Co., the taxpayer made all purchases from that source, and fully advised the Shuttleworth Co. of any purchases made elsewhere. Prior to the taxable year in question the taxpayer made separate and independent income and profits-tax returns to the collector of internal revenue at Philadelphia. On November 1, 1920, and after the Shuttleworth Co. had furnished to the Commissioner certain information in respect of its activities, the Commissioner sent to the Shuttleworth Co.1925 BTA LEXIS 2063">2068 a communication reading in full as follows: TREASURY DEPARMENT, Washington, November 1, 1920.OFFICE OF COMMISSIONER OF INTERNAL REVENUE, IT:SA:CR:Af. MLS. SHUTTLEWORTH KELLER & CO., 474 West Broadway, New York N.Y.SIRS: Reference is made to the Affiliated Corporations Questionhaire filed by you for each of the taxable years 1917, 1918 and 1919. From the facts presented, you are informed that, for the taxable years 1917 and 1918, the companies listed below were affiliated within the purview of Articles 77 and 78 of Regulations 41, Treasury Decision 2662, and Section 240 of the Revenue Act of 1918. For the purpose of consolidation the companies should be divided into two groups. A consolidated excess profits tax return for 1917 and a consolidated income and profits tax return for 1918 should be filed for each group: GROUP I. Shuttleworth, Keiller and Co. (Parent)W. E. Shuttleworth and Co.Congress Warehouse and Forwarding Co. GROUP II. Gallen Paper Company. Shuttleworth Hogg and Mather, Inc. 3 B.T.A. 1">4 For the taxable year 1919 the companies listed below were affiliated within the provisions of Section 240 of the Revenue Act of 1918. 1925 BTA LEXIS 2063">2069 Therefore, a consolidated income and profits tax return should be filed for these companies if such action has not been taken: Shuttleworth, Keiller and Co. (Parent.) W. E. Shuttleworth and Co.Congress Warehouse and Forwarding Co. Gallen Paper Co. Shuttleworth Holly Co. Shuttleworth, Hogg and Mather, Inc. Shuttleworth Dumouchel Co. Shuttleworth Wollny Co., Inc.George A. Fink Co. The companies listed below were not affiliated within the purview of the law and regulations hereinbefore referred to and each company should, therefore, file a separate return for each of the taxable years indicated, where such action has not already been taken, and provided they were not affiliated with any other companies not herein considered: Doscher-Tetamore Co., Inc., 1917, 1918 and 1919. Shuttleworth Holly Co., 1917 and 1918. Shuttleworth Dumouchel Co., 1917 and 1918. Shuttleworth Wollny Co., Inc., 1918. Kolb Carton Co., 1919. Berlin Veneer Works, Inc., 1917, 1918 and 1919. Wm. Spreen and Co., Inc., 1917, 1918 and 1919. The consolidated excess profits tax returns for the taxable year 1917 should be forwarded direct to this office within thirty days1925 BTA LEXIS 2063">2070 from the date of this letter. A copy of this letter should be attached to each return when filed. In your reply, refer to IT:SA:CR:Af-MLS. Respectfully, (Signed) G. V. NEWTON, Deputy Commissioner.During the year 1920 the stockholders and the respective percentages of stock held by them in the Shuttleworth Co. and the taxpayer were as follows: January 1, 1920.December 31, 1920.Shuttleworth Co.Taxpayer.Shuttleworth Co.Taxpayer.W. E. Shuttleworth39.620.00.4E. G. Shuttleworth39.624.3Frank Keiller21.710.9.6.3Margaret Keiller6.64.9Russell Keiller8.54.5Florence Lee6.63.4C. H. Shuttleworth15.07.515.68.9C. H. Shuttleworth, Inc.6.3J. L. Wolff13.36.713.37.9John Weidman1.6.82.01.8C. V. Shuttleworth1.5.71.5.7Clinton Cuttrell1.3.62.01.0R. H. Jackson1.3.6M. A. Paulsen.7.3.7.3J. D. Tompkins4.02.0H. Beisler2.01.0Shuttleworth Keiller & CoH. J. Hogg19.910.9C. W. Mather19.919.9J. J. Gallen7.17.1W. S. Graham3.02.01001001001003 B.T.A. 1">5 For1925 BTA LEXIS 2063">2071 the taxable year 1920 the taxpayer filed a return on Form 1122, notifying the collector at Philadelphia of the filing of a consolidated return with the Shuttleworth Co. with the collector at New York, and the Shuttleworth Co. duly filed the consolidated return above mentioned. Form 1120, as issued by the Commissioner for the use of corporation taxpayers for the year 1920, instructed corporations required to file consolidated returns as follows: That the parent company should file the consolidated return in the office of the collector at the place where its principal office was located and that the subsidiaries should file Form 1122 in the offices of the collectors of their respective districts. That if the stock ownership was between 95 per cent and 50 per cent, the parent company must furnish the information called for in the return by questions 11 to 14, page 3. That the department preferred that the total tax assessed against the affiliated companies be allocated to and paid by the parent company to the collector of its district. The information return of subsidiary or affiliated corporation, Form 1122, contained the following instruction: The department prefers that1925 BTA LEXIS 2063">2072 the entire tax shown on a consolidated return be paid by the parent or principal reporting corporation instead of being apportioned among the corporations composing the affiliated group. The official Form No. 1120, filed for the year 1920 by the Shuttleworth Co. as its consolidated return (including taxpayer), directed the corporation to state whether it owned or controlled over 50 per cent of the stock of another corporation, and, if so, to state whether the corporation had filed an affiliated corporations questionnaire for 1917 or subsequent taxable years, and stated that, if such a questionnaire had been filed, a further questionnaire need not be filed; it further required the parent company to state whether substantially the same conditions as set forth in such prior questionnaire obtained during the taxable year 1920. The Shuttleworth Co. answered all questions in the affirmative and filed no further questionnaires for the year 1920. The Shuttleworth Co., prior to the filing of the consolidated return as above set forth, notified each of the companies proposed to be included therein that a consolidated return was required and requested each of them to send statements1925 BTA LEXIS 2063">2073 to it, together with their checks for the amount of tax shown to be due upon a separate computation of their tax liability. The Congress Warehouse & Forwarding Co.; George A. Fink Co.; Shuttleworth, Holly Co.; W. E. Shuttleworth & Co.; Shuttleworth, Dumouchel Co.; Shuttleworth Wollny Co.; Gallen Paper Co.; and Shuttleworth, Hogg & Mather, Inc., forwarded such statements, together with remittances of the 3 B.T.A. 1">6 amounts of tax computed upon their several statements as set forth in the following table: AmountCongress Warehouse & Forwarding Co$20,229.20George A. Fink Co1,466.01Shuttleworth, Holly Co3,048.93W. E. Shuttleworth & Co274.50Shuttleworth, Dumouchel CoShuttleworth, Wollny Co2,115.11Gallen Paper Co565.00Shuttleworth, Hogg & Mather, Inc20,272.96By reason of losses incurred by the Shuttleworth Co. in the calendar year 1920, the amount of income and profits tax due by it a the companies consolidated with it on the above-mentioned return was $27,135.52, which said company duly paid to the collector for the second district of New York. Thereafter, and on July 24, 1922, the Shuttleworth Co. was adjudicated a bankrupt, and on August 11, 1922, subject1925 BTA LEXIS 2063">2074 to the approval of the court, which was given on or about October 18, 1922, all of the remaining assets of the said bankrupt were sold to W. E. Shuttleworth, the president of the Shuttleworth Co., and the said sale included "Claims against the United States of America and the State of New York for refund of taxes improperly paid." Thereafter, and on May 23, 1923, the Commissioner addressed a communication to the Shuttleworth Co. reading as follows: IT:SA:CR:E. CEL-Af. MAY 23, 1923. SHUTTLEWORTH, KEILLER AND COMPANY, 220 West Broadway, New York, N.Y.SIRS: Reference is made to an executed Affiliated Corporations Questionnaire for the taxable year 1919 filed by your corporation, and to other data appearing in the case. After a reconsideration of all the facts in the case, you are advised that during the taxable year 1919 the companies as grouped below were affiliated within the purview of Section 240 of the Revenue Act of 1918. GROUP I. Shuttleworth, Keiller and Company. W. E. Shuttleworth and Company. Congress Warehouse and Forwarding Corporation. GROUP II. Gallen Paper Company. Shuttleworth, Hogg and Mather, Incorporated. A consolidated1925 BTA LEXIS 2063">2075 income and profits tax return should have been filed by each group of companies indicated for that year. In the event that such consolidated returns should be needed in auditing the case, you will be notified by this office. 3 B.T.A. 1">7 You are further advised that during the taxable year 1919, the companies listed below were not affiliated with each other or with any other company named herein, within the purview of the authority cited. Shuttleworth, Holly Company. Shuttleworth, Dumouchel Company. Shuttleworth, Wollny Company, Incorporated. George A. Fink Company. Kolb Carton Company. Berlin Veneer Works, Incorporated. Wm. Spreen and Company, Incorporated. Each company, therefore, should file a separate income and profits tax return for that year, provided that such action has not been taken. The ruling outlined herein supersedes that contained in office letter dated November 1, 1920, relative to the affiliation of the companies named herein during the taxable year 1919. If not in agreement with this ruling, you are granted thirty days from the date of this letter within which to submit an answer setting forth your exceptions. In the event of further1925 BTA LEXIS 2063">2076 correspondence, reference should be made to IT:SA:CR:E - CEL:Af. Respectfully, E. W. CHATTERTON, Deputy Commissioner.(Signed) By WM. P. BIRD, Chief of Subdivision.Thereafter, and on November 21, 1923, the Commissioner addressed a communication to the taxpayer asserting a tax against it and the Gallen Paper Co. for the year 1920 as affiliated companies in the amounts, respectively, of $20,231.05 and $1,894.62, of which the deficiency here in question is a part, and in the computation of that deficiency gave no credit whatever for the payments, or any part thereof, theretofore made by the taxpayer and the Gallen Paper Co. to the Shuttleworth Co. and by it paid in part to the collector of the second district of New York as tax due upon the consolidated return. The Commissioner in office on the date of the affiliation ruling of November 1, 1920, was William M. Williams. The Commissioner in office on the date of the ruling of May 23, 1923, rescinding the affiliation ruling of November 1, 1920, was David H. Blair. All of the facts above set forth in respect of affiliation were before Commissioner William M. Williams at the time of the ruling of November 1, 1920, as1925 BTA LEXIS 2063">2077 fully as they were in possession of Commissioner David H. Blair at the time of the rescinding ruling of May 23, 1923. DECISION. The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 15 days' notice, under Rule 50. 3 B.T.A. 1">8 OPINION. JAMES: The first question to be determined in this appeal is whether the taxpayer was properly affiliated with the Shuttleworth Co. for the year 1920. If this point should be decided in favor of the taxpayer, it becomes unnecessary to consider whether the Commissioner in 1923, David H. Blair, could rule differently with respect to affiliation for the year 1920 from the ruling of his predecessor for the year 1919. It appeals from the evidence that the taxpayer was in many respects operating under the direction of the Shuttleworth Co. during 1920; that its officers were in the main selected from that company, and that a majority of its stock was controlled through a voting trust agreement by that company. But it is apparent that independent stockholders of the taxpayer owned and controlled at the beginning of the year 49.9 per cent of its stock and at the end of the year 39.9 per1925 BTA LEXIS 2063">2078 cent, and neither they nor their stock were in any respect under the control of the Shuttleworth Co. We can not hold that 60.1 per cent of the stock of a corporation constitutes substantially all of that stock for purposes of control in the absence of evidence of other factors indicating a control over at least a very considerable portion of the balance of the stock. On the merits, therefore, we are of the opinion that Commissioner Blair was correct in determining that the taxpayer and the Shuttleworth Co. were not affiliated during the year 1920. We are next to inquire whether Commissioner Blair could lawfully rule in respect of affiliation for the year 1920 in a manner different from the ruling of Commissioner Williams for the year 1919. This question also divides itself into two parts: (1) Whether the letter of November 1, 1920, which Commissioner Williams sent to the Shuttleworth Co., was, in the light of that letter and the regulations and instructions of the Commissioner, a ruling of affiliation as to the year 1920; and (2) if it was such a ruling, whether Commissioner Blair had authority to reverse it? Upon the first of the foregoing points we are of the opinion that1925 BTA LEXIS 2063">2079 the ruling contained in the letter of November 1, 1920, was not a ruling in respect of affiliation for that year, but related solely to the years 1917, 1918, and 1919. It so states, and nowhere in its contents can be found any statement with respect to the year 1920. But the taxpayer contends that the instructions of the Commissioner in respect of the filing of affiliated corporations questionnaires and the instructions contained upon the forms provided for income-tax returns indicated that a ruling once made on a question of affiliation continued until reversed, and was, in fact, a ruling for all years until official notice of the reversal was sent by the Commissioner. With 3 B.T.A. 1">9 this position we are unable to agree. It is true that the Commissioner, upon the forms provided for returns, asked questions relating to prior filings of consolidated returns, and, if the conditions were unchanged in respect of stockholdings and in other particulars, excused the filing of further information, which, in the nature of things, would consist merely of the filing of cumulative evidence, but this falls far short of holding out the promise or representation that a taxpayer once held affiliated1925 BTA LEXIS 2063">2080 for one year would be held affiliated for all succeeding years, and there is nothing in the instructions or directions upon the returns or elsewhere which contains any such implications. At the most, taxpayers were instructed that, if previous returns had been made in a certain manner, successive returns would continue to be so made until or unless a change was directed. No doubt this resulted, in the taxpayer's case, in contributing to placing it in the unfortunate position in which it finds itself under the present circumstances, but that unfortunate position is no excuse for the misinterpretation of the instructions of the Commissioner or for placing upon those instructions any unwarranted construction. It being our view that Commissioner Williams made no ruling as to the year 1920, it is unnecessary for us to consider whether, had he done so, Commissioner Blair could have reversed such a ruling. This brings us to the consideration of the effect of the payments made by the taxpayer to the Shuttleworth Co. and by it to the collector. It appears from the letter of May 23, 1923, that the Commissioner determined as to the year 1920 two groups of affiliation. In Group I is1925 BTA LEXIS 2063">2081 included the Shuttleworth Co., W. E. Shuttleworth & Co., and Congress Warehouse & Forwarding Co. The Shuttleworth Co. contributed nothing toward the payment of the tax upon its consolidated return for the year 1920. The entire tax was paid by the several associated companies. Of the companies in Group I, W. E. Shuttleworth & Co. contributed $274.50, and the Congress Warehouse & Forwarding Co. $20,229.20, a total of $20,503.70. Of the companies in Group II, Gallen Paper Co. and Shuttleworth, Hogg & Mather, Inc., contributed $565 and $20,272.96, respectively, a total in that group of $20,837.96; and the other companies, George A. Fink Co., Shuttleworth, Holly Co., and Shuttleworth, Wollny Co., contributed $1,466.01, $3,048.93, and $2,115.11, a total of $6,650.05. The total contributed by all companies was $47,971.71. From these contributions the Shuttleworth Co., for and on behalf of all the corporations of the affiliated group, paid the tax of $27,135.52 shown on the consolidated return. 3 B.T.A. 1">10 The Commissioner apparently proposes to credit this amount of $27,135.52 to Group I alone, leaving the companies in Group II, and those not affiliated at all, to pay their taxes1925 BTA LEXIS 2063">2082 anew. By implication it would appear that the companies in Group I, since the loss of the Shuttleworth Co. will be offset against a smaller balance of profits, must show taxes upon their consolidated return of much less than $27,135.52, and that the Commissioner will credit or refund the entire amount of such overplus either to Group I, to the Shuttleworth Co. itself, or to W. E. Shuttleworth & Co. For such a procedure we find no warrant in the Revenue Act of 1924, and for such an allocation of credit for taxes paid none in the Revenue Act of 1918. Section 240(a) of the Revenue Act of 1918 provides, in part, as follows: In any case in which a tax is assessed upon the basis of a consolidated return, the total tax shall be computed in the first instance as a unit and shall then be assessed upon the respective affiliated corporations in such proportions as may be agreed upon among them, or, in the absence of any such agreement, then on the basis of the net income properly assignable to each. There is nothing in the evidence before us which indicates that the taxpayer corporations participating in the consolidated return for the year 1920 ever agreed to the assumption of the1925 BTA LEXIS 2063">2083 tax by the Shuttleworth Co. On the contrary, it is clearly in evidence that that tax was paid through the Shuttleworth Co. and that the subsidiaries furnished the funds from which payment was made. The Commissioner was never advised of any agreement among the companies that he should look to the Shuttleworth Co. solely for the amount of tax and, in the absence of any such agreement, it was his duty to assess the tax among the companies in the proportion shown on the consolidated return of their respective net incomes to the total net income thereon, ignoring, for that purpose, minus quantities. This apparently, he did not do, but instead he assessed the entire tax to the Shuttleworth Co., a mere ministerial error on the part of the collector, subject to correction at any time. In our opinion the assessment against the several companies should be corrected to conform to the above-quoted provision of section 240(a). Under the provisions of section 273 of the Revenue Act of 1924 it is the duty of the Commissioner to determine the deficiency upon the basis of the correct amount of tax, less the amount of tax shown by the taxpayer upon his return, with other adjustments not here1925 BTA LEXIS 2063">2084 in issue. Upon its return, this taxpayer, through the medium of the Shuttleworth Co., indicated an amount of tax shown to be due in the proportion of the net income returned by this taxpayer in the consolidated return to the total net income, exclusive of minus quantities. This amount the Commissioner has not credited in connection with the conputation of the deficiency here in question 3 B.T.A. 1">*11 It should be credited in the determination of this deficiency. The return of the taxpayer filed as a part of the above consolidated return is in evidence and the proper computation can be made therefrom. The deficiency determined by the Commissioner will be corrected in the manner above set forth, and, as so corrected, will be settled as set forth in the decision.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621011/	Mulder Bros., Inc., 1 Formerly Michigan Door Company v. Commissioner. Mulder Bros., Inc., Transferee, Formerly Michigan Door Company, Successor by merger to Mulder Bros., Inc. v. Commissioner. Louis N. Mulder and Catherine Mulder v. Commissioner. Mulder Bros., Inc., Transferee, Formerly Michigan Door Company, Successor by merger to C. and L. Realty Company v. Commissioner. Mulder Bros., Inc. v. CommissionerDocket Nos. 1741-64 - 1744-64.United States Tax CourtT.C. Memo 1967-43; 1967 Tax Ct. Memo LEXIS 217; 26 T.C.M. 217; T.C.M. (RIA) 67043; March 8, 1967Robert W. Tripp, for the petitioners in all docket numbers. J. Connor Austin, for the petitioners in Docket No. 1743-64. Charles R. Abbott, for the respondent. MULRONEY Memorandum Findings of Fact and Opinion MULRONEY, Judge: Respondent determined the following deficiencies and additions to tax: Addition to TaxDocketT/Y EndedIncome TaxSec. 6653(b),NumberPetitioner4/30Deficiency1954 IRC1741-64Mulder Bros., Inc., etc.1955$ 2,219.55$ 1,109.7719562,739.701,369.8519573,163.381,581.6919582,325.581,162.79195954,268.8027,134.40T/Y Ended12/311742-64Mulder Bros., Inc., Transferee, etc.19558,153.904,076.9519568,170.584,085.2919575,897.632,948.81Period 1/1/58-10/31/5824,409.0312,204.51T/Y Ended12/311743-64Louis N. Mulder and Catherine Mulder19555,426.712,713.35195610,982.395,491.19195714,005.267,002.63195820,809.2910,404.64T/Y Ended11/301744-64Mulder Bros., Inc., Tranferee, etc.19561,290.0019572,203.5019581,976.001967 Tax Ct. Memo LEXIS 217">218 The issues in these consolidated cases are (1) whether respondent properly disallowed deductions by the corporations involved for salary payments, travel and entertainment expenses, and personal expenditures and whether any of the disallowed expenditures were properly includable in the individual taxpayer's income for the years involved; (2) whether Michigan Door Company understated its closing inventory for the taxable year ended April 30, 1959; (3) whether Mulder Bros., Incorporated realized income of $10,000 in connection with the surrender of a lease in 1955; (4) whether Mulder Bros., Incorporated realized income from the sale of reject doors in 1955, 1956, and 1957; (5) whether Mulder Bros., Incorporated received a purchase rebate in 1957 which it failed to report on its return; (6) whether Mulder Bros., Incorporated failed to reduce its purchases account by $18,000 in the period January 1, 1958 through October 31, 1958 because of the cancellation of a purchase order in that amount and whether the handling of this transaction resulted in additional income of $18,000 to the Mulders for that year; (7) whether respondent properly disallowed a deduction in 1956 for a pension fund1967 Tax Ct. Memo LEXIS 217">219 contribution on behalf of Catherine Mulder; (8) whether respondent properly disallowed deductions claimed by C. & L. Realty Co. as interest paid on loans in the taxable year ended November 30, 1956, 1957 and 1958; (9) whether any part of the underpayment of tax for the years in issue in docket Nos. 1741-64, 1742-64 and 1743-64 was due to fraud within the meaning of section 6653(b); and (10) whether any of the years in issue in docket Nos. 1741-64, 1742-64 and 1743-64 is barred by the statute of limitations within the meaning of section 6501. Findings of Fact Some of the facts were stipulated and they are so found. Louis N. and Catherine Mulder, husband and wife, are residents of Ada, Michigan. They filed joint Federal income tax returns for the years 1955, 1956, 1957, and 1958 with the district director of internal revenue, District of Michigan at Detroit, Michigan. The corporate petitioner is a Michigan corporation with its principal office in Grand Rapids, Michigan. Michigan Door Company filed its corporation income tax returns for the taxable years ended April 30, 1955, 1956, 1957, 1958 and 1959 with the district director of internal revenue, District of Michigan at Detroit, 1967 Tax Ct. Memo LEXIS 217">220 Michigan. During the years 1955 through October 31, 1958, Mulder Bros., Incorporated was a Michigan corporation with its principal office in Grand Rapids, Michigan. It filed its corporation income tax returns for the years 1955, 1956, 1957 and for the taxable period from January 1, 1958 through October 31, 1958 with the district director of internal revenue, District of Michigan, at Detroit, Michigan. During the years in issue the C. & L. Realty Company, Inc. was a Michigan corporation with its principal office in Grand Rapids, Michigan. It filed its corporation income tax returns for the taxable years ended November 30, 1956 through 1958 with the district director of internal revenue, District of Michigan at Detroit, Michigan. On October 31, 1958, Mulder Bros., Incorporated merged into Michigan Door Company, with Michigan Door Company being the surviving corporation. The assets of Mulder Bros., Incorporated, with a fair market value in excess of $80,000, were transferred to Michigan Door Company, and as a result of the merger and transfer of assets Mulder Bros., Incorporated became insolvent and has remained insolvent and wholly without assets. On or about August 1, 1960, the1967 Tax Ct. Memo LEXIS 217">221 C. and L. Realty Company merged with Michigan Door Company, with Michigan Door Company being the surviving corporation. The assets of the C. and L. Realty Company, with a fair market value in excess of $10,000, were transferred to Michigan Door Company, and as a result of the merger and transfer of assets the C. and L. Realty Company became insolvent and has remained insolvent and wholly without assets. During 1962 the corporate name of Michigan Door Company was changed to Mulder Bros., Incorporated. It is stipulated that Mulder Bros., Incorporated (formerly Michigan Door Company) is liable as a transferee, at law and in equity for any deficiencies in income taxes which may be determined to be due from Mulder Bros., Incorporated for the years 1955, 1956, 1957 and for the taxable period from January 1, 1958 through October 31, 1958, plus interest. It is also stipulated that Mulder Bros., Incorporated (formerly Michigan Door Company) is liable as a transferee, at law and in equity, for any deficiencies in income taxes which may be determined to be due from the C. and L. Realty Company for the taxable years ended November 30, 1956, 1957 and 1958, plus interest. Mulder Bros., Incorporated1967 Tax Ct. Memo LEXIS 217">222 (formerly Michigan Door Company) is the petitioner in docket No. 1741-64 and the petitioner and transferee of assets in docket Nos. 1742-64 and 1744-64. During the years in issue Michigan Door Company was the sole stockholder of Mulder Bros., Incorporated, which corporation manufactured wood doors. Michigan Door Company was the sales outlet for doors manufactured by Mulder Bros., Incorporated. During the years in issue Louis N. Mulder was president of Michigan Door Company, Mulder Bros., Incorporated, and the C. and L. Realty Company, and he was sole stockholder of Michigan Door Company and the C. and L. Realty Company. During the years in issue Catherine Mulder was secretary-treasurer of Michigan Door Company and Mulder Bros., Incorporated. Louis N. Mulder went to school through the fifth grade. He started in the door manufacturing business sometime in 1950. During the years here in issue Louis maintained close control over the daily operations of the door manufacturing business. He was at the plant nearly every day, and it was customary for him to arrive early and leave late. Most of the sales of the Michigan Door Company were obtained through mail orders or by telephone. A perpetual1967 Tax Ct. Memo LEXIS 217">223 inventory was maintained so that the number of doors available could be readily ascertained. During the years 1955, 1956, 1957 and 1958, Louis received weekly checks from Mulder Bros., Incorporated and from Michigan Door Company purportedly for travel expenses. He instructed the bookkeeper to make these checks out in uneven amounts, with the weekly checks received from the two corporations usually making a total of $80. For example, on December 7, 1956, he received a check from Michigan Door Company in the amount of $31.05 and on the same date he received a check from Mulder Bros., Incorporated in the amount of $48.95, for a weekly total of $80; on September 13, 1957 he received a check from Mulder Bros., Incorporated in the amount of $46.30 and on the same date received a check from Michigan Door Company in the amount of $33.70. During the year 1956 numerous expenditures totaling $7,187.76, in connection with the construction of a cottage at Grand Haven, Michigan, were paid by and charged to Mulder Bros., Incorporated. The cottage was owned by Louis Mulder and his wife. During the years 1955, 1956, 1957, 1958 and 1959 numerous personal expenditures of Louis N. Mulder were paid1967 Tax Ct. Memo LEXIS 217">224 by Mulder Bros., Incorporated and Michigan Door Company. These personal expenditures included utility bills, painting various parts of his residence, household equipment, country club expenses and payments to a maid employed in the Mulder residence. In 1958 a payment of $190 to Louis N. Mulder's father-in-law was made by Mulder Bros., Incorporated and charged to the corporation, and in the fiscal year 1959 a payment of $250 was made to him by Michigan Door Corporation and charged to the corporation. In the fiscal year 1959 a payment of $2,336.87 was made by Michigan Door Company and charged to the corporation for a fence constructed at the Mulder residence. During the years 1955, 1956, 1957 and 1958 Catherine Mulder was paid a salary of $1,365, $1,360, $4,675 and $3,706, respectively, from Mulder Bros., Incorporated and during the fiscal years 1955, 1956, 1957 and 1959 she was paid a salary in the respective amounts of $3,120, $3,288, $1,878 and $2,264 from Michigan Door Company. During the period here involved either the Michigan Door Company or Mulder Bros., Incorporated sent doors to the Zeeland Sash & Door Company for further processing. The president of the Zeeland Sash & Door1967 Tax Ct. Memo LEXIS 217">225 Company was Cyrus Mulder, who was Louis' brother. Any doors damaged during the processing were usually sold by the Zeeland Sash & Door Company as "reject" doors, and in 1954, 1955, 1956 and 1957 the Zeeland Sash & Door Company issued checks payable to Louis N. Mulder for amounts received from "reject" door sales in the respective amounts of $295, $201, $216 and $420. On October 17, 1958, Mulder Bros., Incorporated issued a check to Michigan Door Company in the amount of $18,000 and charged the amount to purchases. Michigan Door Company secured a letter of credit in the amount of $18,000 from Michigan National Bank drawn in favor of the American Wood Products International Corporation, New York City. Michigan Door Company issued a note to the Michigan National Bank in the amount of $18,000, together with an assignment of all receivables in return for the letter of credit. The letter of credit was not used and the Michigan National Bank returned the note and assignment of receivables to the Michigan Door Company. On November 21, 1958, the Michigan National Bank received [a] check (dated November 21, 1958) in the amount of $18,000 from the Michigan Door Company. The Michigan National1967 Tax Ct. Memo LEXIS 217">226 Bank issued the following instruments (all dated November 21, 1958) in exchange for said check: InstrumentAmountPayeeTime Certificate of Deposit$5,000L. & C. MulderTime Certificate of Deposit5,000L. & C. MulderTime Certificate of Deposit5,000L. & C. MulderBank Money Order2,000Louis MulderBank Money Order1,000Louis MulderOn October 25, 1962, after a jury trial in the United States District Court (Western District of Michigan, Southern Division), Louis N. Mulder was found guilty of evading his income tax for the year 1958. A verdict of not guilty was returned by the jury on the remaining 11 counts of the indictment involving the income taxes of Louis N. Mulder, Michigan Door Company and Mulder Bros., Incorporated for taxable years which are before us here. On November 8, 1962, the United States District Court entered its judgment in accordance with the verdict of the jury, which judgment is now final. In docket No. 1741-64 (Mulder Bros., Incorporated), the respondent (1) disallowed deductions for salary paid to Catherine Mulder by Michigan Door Company in the taxable years ended April 30, 1955, 1956, 1957 and 1959 in the respective1967 Tax Ct. Memo LEXIS 217">227 amounts of $3,120, $3,288, $1,878 and $2,264; (2) disallowed deductions by Michigan Door Company in the taxable years ended April 30, 1955 through 1959 for "personal expenses of the Corporation's officers and unsubstantiated travel and entertainment expense in the total respective amounts of $4,278.51, $5,844.33, $4,205.42, $4,472.26 and $9,195.25"; (3) disallowed deductions for salaries paid by Michigan Door Company in the taxable year ending April 30, 1959 to the Mulders' personal maid and to Louis N. Mulder's father-in-law in the respective amounts of $108.27 and $250; and (4) determined that the closing inventory of Michigan Door Company (now Mulder Bros., Incorporated) as of April 30, 1959 was understated by $122,620.11 and the closing inventory of Mulder Bros., Incorporated as of October 31, 1958 was understated by $21,254.78. Respondent's explanation of the net effect for the taxable year ended April 30, 1959 of these two adjustments is as follows: It has been determined that the closing inventory of Michigan Door Company (now known as Mulder Bros., Inc.) was understated in the amount of $122,620.11. It has also been determined that the ending inventory of Mulder Bros., Inc. 1967 Tax Ct. Memo LEXIS 217">228 for the taxable period January 1, 1958 through October 31, 1958 was understated by $21,254.78 and since Michigan Door Company (now known as Mulder Bros., Inc.) took over the assets of Mulder Bros., Inc. as of November 1, 1958, the opening inventory of Michigan Door Company (now known as Mulder Bros., Inc.) should be increased by this amount. The net adjustment to inventory is computed as follows: Closing inventoryunderstated$122,620.11Opening inventoryunderstated(21,254.78)Net understatement$101,365.33In Docket No. 1742-64 (Mulder Bros., Incorporated, Transferee) the respondent (1) disallowed deductions for salary payments to Catherine Mulder by Mulder Bros., Incorporated in 1955, 1956, 1957 and for the period from January 1, 1958 to October 31, 1958 in the respective amounts of $1,365, $1,360, $4,675 and $3,706; (2) determined that Mulder Bros., Incorporated received income of $10,000 in 1955 in connection with a payment received for the surrender of certain leasehold improvements; (3) determined that Mulder Bros., Incorporated received additional income from the sale of "reject" doors in 1955, 1956, and 1957 in the respective amounts of $201, $2161967 Tax Ct. Memo LEXIS 217">229 and $420; (4) determined that Mulder Bros., Incorporated received additional income of $328.75 in 1957 in connection with a purchase rebate made by the Atkinson Lumber Company; (5) determined that Mulder Bros., Incorporated received additional income of $18,000 in the period January 1, 1958 through October 31, 1958 in connection with the cancellation of a purchase order; (6) determined that Mulder Bros., Incorporated understated its closing merchandise inventory as of October 31, 1958 in the amount of $21,254.78; (7) disallowed a deduction of $195 claimed by Mulder Bros., Incorporated in 1956 as a contribution to a pension trust plan on behalf of Catherine Mulder; and (8) disallowed deductions claimed by Mulder Bros., Incorporated in 1955, 1956, 1957 and for the period January 1, 1958 through October 31, 1958 for travel and entertainment expenses, automobile expense, utility bills, salary paid to the maid in the Mulder residence, personal expenses of the Mulders, payments to Louis N. Mulder's father-in-law and payments made for the construction of a cottage owned by the Mulders in the total amounts of $4,114.56, $13,941.66, $8,398.69 and $5,414.98. In Docket No. 1743-64 the respondent1967 Tax Ct. Memo LEXIS 217">230 determined that Louis N. Mulder and his wife received constructive dividends and additional income from Mulder Bros., Incorporated and Michigan Door Company in the years 1955 through 1958 in the following amounts (less dividend exclusion): YearMulder Bros., Inc.Michigan Door1955$ 6,265.56$ 5,209.27195615,107.665,451.00195720,803.66 4,158.78195823,864.9811,602.57In Docket No. 1744-64 (Mulder Bros., Incorporated, Transferee of the C. and L. Realty Company) disallowed deductions claimed by the C. and L. Realty Company for salary paid to Louis N. Mulder, president of the corporation, to the extent of $1,800 in each of the fiscal years ended November 30, 1956, 1957 and 1958, and respondent also disallowed deductions for interest on certain outstanding debenture notes in the fiscal years ended November 30, 1956, 1957 and 1958 in the respective amounts of $2,500, $2,437.50 and $2,000. A part of the underpayment of taxes for each of the taxable years ended April 30, 1955 through 1959 in Docket No. 1741-64, for the taxable years 1955 through 1957 and for the taxable1967 Tax Ct. Memo LEXIS 217">231 period from January 1, 1958 through October 31, 1958 in Docket No. 1742-64, and for the taxable years 1955 through 1958 in Docket No. 1743-64 was due to fraud. The income tax returns filed by petitioners in Docket Nos. 1741-64, 1742-64 and 1743-64 for each of the taxable years there involved were false and fraudulent with intent to evade tax. Opinion In July of 1959, respondent's agents started examining the returns filed in the years 1955 through 1958 or 1959 of Louis Mulder and his corporations. On February 5, 1964 over four and a half years later, respondent determined deficiencies existed in the returns filed by these taxpayers in said years. Because of the lapse of time and the 3-year statute of limitations pleaded in Docket Nos. 1741-64, 1742-64 and 1743-64, respondent had the first burden of proving that the returns filed by the taxpayers in said dockets were "false or fraudulent [returns] with the intent to evade tax" within section 6501(c) (1) of the 1954 I.R.C.Respondent showed that throughout the entire period here involved Louis N. Mulder filed1967 Tax Ct. Memo LEXIS 217">232 joint returns each with his wife, Catherine, and he was the president of Michigan Door Company and Mulder Bros., Incorporated, and the sole stockholder of Michigan Door Company that owned all of the stock of Mulder Bros., Incorporated. He signed all of his personal returns and all of the returns here involved for the entities as president with the exception of the return for the period January 1, 1958 to October 31, 1958 for Mulder Bros., Incorporated which is signed by Catherine J. Blok as "Ass't Secretary." Throughout the entire period here involved the funds of both corporations were constantly used to pay Mulder with disguised entries or to pay the expenses of the Mulder family and the treatment of such expenditures was in such a manner as to make them appear as business expenses or deductions of the corporations. Petitioners' counsel readily conceded in his opening statement at the trial that there were items of a personal nature paid by the corporations which he (Mulder) should have paid back to the corporations. First we have the weekly checks made out to Louis by both corporations, deliberately made out in odd amounts (which, however, always added up to $80 a week) which1967 Tax Ct. Memo LEXIS 217">233 were always entered on the books of the corporations as entertainment or traveling expenses. The bookkeeper testified it was Louis Mulder who told him to issue these weekly traveling expense checks in odd amounts to always total $80. He said he was never told what these particular checks were issued for. 2There are here three stipulated exhibits showing in all over a hundred items totaling from about two to four thousand dollars each year paid by the two corporations during the years 1955 through 1959, which were without question personal expenses of the Mulder family. The items range from the home utility bill and the salary of the personal maid who worked in the Mulder home (and was treated as an employee of one of the corporations) to the cost of construction of the Mulder's lake cottage. These items were not placed in any officer's drawing account but were scattered in various corporate accounts so the auditors who came two or three times1967 Tax Ct. Memo LEXIS 217">234 a year and who made out the corporate returns would naturally include the items as corporate business expense items. The bookkeeper said he was told to do this by Louis Mulder and that he believed the only corporation that had an officer's drawing account was Michigan Door Company and this was only used for big items such as the purchase of a car. In addition, we have the Zeeland Sash & Door Company checks mentioned in our findings which were cashed and the money turned over to Louis Mulder. This is enough to show that all of the returns for the years in question in Docket Nos. 1741-64, 1742-64, and 1743-64 were false and fraudulent with intent to evade tax under section 6501(c) (1) of the 1954 I.R.C. Mulder knew his corporations were paying thousands of dollars of his personal expenses each year. He knew this was being done in a manner that served to reduce the profits his corporations were reporting on their income tax returns from the manufacture and sale of doors. These items of a personal nature that the companies paid for him, together with the other payments to him, all constituted other income he received each year in addition to his salary which he1967 Tax Ct. Memo LEXIS 217">235 deliberately did not report on his income tax returns. We have held the sole stockholder's practice of charging personal items to corporate business expense is evidence of fraud by both the individual officer and his corporation. See Elmer J. Benes, 42 T.C. 358">42 T.C. 358 (1964), affd. 355 F.2d 929 (C.A. 6, 1966). We hold the deficiency determinations in the above dockets are not barred by the statute of limitations. We turn now to the deficiency determinations in all of the dockets. Most of the issues involved are factual and respondent's determinations as to such issues are presumptively correct. Welch v. Helvering, 290 U.S. 111">290 U.S. 111. Petitioners have the burden of proving error in respondent's determinations, but the evidence produced at the trial was extremely scant and in most instances was generally insufficient to meet the requisite burden of proof. As to some of the issues, the petitioners made no serious effort to produce any evidence and, absent any concessions1967 Tax Ct. Memo LEXIS 217">236 by the parties, petitioners cannot prevail as to such issues. In respondent's determination of deficiency of Michigan Door Company there is a conclusion that its April 30, 1959 closing inventory was understated in the amount of $122,620.01. This closing inventory of finished products and raw material was stated to be $96,360.88 in its return and the corporation's physical inventory showing said amount at the close of April 1959 was produced and admitted in evidence. The inventory of Michigan Door Company consisted of (1) finished doors and (2) raw materials. A perpetual inventory for finished doors was kept by office personnel. In order to reconstruct the corporation's closing inventory as of April 30, 1959, the respondent used as a starting point the results of an actual physical inventory taken on January 20, 1960 by the revenue agents with the assistance of Louis N. Mulder, Wayne Spillane (the warehouse manager) and Lloyd Nesbitt (the plant manager). Only the raw material on hand was counted on this occasion. The perpetual inventory was accepted as an accurate count of finished doors. 31967 Tax Ct. Memo LEXIS 217">237 Petitioner had the burden of proof to show respondent's computation of understatement was wrong. However, respondent, with commendable fairness, put his agent on the stand and the agent testified as to his method of reconstructing the April 30, 1959 inventory. He used the perpetual inventory, the January 20, 1960 totals to which were added the products sold since April 30, 1959, and deducted certain raw materials purchased during said period, and he made certain estimates and approximations. This method was followed to reconstruct the April 30, 1959 inventory of Michigan Door Company for oak, lauan and ribbon mahogany doors. To reconstruct the April 30, 1959 inventory for birch doors and "skins" the respondent was compelled to approximate the understatement of inventory at 30 percent, which estimate was based upon the inventory understatements computed by respondent for the other categories of finished doors and "skins" on the apparent assumption that the understatements were roughly parallel in each of the several categories. On the whole, we think the agent's reconstruction fairly shows1967 Tax Ct. Memo LEXIS 217">238 an understatement but upon close analysis of the various steps taken by him we are satisfied there should be some reduction in the understatement as computed by him. Among the considerations that lead us to this conclusion would be (1) there is evidence that the January 20, 1960 perpetual inventory could be overstated due to a time lag in office procedure, (2) the 30 percent figure of understatement of the birch doors in the agent's computation is admittedly an estimate or approximation, (3) the record shows that normally a year-end inventory took three days while here the inventory of January 20, 1960 (the starting point of respondent's reconstruction) was hurriedly taken in a few hours. After considering the above and using our best judgment, and mindful of the fact that the burden was on petitioner, we hold the inventory of April 30, 1959 was understated in the amount of $70,000. On October 31, 1958, Mulder Bros., Incorporated merged into its parent corporation, Michigan Door Company (corporate name changed to Mulder Bros., Incorporated in 1962). In Docket No. 1742-64 (Mulder Bros., Incorporated, Transferee), respondent determined that the closing inventory of Mulder Bros., 1967 Tax Ct. Memo LEXIS 217">239 Incorporated as of October 31, 1958 was understated by $21,254.78 due to the omission of a purchase of merchandise in that amount from American Wood Products which was not included in closing inventory. Petitioner in that docket number has not shown that this adjustment was in error. We sustain respondent on this issue. Respondent made a corresponding adjustment in Docket No. 1741-64 (Mulder Bros., Incorporated) by increasing the opening inventory of Michigan Door Company (which had taken over all the assets of Mulder Bros., Incorporated) by the same amount, i.e., $21,254.78, which resulted in a determination that Michigan Door Company had understated its taxable income for its taxable year ended April 30, 1959 due to understatements of inventory in the net amount of $101,365.33 ($122,620.11 minus $21,254.78). Respondent determined in Docket No. 1742-64 that Mulder Bros., Incorporated had additional income from the sale of "reject" doors in 1955, 1956 and 1957 in the respective amounts of $201, $216 and $420. During these years Mulder Bros., Incorporated would send doors to the Zeeland Sash & Door Co. for glazing. 4 Some of the doors were damaged either in handling or in the glazing1967 Tax Ct. Memo LEXIS 217">240 process and these damaged doors were not returned to Mulder Bros., Incorporated but would be sold in that condition by Zeeland Sash & Door Co., which would periodically remit by checks payable to Louis Mulder, not to Mulder Bros., Incorporated, the amounts received from such sales. The checks made out by Zeeland Sash & Door Co. payable to Louis N. Mulder are in evidence. There is testimony from an officer of Zeeland Sash & Door Co. indicating that they were instructed by Louis Mulder to make these checks payable to him personally. Louis' only explanation at the trial was that these payments were placed in a "special pot" which would be used for trips to Texas and to the West Coast to learn new techniques for glazing doors. We give little credence to this explanation. Even if this were indeed the purpose, it is difficult to see why the corporation itself could not set aside the special fund. We find that the income from the sale of "reject" doors in 1955, 1956 and 1957 is taxable to Mulder Bros., Incorporated in those years. Respondent is sustained on this issue. Respondent determined in Docket No. 1742-64 that1967 Tax Ct. Memo LEXIS 217">241 Mulder Bros., Incorporated had additional income of $18,000 in the taxable period January 1, 1958 through October 31, 1958 through its failure to show on its books the cancellation of a purchase order previously charged to the purchases account. Most of the facts in this issue have been fully stipulated and we have outlined them in our findings of fact. On October 17, 1958, Mulder Bros., Incorporated issued a check for $18,000 to Michigan Door Company and charged this amount to purchases. Michigan Door Company obtained a letter of credit in this amount from Michigan National Bank in favor of the American Wood Products International Corporation. Michigan Door Company issued a note for $18,000 to the bank, together with an assignment of all receivables. Apparently the purchase was canceled. The letter of credit was not used and the bank returned the note and assignment of receivables to Michigan Door Company. On November 21, 1958, the bank received a check for $18,000 from the Michigan Door Company, and on the same date the bank issued three certificates of deposit, each in the amount of $5,000, with Louis N. Mulder and his wife as payees, and two bank money orders, totaling $3,000, 1967 Tax Ct. Memo LEXIS 217">242 with Louis Mulder as payee. It is fairly clear from these facts that the purchases account of Mulder Bros., Incorporated was overstated by $18,000 in the taxable period ending October 31, 1958, and that the steps taken were designed to funnel $18,000 of corporate funds to Louis Mulder. There is no evidence in the record to suggest some other explanation. We sustain respondent on this issue in Docket No. 1742-64. On these facts, we also sustain respondent's determination in Docket No. 1743-64 that Louis N. and Catherine Mulder received additional income of $18,000 in 1958. During the years 1955 through 1958 and for a part of 1959, Louis Mulder caused both Mulder Bros., Incorporated and Michigan Door Company to issue weekly checks payable to him, which, though deliberately made out in odd amounts, generally totaled $80 a week and they were charged by both corporations to business expenses. During 1955 the weekly checks issued by Mulder Bros., Incorporated were, for the most part, in the amount of $40.25, while the weekly checks issued by Michigan Door Company were generally in the amount of $39.75. The pattern often varied in subsequent years, although the weekly checks continued, 1967 Tax Ct. Memo LEXIS 217">243 for the most part, to add up to $80 a week. When Mulder Bros., Incorporated merged into Michigan Door Company on October 31, 1958, it appears that the weekly checks were then issued by Michigan Door Company to Louis N. Mulder in the amount of $80. When Louis bought a house in Phoenix, Arizona, and stayed there with his family about three months late in 1958 and early in 1959, these weekly checks of $80 continued to be issued to him. In Docket No. 1741-64 respondent allowed $180 in each of the taxable years ended April 30, 1955 through 1959 and disallowed the business expense deductions claimed by Michigan Door Company for the remaining weekly payments made to Louis. In Docket No. 1742-64 respondent disallowed deductions for travel and entertainment expenses claimed by Mulder Bros., Incorporated in connection with these weekly payments to Louis in the years 1955, 1956, 1957 and for the taxable period from January 1, 1958 through October 31, 1958 in the respective amounts of $2,080, $2,080, $2,080 and $1,760. It appears fairly certain from the record that Louis spent long hours at the plant and did very little traveling. Most of the sales were received through mail order or by telephone. 1967 Tax Ct. Memo LEXIS 217">244 In fact, the plant foreman (1954 through September 1957) testified that 95 percent of the sales resulted from mail orders. The record shows that Louis was reimbursed by specific checks (apart from the weekly checks) for travel expenses. At the trial, Louis testified generally that he took a few business trips each year but admitted "I didn't keep track of it." He offered no persuasive evidence other than these general statements. Moreover, we are unconvinced that he incurred any travel, entertainment or other business expenses during his brief stay in Phoenix, Arizona, where he went mainly because of his arthritic condition. On the basis of the whole record, we cannot find that the two corporations were entitled to any deduction for travel and entertainment expenses in excess of those allowed by the respondent. We sustain respondent on these issues in Docket No. 1741-64 and Docket No. 1742-64. During 1956 a cottage was constructed for Louis N. Mulder and his wife at Grand Haven on Lake Michigan. Expenses incurred in the construction were paid by Mulder Bros., Incorporated in the stipulated amount of $7,187.76 and they were charged to various accounts on the corporate records. Respondent1967 Tax Ct. Memo LEXIS 217">245 disallowed a deduction claimed by Mulder Bros., Incorporated in 1956 for the expenses incurred for the cottage (Docket No. 1742-64). We sustain respondent on this issue. The cottage was owned by the Mulders and there is no persuasive evidence to indicate that it was anything more than a private cottage for their personal use. Petitioner makes a brief argument that some portion of these expenses should be allowed as deductions by the corporation because the cottage, together with a speedboat owned by the Mulders, was used to entertain employees of the corporation. Petitioner refers us to testimony by Wayne Spillane, a former employee of Mulder Bros., Incorporated. But the testimony of Spillane (who, during the years 1959 through 1960 was the son-in-law of Louis N. Mulder) was merely that he entertained summer employees in the speedboat when they came out to the cottage, and he also stated that the "younger kids" were primarily interested in such diversion. But his testimony also revealed that he and his relatives and in-laws used the cottage in 1956. We do not believe, on this record, that the cottage was meant to serve any business purpose of the corporation or that it was used in1967 Tax Ct. Memo LEXIS 217">246 any part for business purposes during 1956. Moreover, even if some occasional business entertaining did take place, we do not see how this would turn a part of the construction costs of the cottage into a business expense deductible by the corporation. Prior to June 1950 Louis N. Mulder leased property on Franklin Street in Grand Rapids, Michigan, for a term ending September 30, 1960. Louis testified that he in turn sub-leased this same property to the Michigan Door Company (which corporation later became Mulder Bros., Incorporated). About 1955, the plant was moved to new premises. Louis testified that the lessor of the Franklin Street property "asked me if I would release the lease * * * [and] give him back the property" and that "for the abandonment of the property he would give me $10,000 by note." Louis agreed to this offer to cancel the lease and he received a note for $10,000 which he treated as his own income on his income tax return. Respondent did not cross-examine Louis about the lease cancellation. We can find no support in the record for respondent's position in Docket No. 1967 Tax Ct. Memo LEXIS 217">247 1742-64 that as a result of the lease cancellation in 1955, Mulder Bros., Incorporated realized taxable income of $10,000 in 1955. Respondent attempts a finespun rationalization on brief for his position, but it is conjectural in nature and it is not supported by anything in this record. We sustain the petitioner in Docket No. 1742-64 on this issue. Respondent determined in Docket No. 1742-64 that Mulder Bros., Incorporated had additional income of $328.75 in 1957 because of a purchase rebate in that amount made by Atkinson Lumber Company. Respondent's explanation in the notice of deficiency is that the rebate was made to Louis Mulder instead of to Mulder Bros., Incorporated, that the check was cashed by him, and that the corporation did not receive any credit for that amount. Petitioner has not met its burden on this issue. We sustain respondent on this issue. Respondent determined in Docket No. 1743-64 that Louis Mulder received additional income of $9,706.22 in 1957, with the explanation that this amount represented a bonus received by Louis Mulder in that year from Mulder Bros., Incorporated. Petitioner has offered no evidence to meet his burden on this issue. We sustain respondent1967 Tax Ct. Memo LEXIS 217">248 on this issue. In Docket No. 1741-64 the respondent disallowed a deduction of $108.27 in the taxable year ended April 30, 1959 for payments by Michigan Door Company to the maid in the Mulder's residence, and respondent also disallowed a deduction of $250 in the same taxable year for payments by Michigan Door Company to Louis Mulder's father-in-law. In Docket No. 1742-64 the respondent disallowed deductions of $747.95, $738.52, $819.43 and $622.85 in the years 1955 through 1957 and for the taxable period of January 1, 1958 through October 31, 1958 for payments by Mulder Bros., Incorporated to the maid in the Mulder residence, and respondent also disallowed a deduction of $190 in the taxable period of January 1, 1958 through October 31, 1958 for payments made by Mulder Bros., Incorporated to Louis Mulder's father-in-law. Petitioners have offered no evidence to show these payments were ordinary and necessary business deductions. As to Louis Mulder's father-in-law, there was testimony by the warehouse manager for Mulder Bros., Incorporated who was employed there from 1954 to 1960, that the father-in-law was not an employee there. Nor is there any evidence to show that he was employed1967 Tax Ct. Memo LEXIS 217">249 by either Mulder Bros., Incorporated or by Michigan Door Company in some other capacity. We sustain respondent on these issues. In Docket No. 1741-64 respondent disallowed deductions for certain expenditures by Michigan Door Company in each of the fiscal years ended April 30, 1955 through 1959 and also disallowed deductions for certain expenditures by Mulder Bros., Incorporated (Docket No. 1742-64) in each of the years 1955, 1956, 1957 and for the taxable period from January 1, 1958 through October 31, 1958 on the ground that they represented personal expenditures for the benefit of Louis Mulder and his family for such items as gasoline, insurance, utilities and other miscellaneous items of merchandise and services. Detailed lists of these personal expenditures made by both corporations for the benefit of the Mulders have been placed in evidence and it appears that Louis Mulder examined such lists and agreed that many of the categories there listed were personal expenditures. Petitioners in these two dockets have offered no satisfactory evidence to show that the amounts remaining here in issue were ordinary and necessary business expenses. Respondent is sustained on those issues1967 Tax Ct. Memo LEXIS 217">250 in Docket No. 1741-64 and in Docket No. 1742-64. We have found above that the numerous expenditures made by Mulder Bros., Incorporated and by the Michigan Door Company were in fact personal expenses of Louis N. and Catherine Mulder or for their economic benefit and were therefore not deductible by the corporations as ordinary and necessary business expenses. Respondent determined in Docket No. 1743-64 that these corporate expenditures constituted additional taxable income for Louis N. and Catherine Mulder in the years 1955 through 1958. Petitioner's entire argument on brief is simply that these expenses were business expenses of the corporations and therefore not additional income to Louis and Catherine. Louis completely controlled both corporations during the years before us and on this record it is clear that the use of corporate funds for the personal expenditures and other economic benefits for the Mulder family, as well as the income of the corporation diverted to Louis N. Mulder, constitute taxable income in the years 1955 through 1958 to Louis N. and Catherine Mulder, see American Properties, Inc., 28 T.C. 1100">28 T.C. 1100,1967 Tax Ct. Memo LEXIS 217">251 affd., 262 F.2d 150 (C.A. 9, 1958), and we so hold. It is stipulated that Michigan Door Company made payments (as salary) to Catherine Mulder in the fiscal years ended April 30, 1955, 1956, 1957 and 1959 in the respective amounts of $3,120, $3,288, $1,878 and $2,264, and it is further stipulated that Mulder Bros., Incorporated also made payments to Catherine Mulder in 1955, 1956, 1957 and 1958 in the respective amounts of $1,365, $1,360, $4,675 and $3,706. In Docket Nos. 1741-64 and 1742-64 the respondent disallowed deductions claimed by the corporation for these payments, with the explanation that it was not established that Catherine Mulder performed any services for the corporations or that the amounts paid to her constituted ordinary and necessary business expenses. The question of what constitutes reasonable compensation within the meaning of section 162(a)(1) of the 1954 I.R.C. is one of fact to be determined by the circumstances of each case. Courts consider several factors in making such a determination, Mayson Mfg. Co. v. Commissioner, 178 F.2d 1151967 Tax Ct. Memo LEXIS 217">252 (C.A. 6, 1949), Geiger & Peters, Inc., 27 T.C. 911">27 T.C. 911, but it is not necessary to enumerate them here because, on this record, there is no satisfactory evidence to show that Catherine performed any services whatever for the corporations during these years. Louis N. Mulder testified that his wife was ill at the time of the trial. Consequently, we have no testimony from Catherine. There is no evidence that her role as secretary-treasurer of the two corporations required any services or that she, in fact, did perform any services in such capacity. There is evidence that there was a normal complement of office personnel, i.e., secretaries and a bookkeeper, to perform the usual clerical operations. Moreover, we are unimpressed with the suggestion by Louis that Catherine helped with the advertising. We find, on the basis of this record, that no portion of these payments made by the two corporations to Catherine Mulder constituted reasonable compensation during the years involved and that such payments were not deductible by the two corporations as ordinary and necessary business expenses. In Docket No. 1742-64 the respondent disallowed a deduction in 1956 for a payment of $1951967 Tax Ct. Memo LEXIS 217">253 made by Mulder Bros., Incorporated to a Pension Trust Plan with respect to Catherine Mulder. Respondent determined that she was not a full-time employee of the corporation, that this disqualified her as a member of the trust, and that therefore her share of the contribution to the plan was disallowed. Petitioner has offered no evidence to meet its burden of proof on this issue, and we have already found, in connection with the issue of reasonable compensation, that she did not render any services to Mulder Bros., Incorporated during the years before us. We sustain respondent on this issue. In Docket No. 1744-64 respondent allowed a deduction of $600 and disallowed the remaining $1,800 deduction for amounts paid by C. and L. Realty Company to Louis N. Mulder as salary in each of the taxable years ended November 30, 1956, 1957 and 1958. The question of an allowable deduction for reasonable compensation is one of fact. 27 T.C. 911">Geiger & Peters, Inc., supra. Louis was the president and sole stockholder of C. and L. Realty Company during the years in issue. The corporation owned a new building which was built some time in 1955. (The corporation's income tax returns - in Schedule1967 Tax Ct. Memo LEXIS 217">254 J - indicate that the building, sidetrack, parking lot, office equipment and heating equipment were acquired in June 1955.) In his testimony, Louis referred to it as "a $450,000 building." He also testified that "I was my own contractor and supervised most of the work being done on this new building to fit in with our production." Our concern here is only with the taxable years ended November 30, 1956, 1957 and 1958, and as to these taxable years there is no satisfactory evidence that the corporation was entitled to a deduction of more than $600 in each taxable year for the personal services actually rendered by Louis. It appears that the new building was divided into two sections, with his controlled corporation (or corporations) occupying one section and the other section leased to a third party. Louis testified that the latter lease was for a monthly rental of $2,300. 5 The tax returns of the C. and L. Realty Corporation do not show any salary expenses (apart from the payments to Louis), expenses for janitorial services, expenditures for repairs (except for an item of about $1,100 in the taxable year ended November 30, 1956), or any of the customary expenses associated with the1967 Tax Ct. Memo LEXIS 217">255 rental and maintenance of a building. It would be a justifiable inference, under these circumstances, that the expenditures of this nature were borne by the tenants. We have also considered Louis' testimony that he had to obtain a new tenant for a portion of the building after about two years and the services rendered by him. Louis' efforts in this respect were that the proper leasing and rental of the property were among obviously sporadic in nature and we feel they are adequately covered by the amount of salary allowed each year by the respondent. On brief, Louis seeks to justify a substantial salary by pointing to the tremendous growth of his door manufacturing companies. However, these efforts in connection with other corporations have no bearing whatsoever on the reasonableness of his compensation from the C. and L. Realty Company. We have considered all of the evidence and we are not convinced, on this record, that Louis actually rendered personal services to the C. and L. Realty Company to justify a deduction by the corporation for reasonable compensation in excess of $600 for each of the taxable years ended November 30, 1956, 1957 and 1958. We sustain respondent on this issue. 1967 Tax Ct. Memo LEXIS 217">256 In Docket No. 1744-64 the respondent disallowed interest deductions claimed by C. and L. Realty Company in the taxable years ended November 30, 1956, 1957 and 1958 in the respective amounts of $2,500, $2,437.50 and $2,000. These amounts represented interest on $50,000 debenture notes bearing interest at 5 percent originally issued to Louis Mulder. Respondent contends the above amounts were dividend distributions to Louis, apparently on the ground that the $50,000 advanced by Louis to the corporation was not really a loan, but risk capital. Louis testified that a mortgage loan was obtained from a bank in order to finance the construction of the new building and that "[after] the building was two-thirds constructed, mortgage money became very tight in the banks, and the banks cut me off and they said that is all they would go on the mortgage, what we had borrowed." As a consequence, Louis advanced $50,000 to the C. and L. Realty Company and took back notes bearing interest at 5 percent. 1967 Tax Ct. Memo LEXIS 217">257 Whether the notes represented a true indebtedness between the corporation and its controlling stockholder or whether they represented an equity contribution is a question of fact. O. H. Kruse Grain & Milling v. Commissioner, 279 F.2d 123 (C.A. 9, 1960), affirming a Memorandum Opinion of this Court. Various factors have been relied upon by the courts to reach a determination of this issue but, as we stated in Gooding Amusement Co., 23 T.C. 408">23 T.C. 408, 23 T.C. 408">418, affd. 236 F.2d 159 (C.A. 6, 1956), "the courts have been careful not to lay down any all-embracing rule of general application." We cannot agree with respondent that the thin capitalization argument favors his determination. It appears that the corporation was capitalized at $50,000 and that as of November 30, 1955, the corporation had accounts payable of $116,871.82 and bonds, notes and mortgages payable of $166,591, which liabilities had been reduced by November 30, 1956 to the respective amounts of $92,810.49 and $151,401.21. The C. & L. Realty Company, which was in the rental business, certainly1967 Tax Ct. Memo LEXIS 217">258 did not require the significant amounts of working capital normally required by a manufacturing corporation. We do not regard the debt-equity ratio of C. and L. Realty Company disproportionate under these circumstances. The debt of $50,000 was duly represented by debenture notes with interest at 5 percent. We have examined all of the evidence and, while the question is not free from doubt, we find upon the whole record that a valid indebtedness existed with respect to these advances to the corporation. We hold that petitioner in Docket No. 1744-64 was entitled to a deduction in each of the taxable years ended November 30, 1956, 1957 and 1958 for the interest payments made on such indebtedness. Respondent determined that a part of the underpayment for each of the taxable years involved in Docket Nos. 1741-64, 1742-64 and 1743-64 "was due to fraud" within the meaning of section 6653(b) of the 1954 I.R.C. The burden rests upon respondent to prove fraud by clear and convincing evidence. Cefalu v. Commissioner, 276 F.2d 122 (C.A. 5, 1960), affirming a Memorandum1967 Tax Ct. Memo LEXIS 217">259 Opinion of this Court. The acquittal of Louis N. Mulder after a jury trial in the United States District Court on 11 out of 12 counts of wilfully evading both individual and corporate income taxes for the same taxable years here involved is no bar to the imposition of the civil liabilities under section 6653(b) of the 1954 I.R.C. in the cases before us. Helvering v. Mitchell, 303 U.S. 391">303 U.S. 391 (1938). On the other hand, Mulder's conviction of criminal fraud with respect to his 1958 income tax return precludes him from denying that a part of his underpayment of tax for 1958 was due to fraud. John W. Amos, 43 T.C. 50">43 T.C. 50 (1964), affd. 360 F.2d 358 (C.A. 4, 1965). The requisite proof of fraud on the part of the corporations is necessarily to be found in the acts of its officers. See Auerbach Shoe Co., 21 T.C. 191">21 T.C. 191 (1953), affd. 1967 Tax Ct. Memo LEXIS 217">260 216 F.2d 693 (C.A. 1, 1954). We pointed out earlier that during the entire period here involved the funds of both corporations were constantly used to pay the personal expenses of the Mulder family and that this program was constantly followed. The weekly checks made out to Louis by both corporations were deliberately made out in odd amounts (which, however, neatly dovetailed into a total of $80 a week) which would seem to be an obvious effort to mislead. In 1955, 1956 and 1957 the income from "reject" doors was diverted from Mulder Bros., Inc. to Louis N. Mulder. In 1958, upon cancellation of a purchase order, the amount of $18,000 was diverted to the Mulders through a subterfuge while the purchase account of Mulder Bros., Incorporated remained overstated by that amount. In 1956 the cost of construction of more than $7,000 of a personal lake cottage for the Mulders was charged to Mulder Bros., Incorporated and the expenses were scattered in various corporate accounts. In the taxable year ended April 30, 1959, the cost of a fence (about $2,300) at the Mulder residence was charged to Michigan Door Company. We hold, on the basis of all the evidence, that a part of the1967 Tax Ct. Memo LEXIS 217">261 underpayments of tax by the corporate petitioners in Docket Nos. 1741-64 and 1742-64 for each of the taxable years there involved was due to fraud within the meaning of section 6653(b) of the 1954 I.R.C.We also hold that part of the underpayments of tax by the individual petitioners, Louis N. Mulder and his wife, in Docket No. 1743-64 for each of the years 1955 through 1958 was due to fraud within the meaning of section 6653(b) of the 1954 I.R.C. The actions of Louis N. Mulder as president of both corporations cannot be separated from his actions as an individual taxpayer. His fraudulent conduct in understating the corporate income by consistently charging personal expenses in substantial amounts to the corporations also taints the individual tax returns filed by him with his wife during these years. See 42 T.C. 358">Elmer J. Benes, supra.It will serve no useful purpose again to repeat these indicia of fraud which we have outlined above and which clearly resulted in the omission of taxable income in significant amounts from the joint1967 Tax Ct. Memo LEXIS 217">262 tax returns filed by Louis and his wife for these years. See Spies v. United States, 317 U.S. 492">317 U.S. 492 (1943). We are convinced on this record that the pattern of deliberate concealment of income and the evasion of individual income taxes runs through all of the years here involved. Decisions will be entered under Rule 50. Footnotes1. The corporate petitioner above is called Mulder Bros., Incorporated. However, it has been so named only since 1962. To avoid confusion with a prior corporation also named Mulder Bros., Incorporated, we will henceforth only use the name Mulder Bros., Incorporated, when dealing with the former corporation, and the above named corporate taxpayer will be referred to as petitioner.↩*. Includes a bonus received by Louis in 1957 in the amount of $9,706.22.↩2. The bookkeeper told of other traveling expenses submitted in the form of hotel bills and detailed traveling expenses that were paid and the record shows these other traveling expense items that were substantiated were not disallowed.↩3. Finished doors were made principally from oak, birch, mahogany and lauan. The term "skin" is used to describe the paneling on both sides of a door.↩4. Louis Mulder's brother, Cyrus, was president of Zeeland Sash & Door Co.↩5. The income tax returns of the C. and L. Realty Company for the taxable years ended November 30, 1956, 1957 and 1958 show rental income of $48,000, $60,000 and $60,370, respectively.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621013/	Stewart Supply Company, Inc. v. Commissioner.Stewart Supply Co. v. CommissionerDocket No. 90100.United States Tax CourtT.C. Memo 1963-62; 1963 Tax Ct. Memo LEXIS 283; 22 T.C.M. 246; T.C.M. (RIA) 63062; March 1, 19631963 Tax Ct. Memo LEXIS 283">283 Held, that amounts expended to tear out the front wall of a building occupied by petitioner, to erect a replacement wall, and to make necessary electrical connections in said new wall, are capital expenditures rather than currently deductible repair expenses. Salem G. Mansour, Esq., 1012 M & T Bldg., Buffalo, N. Y., for the petitioner. Philip Shurman, Esq., for the respondent. PIERCE1963 Tax Ct. Memo LEXIS 283">284 Memorandum Findings of Fact and Opinion PIERCE, Judge: The respondent determined a deficiency in the income tax of petitioner for the year 1957 in the amount of $6,120.78. The sole issue presented for decision is: Whether certain expenditures made to tear out the front wall of a building occupied by the petitioner, to replace said wall with a new one, and to make electrical connections in the new wall, constitute capital expenditures which would be recoverable through periodic deductions for depreciation, or whether said expenditures were made for ordinary repairs, so as to be deductible in full as an ordinary and necessary business expense of the year in which they were made. Findings of Fact Some of the facts were stipulated. The stipulation of facts, together with the exhibits therein identified, is incorporated herein by reference. The petitioner, Stewart Supply Company, Inc., is a New York corporation, with its principal office and place of business in Niagara Falls, New York. It filed a Federal corporation income tax return for the calendar year 1957, with the district director of internal revenue at Buffalo. From the time of petitioner's organization in 19461963 Tax Ct. Memo LEXIS 283">285 to and including the year 1957 which is here involved, it carried on its business of a wholesale dealer in automotive parts, tools, supplies and equipment, in a 1-story brick building and an adjoining 2-story building, both located on Main Street in Niagara Falls. Said 1-story building had been constructed at some time prior to the year 1924. Both it and said adjoining 2-story building (which is not directly involved herein) were purchased by petitioner was [from] a predecessor proprietorship on July 1, 1946, at an aggregate cost of $16,000 of which $5,000 was allocated to the land underlying said buildings, and the balance of $11,000 was allocated to the cost of both buildings. The 1-story building here involved 1 was of a steel-reinforced brick construction; and it had a frontage of 50 feet abutting directly on the public sidewalk in front thereof, and a depth of 70 feet. The front wall of the building was topped by a parapet and decorative stone cornice, which extended about to feet above the roof line. After petitioner acquired the two buildings, it made extensive improvements and betterments thereto, including a new heating plant, new plumbing, new doorways at the rear, and1963 Tax Ct. Memo LEXIS 283">286 a new roof on the 1-story building. Also petitioner removed certain partitions, and provided space for offices. As the result of all the foregoing, which were treated as capital improvements, petitioner's cost basis for the two buildings (per its books and records) had been increased as of December 31, 1957, to approximately $63,000. During the summer of 1956, there occurred in Niagara Falls a severe wind and rain storm, which ripped off the roof of a nearby building, causing large pieces of debris to be blown onto the roof of the building involved. One or more pieces of this debris was hurled against the 10-foot high parapet that was superimposed on top of the front wall of the building. Also numerous holes were made in the then new roof. And these holes, which were the only damages then apparent were then repaired. No damage to the front wall or to the parapet was noticeable at that time. About 6 or 7 months later, in February 1957, during a period of severe cold1963 Tax Ct. Memo LEXIS 283">287 weather, petitioner's president, Gordon Stewart, noticed that the front wall of the building was separated from the building itself at the roof line; that the front wall had a crack running laterally across its entire 50-foot length at the roof line; and that the parapet was fipped, outward over the public sidewalk about 7 inches. Stewart thereupon called Jack Johnson, the construction superintendent of a contracting firm, to examine the building with a view to determining what had caused the front wall to become separated and what should be done to remedy the situation. Johnson informed Stewart that the condition apparently had been brought about by a chain of events and circumstances, which began with a crack at the bottom of the parapet where the roof met the front wall; and that this crack may have been caused by the impact of the debris blown from the nearby building during the above-mentioned storm in midsummer 1956. Thereafter rain water had apparently seeped into this crack; collected in "pockets" where the roof joists were imbedded in the front wall; and had then frozen and expanded during the February 1957 "cold spell," so as to cause the front wall to separate from the1963 Tax Ct. Memo LEXIS 283">288 roof. Johnson advised Stewart that the defective condition of the wall could be remedied in either of two ways: (1) The existing wall and parapet could be torn out, and then be replaced by a new wall; or (2) steel tie-rods could be inserted through the existing wall, run the length of the roof, and anchored at the rear of the building - which would tend to pull the existing wall back to its former position. Although the tie-rod method would have been less expensive than replacing the front wall, Johnson was of the opinion, and he so advised Stewart, that the tie-rod method would not give as satisfactory results as replacing the wall; and he accordingly recommended that the wall be replaced. Stewart accepted this recommendation; and the existing wall was thereupon torn out, and a new wall was built to replace it. The new wall was constructed of brick, as had been the old wall; but this new brick was of a different color. Show windows and a door were placed in the new wall in the same positions that show windows and a door had been in the old front wall; although the new door was recessed so as to permit it to be opened outward (rather than inward as formerly) as was required by1963 Tax Ct. Memo LEXIS 283">289 municipal building regulations. Decorative stone inserts which had been placed above the show windows in the old front wall were not replaced. The parapet on the new wall was of approximately 8 feet less height than the 10-foot parapet on the old wall; and a cap stone was placed on this new and lower parapet, much simpler in design than the decorative stone cornice on the old parapet. Petitioner expended an aggregate amount of $12,855.87 in 1957 to tear out the old wall, to construct the new wall, and to make necessary electrical connections in the new wall; and it also paid $150 for two fire doors and frames. On its return for 1957, petitioner deducted the sum of $13,005.87 ($12,855.87 plus $150) as a repair expense, but it has conceded that the just mentioned $150 of said amount is a capital expenditure which is not currently deductible. The respondent, upon audit of petitioner's return for 1957, determined that said amount of $13,005.87 was not currently deductible as "repairs," and he explained his action as follows: It is held that the installation of a new wall to front of building in the amount of $13,005.87 is capitalized as a replacement because there is a resulting1963 Tax Ct. Memo LEXIS 283">290 increase in value, with a life of over 30 years. Depreciation of $216.76 on this amount is allowed for 1/2 year. Opinion The issue in this case is whether the $12,855.87 - which petitioner expended to tear out the old front wall of one of its buildings, to erect a new replacement wall, and to make necessary electrical connections in said new wall - is to be classed as a currently deductible repair expense (as contended by petitioner), or as a capital expenditure to be recovered through periodic deductions for depreciation (as determined and here contended by respondent). Section 162(a) of the 1954 Code provides for the deduction of all ordinary and necessary business expenses of operating a trade or business; and warrant for the deduction of true repair expenses is found in that section. The regulations ( Income Tax Regs., section 1.162-4) issued under section 162, which deal with repair expenses, provide as follows: The cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an1963 Tax Ct. Memo LEXIS 283">291 ordinarily efficient operating condition, may be deducted as an expense, provided the cost of acquisition or production or the gain or loss basis of the taxpayer's plant, equipment, or other property, as the case may be, is not increased by the amount of such expenditures. Repairs in the nature of replacements, to the extent that they arrest deterioration and appreciably prolong the life of the property, shall either be capitalized and depreciated in accordance with section 167 or charged against the depreciation reserve if such an account is kept. [Italics supplied.] The 1954 Code, in section 263, explicitly denies deduction for capital expenditures. In the very early case of Illinois Merchants Trust Co., Executor, 4 B.T.A. 103">4 B.T.A. 103, 4 B.T.A. 103">106, we pointed out the distinguishing characteristics of repairs as opposed to capital expenditures for replacements, in the following language: To repair is to restore to a sound state or to mend, while a replacement connotes a substitution. A repair is an expenditure for the purpose of keeping the property in an ordinarily efficient operating1963 Tax Ct. Memo LEXIS 283">292 condition. It does not add to the value of the property, nor does it appreciably prolong its life. It merely keeps the property in an operating condition over its probable useful life for the uses for which it was acquired. Expenditures for that purpose are distinguishable from those for replacements, alterations, improvements or additions which prolong the life of the property, increase its value, or make it adaptable to a different use. The one is a maintenance charge, while the others are additions to capital investment which should not be applied against current earnings. * * The complete replacement of one of the four sides of a building, as was done by the petitioner in the instant case, is certainly no "incidental" repair. It was more than a mere mending job; it was the substitution of a new, substantial part for an old one. It entailed the expenditure of a sizeable sum of money, almost $13,000; and petitioner has not shown that the useful life of this new wall is less than the 30 years attributed to it by the respondent in his notice of deficiency. It would, in our opinion, bring about a distortion of income to charge this sum in its entirety against the revenues of1963 Tax Ct. Memo LEXIS 283">293 the one year 1957 which is here involved. We believe that the income of petitioner's business would be more clearly reflected if the amount here involved were recovered through periodic deductions for depreciation over the useful life of the new wall, so that the revenue of each year of its future life would bear a proportionate share of the cost of the benefit which the expenditures here involved conferred upon it. In this connection, we think what we said in the case of Joseph E. Hubinger, 13 B.T.A. 960">13 B.T.A. 960, 13 B.T.A. 960">964, affd. (C.A. 2) 36 F.2d 724, is apposite here: We can not believe that Congress intended to allow as charges against the revenues of a day or year the cost of restoring major parts of income-producing property where the restoration is of such character as to be useful over a long period of years. The distinction between maintaining property through repairs necessitated as the result of a casualty, * * * and the restoration of a major part of the property itself, is readily apparent. * * * See to the same effect, P. Dougherty Co., 5 T.C. 791">5 T.C. 791, affd. (C.A. 4) 159 F.2d 269. Also, we are satisfied that the value of1963 Tax Ct. Memo LEXIS 283">294 the building was appreciably increased as the result of the erection of the new wall. The record contains pictorial evidence of both the 1-story building with its new front, and petitioner's adjoining 2-story building which had not the benefit of any such "face lifting." The contrast between the two buildings is striking. We are confident that the building with its brand new front would have brought a higher price than the same building with its old front. We must reject the merely conclusory statements of certain of the witnesses, that the new front did not increase the value of the property. Moreover, we believe that the installation of the new front increased the useful life of the building. Our findings shows that the building had been erected prior to 1924, so that it was at least 33 years old at the time of the erection of the replacement wall. To say that the replacement of one of the building's four 33-year old walls did not increase the useful life is to contradict common sense. Here again, we are compelled to reject the witnesses' conclusions that the useful life of the building was not prolonged. Cases involving the issue of repairs versus capital expenditures are numerous, 1963 Tax Ct. Memo LEXIS 283">295 and it would unduly prolong this opinion to cite and discuss each of them. It suffices, for present purposes, to mention but a few wherein expenditures have been held to be capital in character: Ritter v. Commissioner, (C.A. 6) 163 F.2d 1019, affirming a Memorandum Opinion of this Court (new roof); Georgia Car & Locomotive Co., 2 B.T.A. 986">2 B.T.A. 986 (new roof); Foer Wall Paper Co., 9 B.T.A. 377">9 B.T.A. 377 (improvements to store front); 5 T.C. 791">P. Dougherty Co., supra, (rebuilding of stern of a barge); and 13 B.T.A. 960">Joseph E. Hubinger, supra, (restorations of portions of building damaged by fire). Petitioner has neither pleaded nor argued that it is entitled to a deduction for a loss, with respect to the unrecovered basis, if any there was, that it may have had in the old wall which was removed. We accordingly make no decision here respecting the allowability of such a loss deduction. We decide the present issue for the respondent. Decision will be entered for the respondent. Footnotes1. The term "the building," as used hereinafter, will have reference to the above-mentioned 1-story building, the replacement of the front wall of which is the focal point of the controversy in the instant case.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621014/	Robert E. Cooper, Petitioner v. Commissioner of Internal Revenue, RespondentCooper v. CommissionerDocket Nos. 3164-75, 6401-75United States Tax Court67 T.C. 870; 1977 U.S. Tax Ct. LEXIS 148; February 28, 1977, Filed 1977 U.S. Tax Ct. LEXIS 148">148 Decisions will be entered under Rule 155. Held, petitioner is entitled to deduct certain expenses incurred as a condition of his employment as ordinary and necessary business expenses under sec. 162(a), I.R.C. 1954. Robert E. Radke, for the petitioner.George W. McDonald, for the respondent. Fay, Judge. Simpson, J., concurring. Dawson, Scott, Tannenwald, Featherston, and Wilbur, JJ., agree with this concurring opinion. 1977 U.S. Tax Ct. LEXIS 148">149 Hall, J., dissenting. Raum, J., agrees with this dissent. FAY67 T.C. 870">870 Respondent determined deficiencies in petitioner's Federal income tax as follows: 67 T.C. 870">871 YearDeficiency1972$ 92197396Due to concessions, the sole issue remaining is whether certain expenses incurred by petitioner during the years in issue are deductible under section 162(a)1 as ordinary and necessary business expenses.FINDINGS OF FACTSome facts were stipulated and are so found.Petitioner Robert E. Cooper resided in Van Nuys, Calif., at the time his petition was filed.During the years in issue petitioner was employed as a fireman by the Los Angeles Fire Department and was assigned to Fire Station 89 in North Hollywood, Calif., as his permanent duty post. As such, petitioner normally worked 24-hour shifts 2 and was not permitted to leave the fire station on personal business while on duty.1977 U.S. Tax Ct. LEXIS 148">150 Petitioner is governed in his employment by the orders of his immediate superiors at the fire station -- the Fire Chief and the Board of Fire Commissioners (the board).At one time the Los Angeles Fire Department was completely segregated, with individual fire stations uniformly manned by members of the same race. Sometime during the 1950's the then mayor of Los Angeles and the city council duly ordered the board to integrate the City's fire stations. In an effort to comply with this order, some fire stations were closed and their firemen reassigned to other duty posts. However, the black firemen who were reassigned to fire stations formerly manned by white firemen were forced to accept separate beds, lockers, and dining arrangements at their new duty posts.In response to this form of discrimination, the board lawfully adopted rules and regulations requiring all firemen at each fire station to participate in a nonexclusionary organized mess at the station house, unless officially excused. 67 T.C. 870">872 The only recognized ground for nonparticipation was a physical ailment, which had to be periodically verified by the City's own examining physician. No other excuse relating to personal, 1977 U.S. Tax Ct. LEXIS 148">151 religious, or ethnic considerations was acceptable.As a fire department employee, petitioner was required to participate in the organized mess at his duty post, to the extent of paying his assessed portion of the cost thereof, for each 24-hour shift that he worked.Petitioner objected to paying the amount assessed as his share of such cost for various nonracist reasons, including the fact that he was required to pay the money even though he was often away from the station on fire department business during the mess period. He relented, however, when threatened with disciplinary action, including his dismissal, if he refused to pay.Participation in the mess by petitioner's employer consisted of merely providing the basic facilities for the mess.On his Federal income tax returns for each of the years in issue petitioner deducted the amount of $ 283, which represented his mandatory contribution to the organized mess, as an ordinary and necessary business expense.OPINIONThe sole issue presented is whether petitioner is entitled to deduct the required payment of his pro rata share of the cost of providing a nonexclusionary organized mess for the firemen at his place of employment1977 U.S. Tax Ct. LEXIS 148">152 as an ordinary and necessary business under section 162(a).Section 162(a) provides in part as follows: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 * * We have previously held that a taxpayer may be in the trade or business of being an employee. David J. Primuth, 54 T.C. 374">54 T.C. 374 (1970). Moreover, the fact that the expenses in question constituted a condition of petitioner's employment renders them ordinary and necessary within the meaning of section 162(a). See Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). Thus, the focal point of our inquiry is whether the expenses in question were nondeductible personal expenses under section 67 T.C. 870">873 262, 3 or whether they constituted business expenses which were directly and proximately related to the active conduct of petitioner's trade or business, and therefore deductible under section 162(a).1977 U.S. Tax Ct. LEXIS 148">153 Initially, we observe that many expenditures possess both personal and business attributes. In these situations placement of that often thin line which distinguishes a "personal expense" from a "business expense" depends primarily upon the facts and circumstances of each particular case. Cf. Robert J. Kowalski, 65 T.C. 44">65 T.C. 44, 65 T.C. 44">63 (1975) (Drennen, J., concurring and dissenting), revd. 544 F.2d 686">544 F.2d 686 (3d Cir. 1976). For example, Rev. Rul. 75-316, 1975-2 C.B. 54, provides in part as follows:The fact that a particular expense may under certain circumstances be a nondeductible personal expense does not preclude the deduction of such an expense as an ordinary and necessary business expense under other circumstances. * For specific illustrations of this principle, see: sec. 1.262-1(b)(5), Income Tax Regs. (meals); Rev. Rul. 58-382, 1958-2 C.B. 59 (semiannual physical examination required as a condition of employment); James A. Kistler, 40 T.C. 657">40 T.C. 657 (1963) (commuting expenses between two places of employment); Louis M. Roth, 17 T.C. 1450">17 T.C. 1450 (1952)1977 U.S. Tax Ct. LEXIS 148">154 (home telephone expenses); Foeoletini Alo, T.C. Memo. 1976-397 (shoes and gloves); Arnold Roy Bushey, T.C. Memo. 1971-149 (prescription safety glasses).In this case petitioner is a fireman who works shifts of at least 24 hours in duration. He is not permitted to leave the fire station on personal business while on duty, owing to the nature of his employment. Petitioner is required to financially participate in the organized mess at the fire station as a condition of his employment. He pays the assessed amount under protest, as he is frequently unable or unwilling to physically participate in the mess. Furthermore, the requirement that petitioner pay the assessed amount was not established by his employer for the petitioner's convenience or personal benefit. Rather, it was apparently established in order to comply with the legal and moral obligations owed by 67 T.C. 870">874 the City to its minority employees. Thus, from a realistic point of view, the payments in issue were a matter of business necessity on the part of both petitioner and his employer.In summary, upon consideration of the entire record, including the unusual1977 U.S. Tax Ct. LEXIS 148">155 nature of petitioner's employment, the involuntary nature of the expense incurred, petitioner's limited ability to physically participate in the mess, and his employer's lack of intent to compensate or otherwise benefit petitioner by enacting the requirement, we find that the amounts in issue constitute business expenses rather than personal expenses.In view of these findings, we conclude that petitioner's payment of $ 283 in each of the years in issue was directly and proximately related to the active conduct of his trade or business. 41977 U.S. Tax Ct. LEXIS 148">156 Accordingly, we hold that petitioner is entitled to the claimed deduction in the amount of $ 283 for each of the years in issue. 5Decisions will be entered under Rule 155. SIMPSONSimpson, J., concurring: I agree with the conclusion of the majority, but I have different reasons for so concluding. Section 119 allows an employee to exclude the value of meals or lodging furnished by and for the convenience of the employer, and the Treasury regulations have recognized that such exclusion is available in some situations when there is a charge for the meals or lodging. Section 1.119-1(a)(3), Income Tax Regs., provides:(3) Meals furnished with a charge. (i) If an employer provides meals which an employee may or may not purchase, the meals will not be 67 T.C. 870">875 regarded as furnished for the convenience of the employer. Thus, meals for which a charge is made by the employer will not be regarded as furnished for the convenience of the employer if the employee has a choice of accepting the meals and paying for them or of not paying for them and providing his meals in another manner.(ii) If an employer furnishes an employee meals for 1977 U.S. Tax Ct. LEXIS 148">157 which the employee is charged an unvarying amount (for example, by subtraction from his stated compensation) irrespective of whether he accepts the meals, the amount of such flat charge made by the employer for such meals is not, as such, part of the compensation includible in the gross income of the employee; whether the value of the meals so furnished is excludable under section 119 is determined by applying the rules of subparagraph (2) of this paragraph. If meals furnished for an unvarying amount are not furnished for the convenience of the employer in accordance with the rules of subparagraph (2) of this paragraph, the employee shall include in gross income the value of the meals regardless of whether the value exceeds or is less than the amount charged for such meals. In the absence of evidence to the contrary, the value of the meals may be deemed to be equal to the amount charged for them.Thus, under section 119, employees are not taxable on amounts charged for meals if four conditions exist: (1) The meals are furnished by the employer; (2) there is a charge for the meals which must be paid irrespective of whether the employee chooses to eat the meals and irrespective of1977 U.S. Tax Ct. LEXIS 148">158 how much he eats; (3) the meals are furnished for the convenience of the employer; and (4) the charge equals the value of the meals.The employer did not purchase and supervise the preparation of the meals in this case and did not withhold the charge from the compensation paid the petitioner. Yet, the employer furnished the facility for preparing the meals and required the employees to participate in the meals as a condition of their employment. In substance, there is no difference between this situation and the typical situation in which the employer directs the preparation of the meals. In addition, the employer required each employee to pay his assessed share of the costs of the meals, irrespective of whether, in fact, he was able to share in them, and there is no substantial difference between this situation and one in which the employer withholds the charge from the employee's compensation initially. Although the petitioner may receive his customary pay without having the meal charge subtracted from it, he is required to pay his assessed share or forego his employment.67 T.C. 870">876 There can be no question but that, if the meals were furnished in kind, they would qualify for1977 U.S. Tax Ct. LEXIS 148">159 the exclusion. During his tour of duty, the petitioner is not allowed to leave the fire station for personal purposes -- not allowed to leave to eat elsewhere; he must remain available at all times to respond to emergency calls. Such circumstances satisfy the requirements concerning meals furnished for the convenience of the employer. Sec. 1.119-1(a)(2)(ii)(a), Income Tax Regs. Moreover, there is no evidence indicating that the value of the meals was different than the amounts charged for them. See sec. 1.119-1(a)(3)(ii), Income Tax Regs.For these reasons, I would hold that the petitioner is entitled to the exclusion under section 119 for the charges assessed against him. I am concerned about the consequences of allowing the petitioner a deduction under section 162(a). The cost of his meals is a personal expenditure within the meaning of section 262, and it does not lose its personal nature even though it was required by the exigencies of his employment. See David I. Hitchcock, 66 T.C. 950">66 T.C. 950 (1976), on appeal (4th Cir., Sept. 30, 1976); Richard Walter Drake, 52 T.C. 842">52 T.C. 842 (1969); Louis Drill, 8 T.C. 902">8 T.C. 902 (1947).1977 U.S. Tax Ct. LEXIS 148">160 If a deduction is allowed under section 162(a) for this personal expenditure, we may be launched down a slippery slope, and it may be difficult to find a rational basis for drawing a line in other cases involving personal expenditures. HALL Hall, J., dissenting: The majority holds that an employee may deduct the cost of meals consumed on the employer's premises but not provided by the employer, where for good business reasons the employer insists that the employees pay into a common mess fund for such meals. I find no authorization in the Code for any such deduction. The cost of an employee's meals is normally a personal expense to the employee and except as otherwise provided in the Code (e.g., business entertainment), their cost is not deductible. Sec. 262. The majority finds warrant for the deduction in section 162(a), trade or business expenses. The opinion appears to imply that merely because an employer prescribes where, when, and in 67 T.C. 870">877 what manner an otherwise personal expense must be made, this suffices to convert it to a business expense. I have found nothing in the statute or prior case law which supports any such proposition. Employers may have views, 1977 U.S. Tax Ct. LEXIS 148">161 even requirements, regarding numerous facets of an employee's personal life (clothing, manner of transportation, etc.), without rendering deductible the otherwise personal expenditures necessitated thereby. In this case the employer, for reasons satisfactory to it, insisted that its employees, including petitioner, eat meals together. The expense was still for meals, and in my view still personal. Nor does it matter that petitioner was "on duty" while in the mess hall. One may be on duty and nonetheless incur personal expenses.To the extent that petitioner was required to, and did, pay for meals he did not eat (for whatever reason), I would concede that the cost would be an ordinary and necessary expense of the business of being a fireman. But where the money goes to buy meals which the petitioner ate, I see no reason why the employer's mere strictures on the time, place, and manner of dining would make the cost of such meal a business expense.Unlike the concurring opinion, I am equally unable to find any help for petitioner in section 119. In that section Congress has chosen to permit the exclusion from income of meals furnished by the employer for the employer's convenience. 1977 U.S. Tax Ct. LEXIS 148">162 It is true that the regulations apply this exclusion even if there is an express deduction of a charge therefor from the employee's compensation. This seems a sensible recognition of the fact that in any event there is no such thing as a free lunch. The difficulty, however, is that Congress saw fit to provide the exclusion only where the employer furnished the meals. It is not for us to apply an essentially legislative judgment that "there is no difference between this situation and the typical situation in which the employer directs the preparation of the meal." It may or may not be that as a matter of sound legislative policy no such distinction should be drawn. But from our standpoint as judges, there is indeed a difference between the two situations. The difference is that Congresshas provided an exclusion in the "typical situation" and has not provided one where the employer does not furnish the meals. Moreover, Congress has at best provided an exclusion, 67 T.C. 870">878 not a deduction. The petitioner here seeks a deduction. Had Congress intended not merely to render excludable the value of employer-furnished meals, but to render deductible the cost of purchasing1977 U.S. Tax Ct. LEXIS 148">163 employee-furnished meals, it would no doubt have provided such a deduction in Part VII of Chapter 1, correlative to section 119's exclusion. Its failure to do so reinforces my conclusion that respondent is here entitled to decision. Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended.↩2. Work shifts of 96 consecutive hours were sometimes necessary, and on one occasion petitioner was required to work 5 consecutive days and nights, combating an exceptionally large fire.↩3. SEC. 262. PERSONAL, LIVING, AND FAMILY EXPENSES.Except as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses.↩4. In reaching this conclusion we do not adopt any form of "but for" test. In fact, we have previously rejected such a test. See Ronald D. Kroll, 49 T.C. 557">49 T.C. 557, 49 T.C. 557">567 (1968).Nor are we concerned that our decision today will encourage a multitude of unjustified deductions. Indeed, under circumstances which are distinguishable from the present case, we have held that similar expenses constituted nondeductible personal expenses. See Louis Drill, 8 T.C. 902">8 T.C. 902 (1947); Frank J. Borsody, T.C. Memo. 1976-47; John M. Murphey, T.C. Memo. 1975-317; Ion Z. Josan, T.C. Memo. 1974-144; Bayard L. Moffit, T.C. Memo. 1972-187; Jess H. Taylor↩, a Memorandum Opinion of this Court dated June 24, 1952.5. Respondent has not challenged petitioner's substantiation of the claimed expenses.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621015/	Earl J. Carroll and Marianne S. Carroll v. Commissioner.Carroll v. CommissionerDocket No. 1495-68.United States Tax CourtT.C. Memo 1971-59; 1971 Tax Ct. Memo LEXIS 279; 30 T.C.M. 249; T.C.M. (RIA) 71059; March 29, 1971, Filed 1971 Tax Ct. Memo LEXIS 279">279 The petitioner entered into an agreement with his attorney to credit the amount due to the attorney for legal services in the settlement of petitioner's tax liability against an amount owing by the attorney to the petitioner on account of a cash loan in a prior year. Held: Credit of an amount due for services against a loan due petitioner resulted in a payment on account of legal services, deductible by the petitioner in the year thus credited. The petitioner incurred expenditures in the development of certain patents for which he was to receive an interest in an Italian corporation to be formed in order to exploit the invention. The project was subsequently abandoned as worthless. Held: Upon the abandonment of the project, the expenditures incurred by the petitioner gave rise to a capital loss. The petitioner incurred expenditures and advanced funds for the stock of, or as a capital contribution to, or as a loan to, an Italian corporation formed in order to exploit a certain invention. The funds were dissipated by the promoter, and the petitioner's investment became worthless. Held: Upon the abandonment of the project, the expenditures incurred and investments and loans made1971 Tax Ct. Memo LEXIS 279">280 by the petitioner gave rise to a capital loss. James R. Zuckerman, for the petitioners. Patrick E. Whelan, for the respondent. QUEALYMemorandum Findings of Fact and Opinion QUEALY, Judge: The respondent determined deficiencies in the petitioners' income taxes as follows: YearAmount1963$1,581.1019642,814.9619655,012.3219662,931.50 250 The issues presented for decision are: (1) Whether payment was made by the petitioner of certain legal fees; (2) Whether expenditures with respect to certain vibration isolation devices gave rise to ordinary or capital losses; and (3) 1971 Tax Ct. Memo LEXIS 279">282 Whether expenditures with respect to certain cable isolation devices gave rise to ordinary or capital losses. 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 petitioners, Earl J. and Marianne S. Carroll, are husband and wife and resided at all times material hereto in Greenwich, Connecticut. The joint tax returns of the petitioners for all periods here involved were filed on the cash basis with the district director of internal revenue, Hartford, connecticut. Inasmuch as Marianne S. Carroll is a petitioner solely as a result of the filing of a joint return, Earl J. Carroll will hereinafter be referred to as the petitioner. Issue 1. Payment of Legal Fees The petitioner, an attorney, conducted a law practice in Germany from 1945 through 1954. In 1961, the respondent determined deficiencies in the petitioner's income taxes for some of those years in the total amount of $920,530.76. The deficiencies were determined with respect to amounts earned by the petitioner in his practice of law in Germany. After extensive proceedings in this and other Federal courts in 1963, 1971 Tax Ct. Memo LEXIS 279">283 it was ordered and decided pursuant to agreement of the parties that there was a deficiency in only one of the years in the amount of $70,000. The petitioner was represented in the court proceedings, as well as in proceedings at the administrative level, by Temple W. Seay (hereinafter "Seay") of Washington, D.C. who was an experienced tax attorney. The petitioner paid Seay a retainer of $2,500 in 1959 and agreed to pay Seay the balance of his legal fees, which were left undetermined at that time, at the conclusion of the proceedings. In July 1961, which was about the time that Seay prepared a petition to this Court for a redetermination of the deficiencies determined with respect to amounts earned by the petitioner in his practice of law in Germany, Seay asked the petitioner for a loan of $100,000. Seay wanted the loan so that he could cause his wholly owned corporation, Metro-WBOF, Inc. (hereinafter "WBOF"), to discharge a corporate obligation at a discount. The petitioner agreed to lend the $100,000 to Seay with the understanding that any legal fees due Seay at the conclusion of the matter could be offset against the amount of the loan. Seay told the petitioner that all of1971 Tax Ct. Memo LEXIS 279">284 his assets were held by WBOF and that the petitioner's loan to him would be better secured by having WBOF, as well as himself, obligated to repay the loan. With this in mind, the petitioner and Seay, acting individually and as president of WBOF, entered into an agreement on July 7, 1961 that provided for a loan of $100,000 at 5 percent interest. Under the terms of this agreement, $50,000 was to be advanced immediately and the balance on or before September 30, 1961. A $50,000 note calling for installment payments was to be issued for the initial advance and any notes issued were to be secured by a chattel mortgage on WBOF's operating equipment. The agreement also stated that the petitioner could convert all or any portion of the loan into stock of WBOF. However, the agreement failed to state a conversion price. On the day this agreement was entered into, the petitioner authorized his bank to deliver a bank check to Seay in the amount of $50,000. The bank, at Seay's direction, and without the petitioner's knowledge, made its check for $50,000 payable to Seay and WBOF. Sometime later, the petitioner received from Seay promissory notes issued by WBOF for the $50,000 that the petitioner1971 Tax Ct. Memo LEXIS 279">285 had advanced to Seay. Upon the petitioner's request for Seay's personal notes for this advance, Seay promised to substitute his own note for WBOF's notes when the second $50,000 advance was made and further promised to issue, as security for the repayment of his notes, a chattel mortgage covering 50 percent of his stock interest in WBOF. On October 3, 1961, relying on Seay's promises, the petitioner mailed to Seay separate checks in the amount of $30,000 and $20,000, making a total of $50,000. These checks were made payable to Seay. On the back of the checks, the petitioner typed "Loan per agreement dated July 7, 251 1961." The checks were endorsed by Seay and deposited by him in WBOF's bank account. During the following week, the petitioner met with Seay in Washington, D.C. At that time, the petitioner returned to Seay the notes issued by WBOF for the first advance of $50,000 and requested Seay's personal note for $100,000. However, after Seay explained that his endorsement of WBOF's note would make him personally liable for the loan, the petitioner accepted WBOF's note endorsed by Seay in the amount of $100,000. That note provided for interest at 5 percent and payments of1971 Tax Ct. Memo LEXIS 279">286 $25,000 on July 1, 1962, March 31, 1963, March 31, 1964 and March 31, 1965. On December 27, 1961, Seay executed a chattel mortgage in favor of the petitioner mortgaging 50 percent of the stock of WBOF to secure payment of the note issued by WBOF and endorsed by him. At the end of 1962, it was apparent that a settlement of the litigation regarding amounts earned by the petitioner while practicing law in Germany would be reached. At the beginning of 1963, the petitioner and Seay agreed that Seay's legal fees for representing the petitioner in that litigation would be $75,000, which would be credited against the $100,000 due the petitioner. However, no memorandum of payment has been signed and no transfer of the notes has taken place. The balance sheet of WBOF as of December 31, 1962, as certified by the auditors of WBOF in 1963, contained a footnote to paid-in surplus that stated, in part, as follows: Under date of July 7, 1961 the Company borrowed from Mr. Earl J. Carroll the sum of $100,000.00; secured by a negotiable promissory note executed by the company and further secured by Mr. Temple W. Seay (sole stockholder and President of Metro WBOF Inc.) personally. At a later date1971 Tax Ct. Memo LEXIS 279">287 in 1962, Mr. Carroll became indebted to Mr. Seay in rendered. It was agreed between the parties that the sum of $75,000.00 owed by Mr. Carroll to Mr. Seay be offset against the sum of $100,000.00 owed by the company to Mr. Carroll. Under effective date of December 31, 1962, Mr. Seay assigned all rights to this legal fee to the company. Notes payable (due in three equal installments of $25,000.00 each) on the books of the company have therefore been reduced $75,000.00 and a corresponding credit of $75,000.00 has been applied to paid-in surplus together with accrued interest to date. During April 1964, WBOF went into receivership. The petitioner did not file any claim with the receiver. In his 1963, 1964 and 1965 tax returns, the petitioner claimed a deduction of $25,000 as legal fees under the theory that Seay's fee was paid as the installment payments on WBOF's note fell due in those years. In his 1966 return, the petitioner claimed a nonbusiness bad debt deduction of $25,000 with respect to the final installment payment due on the note issued by WBOF. In his notice of deficiency, the respondent disallowed the deductions for legal fees. The respondent did not disallow the bad1971 Tax Ct. Memo LEXIS 279">288 debt deduction claimed in 1966. Issue 2. Expenditures With Respect to Certain Vibration Isolation Devices As the petitioner's tax case drew to a close, he sought an activity in which he could invest his funds profitably and which would occupy his time. While on vacation in Italy in 1960, the petitioner met Carlo Camossi (hereinafter "Camossi"), a mechanical engineer from Milan. The petitioner met Camossi several times later at an Italian resort. When they met in 1962, the petitioner had a folder with him that described certain vibration isolation devices utilizing cables in tension that were being developed by Kerley Engineering, Inc. of Kensington, Maryland (hereinafter "Engineering"). The petitioner and Camossi discussed these devices and later in 1962 Camossi came to the United States to meet with officials of Engineering. On December 19, 1962 the petitioner, acting as attorney for Camossi, negotiated and executed an agreement with James J. Kerley (hereinafter "Kerley") and Ngineering. Under the terms of this agreement, Camossi was to form Kerley Engineering International, S.R.L. (hereinafter "KEI"), a "Societa Responsibilita Limitata" under Italian law, for the purpose1971 Tax Ct. Memo LEXIS 279">289 of acquiring and perfecting certain vibration isolation patent rights that were held by Kerley and Engineering. Kerley was to provide technical assistance in developing the devices for a stated fee plus expenses. Referring to KEI, the agreement stated, in part, * * * Said corporation to be granted the sole and exclusive right, privilege and license within Italy and Germany to manufacture all items contained in said 252 [sic] inventions, improvements and patents referred to in this agreement and in that certain indenture of even date executed by the parties hereto. The corporation hereinabove referred to shall be at liberty to gran [sic] sublicenses hereunder to manufacture and sell the said items within the countries of Italy and Germany. On January 21, 1963 it was agreed that KEI would not be established until June 1, 1963 and that during the interim exploratory research and studies would be conducted. Under his agreement with Engineering and Kerley, Camossi was required to finance the venture. In January 1963, the petitioner and Camossi agreed that in consideration of matching Camossi's expenditures the petitioner would receive one half of Camossi's interest in the1971 Tax Ct. Memo LEXIS 279">290 agreement with Engineering and Kerley. Pursuant to his agreement with Camossi, the petitioner paid $8,000 to Engineering for research work on the devices and $5,000 to Camossi for research and development work on the devices. In 1963, the petitioner obtained a $5,000 promissory note from Camossi, payable April 1, 1966, together with an option to purchase a one-third interest in KEI at a price of $5,000 payable by cancellation of the note. The note and option were issued by Camossi as security that he had properly used the $5,000 advanced by the petitioner and that he would transfer to the petitioner, when and if desired, a onethird interest in KEI. During 1962 and 1963, the petitioner paid $2,569.49 for travel and other expenses incurred by him in connection with the venture. By March 1963, Camossi had concluded that changes and improvements in the patents were required in order to achieve commercial application. However, prior to making these changes and improvements, Camossi wished to obtain from Engineering certain patent documentation that Engineering appeared reluctant to send to him. Camossi believed that Engineering's reluctance to send the documentation stemmed from1971 Tax Ct. Memo LEXIS 279">291 the fact that KEI had not been organized. Accordingly, in March 1963, KEI was formed in Italy by Camossi and another Italian engineer. The authorized capital of KEI was 900,000 lire of which 600,000 lire was subscribed by Camossi and 300,000 lire by the other engineer. As required by Italian law, three tenths of the capital, 270,000 lire (about $450), was paid in to KEI. About the time KEI was formed, the petitioner and Camossi learned that Engineering had allowed the German patent rights covering the vibration isolation devices to lapse. They also learned that other foreign patent rights were not owned by Engineering. In April 1963, Camossi and the petitioner abandoned their efforts to develop and improve the patents held by Kerley and Engineering. The petitioner never exercised his option to acquire a one-third interest in KEI, as he decided to abandon the venture. KEI never became a functioning entity, and no stock or other interests were ever issued. At the time that the petitioner made the above described expenditures, which totaled $15,569.49, he intended to acquire an interest in KEI or to be reimbursed in kind or in some other manner if KEI became profitable. The petitioner1971 Tax Ct. Memo LEXIS 279">292 was not engaged in the trade or business of developing and promoting inventions during 1962 through 1964. On his tax return for 1964, the petitioner claimed that advances for product development in the total amount of $15,569.49 resulted in a loss in that amount in 1964 in connection with his trade or business of "Promotion of Inventions." In his notice of deficiency, the respondent determined that the petitioner was to be reimbursed by KEI for the $2,569.49 of expenses incurred by the petitioner and the $8,000 payment to Engineering and thus that these amounts were loans to KEI that gave rise to nonbusiness bad debts in 1964 when they became worthless. The respondent determined that the $5,000 advanced to Camossi evidenced by Camossi's not payable April 1, 1966 and the option to acquire a one-third interest in KEI gave rise to a nonbusiness bad debt in 1966. Issue 3. Expenditures with Respect to Cable Isolation Devices At about the time that their venture to develop and exploit the inventions of Engineering and Kerley was abandoned, the petitioner and Camossi embarked upon a new venture. This new endeavor involved the development of certain cable isolation devices that had1971 Tax Ct. Memo LEXIS 279">293 been invented by Camossi and others. 253 On April 1, 1963 the petitioner and Camossi agreed to finance equally the cost of perfecting those inventions. They were to have an equal interest in any patents obtained and were to sell the inventions either to third parties or to Cable Isolation Systems, S.p.A. (hereinafter "CIS"), an Italian corporation, in which they were to have equal interests. Camossi was to hold any funds advanced by the petitioner in trust and as security for his performance was to execute a promissory note in the amount of the advance that would become null and void upon his performance of his obligations as trustee. Sometime in April 1963, the petitioner paid $35,000 to Camossi, and Camossi executed a promissory note in that amount, together with an option to acquire an undivided one-half interest in CIS for $35,000 payable by cancellation of the note. The note and option were a security device to assure that Camossi would carry out the terms of the agreement. On May 8, 1963, CIS was formed and one-half of its authorized stock with a stated value of $2,700 was issued to the petitioner. 1 In September 1963, the petitioner advanced $20,000 to CIS and received1971 Tax Ct. Memo LEXIS 279">294 CIS's promissory note with 5 percent interest due September 16, 1966. After Camossi had assigned certain patent applications to CIS and it was determined that CIS was ready to begin production of the cable isolation devices, the petitioner and Camossi agreed in November 1963 to increase CIS's capitalization, to contribute $25,000 each to CIS to pay for machinery, and to guarantee a $200,000 line of credit for CIS by depositing an equal amount of collateral security with the First National City Bank. Camossi advised the petitioner by letter and telephone that he had ordered the machinery and had deposited satisfactory security with the Milan branch of the First National City Bank. The petitioner then on December 13, 1963 forwarded $25,000 to that branch with the instructions that it be deposited in CIS's account. At this point, the petitioner had also expended $4,851.77 in connection with CIS's development of the cable isolation devices. By a letter dated January 30, 1964, the petitioner was advised by an1971 Tax Ct. Memo LEXIS 279">295 Italian bank with which CIS had an account that they had received $21,724 as payment for 13,500 additional shares of CIS stock issued to the petitioner. The petitioner then learned that Camossi had not deposited with the First National City Bank either his $25,000 or satisfactory collateral for the line of credit. The petitioner also learned that Camossi had withdrawn the $25,000 the petitioner had deposited in the Milan branch of the First National City Bank and had deposited that sum in CIS's account in the Italian bank that had notified the petitioner of his increased stock interest in CIS. In February 1964 the petitioner and Camossi met in Milan. Camossi told the petitioner that he had made a direct $25,000 payment on behalf of CIS when he ordered the machinery and that he was arranging a line of credit with a bank in Rome as his properties were not accepted as collateral by the First National City Bank. The petitioner and Camossi then executed an agreement to supplement their agreement of April 1, 1963. This agreement of February 19, 1964, recited that the petitioner had advanced $80,000 pursuant to earlier agreements and stated that the advances were to be allocated as1971 Tax Ct. Memo LEXIS 279">296 follows: (1) $25,000 to purchase 50 percent of the stock of CIS; (2) $30,000 to finance CIS's research development and exploitation of cable isolation devices; and (3) $25,000 to finance inventions embraced in patent applications held by Camossi in trust as the joint property of the petitioner and Camossi. In March 1964, the petitioner again went to Milan. He determined that Camossi had leased a plant but had installed only one machine in that factory. The petitioner retained an Italian attorney and made an unsuccessful attempt to obtain an accounting from Camossi as to the disposition of the $80,000. Due to the expense involved and on the advice of his attorney, the petitioner decided not to bring any legal action against Camossi. The petitioner expended $4,000.74 in his efforts in 1964 to protect or recover his $80,000. In that year, the petitioner abandoned his efforts with respect to CIS's cable isolation devices and the patent applications held by Camossi. The stock and note issued by CIS to the petitioner became worthless in 1964. 254 On his 1964 tax return, the petitioner deducted the $80,000 as a loss arising from the embezzlement by Camossi of funds entrusted1971 Tax Ct. Memo LEXIS 279">297 to him for the development and operation of CIS. In his notice of deficiency, the respondent allocated to the petitioner's CIS stock the $35,000 and $25,000 payments made pursuant to the April and November agreements and determined that the stock became worthless in 1965 giving rise to a loss on account of worthless securities in the amount of $60,000. The respondent determined that the $20,000 advanced to CIS evidenced by CIS's note payable September 16, 1966 gave rise to a nonbusiness bad debt in 1965. On his 1964 tax return, the petitioner deducted the $4,851.77 that he expended in connection with CIS's development of the cable isolation devices and the $4,000.74 that he expended to protect or recover his $80,000 as business expenses. In his notice of deficiency, the respondent determined that the $4,851.77 represented a loan to CIS which became worthless in 1965 giving rise to a nonbusiness bad debt but allowed the deduction of the $4,000.74 as an expense incurred to protect or recover an investment. The following tables summarize the deductions claimed by the petitioner on his returns and the action taken by the respondent on his notice of deficiency: ITEMSDEDUCTIONS AS CLAIMED ON RETURNS19631964196519661. Legal fees$25,000.00$25,000.00$25,000.002. Expenses incurred in connection with the trade or business of promotion of inventions.a. Payment to Engineering8,000.00b. Payment to Camossi5,000.00c. Expenditures in connection with the development of the vibration isolation devices2,569.49d. Expenditures in connection with the development of the cable isola- tion devices4,851.77e. Expenditures in attempt to protect or recover investment in CIS4,000.743. Loss arising from embezzlement80,000.00ITEMSDEDUCTIONS AFTER ADJUSTMENTS19631964196519661. Legal fees2. Nonbusiness bad debtsa. Payment to Engineering$ 8,000.00b. Payment to Camossi$ 5,000.00c. Expenditures in connection with the development of the vibration isolation devices2,569.49d. Expenditures in connection with the development of the cable iso- lation devices$ 4,851.77e. Loan to CIS20,000.003. Worthless securitiesa. Advance for CIS stock35,000.00b. Advance for CIS stock25,000.004. Expenses incurred to protect or re- cover investment in CIS4,000.741971 Tax Ct. Memo LEXIS 279">298 Opinion Issue 1. Payment of Legal Fees The respondent does not question that the requirements of section 162 2 for the deduction of the $75,000 of legal fees have been met except as to the element of payment. The respondent contends that no payment of the legal fees was ever made, as no final agreement was ever reached by the 255 petitioner and Seay regarding the fees due Seay and the loan due the petitioner. The respondent's objection has been overcome by a clear showing that the petitioner and Seay agreed in 1963 to offset the $75,000 of legal fees due Seay against the $100,000 loan due the petitioner.3Although mutual debts do not per se extinguish each other, the actual offset by agreement of the parties of one debt against another operates as payment. See Bailey v. Commissioner, 103 F.2d 448 (C.A. 5, 1939), affirming a Memorandum Opinion of this Court. The $75,000 of legal fees were paid when the petitioner and Seay agreed in 1963 to offset the legal fees against the loan. 1971 Tax Ct. Memo LEXIS 279">299 Bailey v. Commissioner, supra.The deduction must be taken in full in 1963, the year of payment. Section 1.461-1, Income Tax Regs.Issue 2. Expenditures With Respect to Certain Vibration Isolation Devices Towards the end of 1962, the petitioner was principally occupied in seeking various profitable investments which would occupy his time. During that year, he met Camossi, a prior acquaintance, in Italy. Camossi, an Italian mechanical engineer, expressed an interest in information the petitioner had with him relating to certain vibration isolation devices being developed by Engineering. Discussions regarding those inventions between the petitioner, Camossi, and Kerley led to an agreement in December 1962 between Camossi, Engineering, and Kerley. The agreement, which the1971 Tax Ct. Memo LEXIS 279">300 petitioner had negotiated on behalf of Camossi, provided that Camossi would form KEI, a corporation in which he would have a two-thirds interest and Engineering would have a one-third interest. Camossi through the formation of KEI was to undertake the commercial exploitation of the inventions described in the agreement, and KEI was to have the exclusive right to manufacture and sell items developed from those inventions in Italy and Germany. Camossi was to provide all the financing required for this venture. Subsequently, the petitioner and Camossi agreed that the petitioner would have a one-third interest in KEI and that he and Camossi would jointly finance the venture. During 1962 and 1963, the petitioner expended $2,569.49 on behalf of this venture, paid $8,000 to Engineering for research work on the inventions, and paid $5,000 to Camossi for research and development work on the inventions. The respondent contends that the $2,569.49 expense and the $8,000 payment to Engineering were loans that gave rise to nonbusiness bad debts in 1964 and that the $5,000 payment to Camossi gave rise to a nonbusiness bad debt in 1966. The petitioner contends that those expenditures, which1971 Tax Ct. Memo LEXIS 279">301 totaled $15,569.49, were properly deductible in 1963 as either losses or expenses incurred in the trade or business of promoting inventions or as losses incurred in a transaction entered into for profit. In our view, the petitioner acquired in January 1963 the right to receive a one-third interest in KEI in consideration of matching any investment made by Camossi in the venture. KEI was referred to in the agreement between Camossi, Engineering, and Kerley as a "corporation," a characterization that we will rely on in the absence of more specific details as to the nature of this entity. Section 7701(a)(3). Under his agreement with Camossi, the petitioner acquired the right to receive a one-third interest in the corporation in consideration of expenditures which totaled $15,569.49. We must assume that the one-third interest was an ownership interest, that is stock (section 7701(a)(7); Warren v. King, 108 U.S. 389">108 U.S. 389 (1883); Hamlin v. Toledo, St. L. & K.C.R. Co., 78 F. 664">78 F. 664 (C.A. 6, 1897)); and thus conclude that the petitioner acquired a right to receive a "security" within the meaning of section 165(g).4 See sections 1.165-4(d); 1.165-5(a)(2), Income Tax1971 Tax Ct. Memo LEXIS 279">302 Regs. Accordingly, the $15,569.49 expenditure gave rise to a loss in 1963 under 256 section 165(g) when the right to receive that interest became worthless in that year. Camossi did issue a note for the $5,000 advance, however, the note was issued only to assure that Camossi had used the funds in the venture and would transfer a one-third interest in KEI to1971 Tax Ct. Memo LEXIS 279">303 the petitioner. It is clear from these facts that the note was only an additional evidence of the petitioner's investment in KEI rather than a debt. Larry E. Webb, 23 T.C. 1035">23 T.C. 1035 (1955). Issue 3. Expenditures With Respect to Cable Isolation Devices The petitioner expended $35,000, $20,000, $25,000 and $4,851.77 in connection with the development of the cable isolation devices. Although his return indicated that the $35,000, $20,000 and $25,000 expenditures resulted in embezzlement losses, the petitioner now argues that only the $25,000 expenditure resulted in an embezzlement loss. In the interest of clarity, each expenditure is considered separately below. $35,000 Expenditure The petitioner and Camossi organized CIS, an Italian corporation, through which they attempted to develop and exploit the cable isolation devices. The petitioner advanced $35,000 to Camossi in April 1963 with the understanding that he would receive one-half of the stock of CIS for that advance. In May 1963, approximately 30 days after the advance, CIS was formed, and the petitioner received one-half of its stock. CIS was a viable and operating entity from May 1963 until sometime in 1964. 1971 Tax Ct. Memo LEXIS 279">304 There is no doubt that $2,700 was paid into CIS for the petitioner's stock. The petitioner does not deny that at least $7,300 of the $35,000 was also advanced to CIS. It is clear that this advance was a capital contribution. Thus, at this point, it can be concluded that $10,000 of the $35,000 advance gave rise to a loss under section 165(g). With respect to the remaining $25,000, the petitioner contends that his agreement with Camossi of February 19, 1964 allocated that amount to a joint venture of the petitioner and Camossi to develop inventions. Notwithstanding this attempt in the year following the advance to carve out $25,000 as not being for CIS stock, petitioner has not demonstrated that less than the entire $35,000 was advanced through Camossi to CIS. Accordingly, the full $35,000 must be treated as having been advanced for a one-half interest in CIS and that advance gave rise to a loss under section 165(g) when the CIS stock became worthless in 1964. $20,000 Expenditure The petitioner advanced $20,000 to CIS and received CIS's note payable to his order. The petitioner concedes on brief that this transaction was a loan to CIS. Accordingly, this loan of $20,000 gave1971 Tax Ct. Memo LEXIS 279">305 rise to a loss under section 166(d)5 when it became worthless in 1964. $25,000 Expenditure The petitioner deposited $25,000 in CIS's account with the Milan branch of the First National City Bank. The petitioner admits on brief that Camossi withdrew those funds under his authority as managing director of CIS. The facts indicate that at1971 Tax Ct. Memo LEXIS 279">306 least $21,724 of this advance to CIS was deposited in CIS's account in an Italian bank in payment of shares of CIS stock. The petitioner contends that Camossi defrauded him and that he suffered a theft loss within the meaning of section 165 (c)(3). This contention is not supported by the facts. There is no evidence that those funds were used for other than corporate purposes. There is also no basis for the petitioner's contention with respect to fraud by use of the mails or telephone and radio in foreign commerce. Accordingly, this capital contribution of $25,000 gave rise to a loss under section 165(g) when the CIS stock became worthless in 1964. 257 $4,851.77 Expenditure The petitioner expended $4,851.77 in connection with CIS's development of the cable isolation devices. Amounts paid by a stockholder for expenses that are properly allocable to the business of the corporation are not deductible as business expenses by the stockholder. James M. Hawkins, 20 T.C. 1069">20 T.C. 1069 (1953). Thus, the petitioner improperly deducted the $4,851.77 as a business expense. This expenditure1971 Tax Ct. Memo LEXIS 279">307 represented an advance to CIS which gave rise to a loss under section 165(g) when the CIS stock became worthless in 1964. Decision will be entered under Rule 50. Footnotes1. Both the petitioner and his wife were listed as owners of this CIS stock. However, for our purposes, we can consider the petitioner alone as the owner of this stock.↩2. All section references are to the Internal Revenue Code of 1954, as amended.↩3. Although the facts are somewhat contradictory, they establish that Seay became indebted to the petitioner on the petitioner's advance of $100,000 to Seay, which Seay, in turn, advanced to WBOF. The respondent on brief recognizes that the petitioner's loan was to Seay.↩4. SEC. 165(g). Worthless Securities. - (1) General rule. - If any security which is a capital asset becomes worthless during the taxable year, the loss resulting therefrom shall, for purposes of this subtitle, be treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset. (2) Security defined. - For purposes of this subsection, the term "security" means - (A) a share of stock in a corporation; (B) a right to subscribe for, or to receive, a share of stock in a corporation; or (C) a bond, debenture, note, or certificate, or other evidence of indebtedness, issued by a corporation or by a government or political subdivision thereof, with interest coupons or in registered form.↩5. SEC. 166(d). Nonbusiness Debts. - (1) General rule. - In the case of a taxpayer other than a corporation - (A) subsections (a) and (c) shall not apply to any nonbusiness debt; and (B) where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months. (2) Nonbusiness debt defined. - For purposes of paragraph (1), the term "nonbusiness debt" means a debt other than - (A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or (B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621016/	JOHN A. AND SUZANNE H. KUHNEN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentKuhnen v. CommissionerDocket No. 8018-78.United States Tax CourtT.C. Memo 1981-600; 1981 Tax Ct. Memo LEXIS 134; 42 T.C.M. 1438; T.C.M. (RIA) 81600; October 19, 1981. Leland W. Hutchinson, Jr. and Mark W. Weisbard, for the petitioners. Leslie A. Klein, for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: Respondent determined a deficiency of $ 8,121 in petitioners' Federal income tax for the year 1975. The disposition of some issues has been agreed to by the parties. The two issues presented for decision are: (1) whether petitioner John A. Kuhnen has established1981 Tax Ct. Memo LEXIS 134">135 a basis of $ 20,000 in his stock in the United States Insulation Co., Inc.; (2) whether the petitioner's loss on the stock, which became worthless in 1975, is deductible under section 1651 as an ordinary loss. FINDINGS OF FACT Some facts are stipulated and are so found. John A. Kuhnen (petitioner) and Suzanne Kuhnen, husband and wife, were legal residents of Glencoe, Illinois, when they filed their petition in this case. They filed their joint Federal income tax return for 1975 with the Internal Revenue Service at Chicago, Illinois. From 1955 to 1969 the petitioner was employed as a sales engineer for Sprinkmann and Sons, a company which sold and installed insulation. His salary in 1955 was $ 15,000. In 1965 it was $ 21,000. From 1966 to 1969 it was $ 35,000. As early as 1965 the petitioner realized that his family of eight was having difficulty living on his salary at Sprinkmann and Sons. Consequently, during 1965 he formed United States Insulation Co., Inc. (hereinafter the "Company"). A certificate of incorporation1981 Tax Ct. Memo LEXIS 134">136 was issued by the Secretary of State of Illinois on September 8, 1965. Petitioner chose to organize the Company to obtain limited liability and to separate it from his personal life. In 1965 the petitioner contributed $ 1,000 in return for the authorized issuance of 996 shares of stock in the Company. Although its corporate status was maintained, the Company did not conduct any business until mid-1969 during which period the petitioner continued to work for Sprinkmann and Sons. In 1969 he again evaluated his financial situation. He decided that his salary at Sprinkmann was not sufficient and therefore he activated the Company which began carrying on the business of selling and installing insulation, the same work previously done by petitioner at Sprinkmann. Petitioner's primary motive in activating the Company was to earn more income to enable him to finance the college educations of his children. At the time the Company began the active conduct of its business the petitioner entered into a written agreement with Richard Shofstall, who was then a distributor for the Dow Chemical Company, under the terms of which the petitioner would contribute an additional $ 19,000 to1981 Tax Ct. Memo LEXIS 134">137 the Company and Mr. Shofstall would contribute $ 15,000. Based on his experience in the business, Mr. Shofstall had informed petitioner that in his opinion the Company needed a total capitalization of $ 35,000 to begin operations. As part of the agreement, the Company was able to purchase insulation materials on open account from Dow Chemical, paying for such materials from the cash flow received from the resale and installation of such materials, a period usually more than 60 days. No other supplier would sell insulation materials to the Company on terms other than normal 30-day open account conditions. Pursuant to his agreement with Mr. Shofstall, the petitioner contributed an additional $ 14,000 in cash and a $ 5,000 note to the Company in 1969 and early 1970 in return for 19,000 shares of stock, and Mr. Shofstall contributed $ 15,000 in cash for 15,000 shares. Petitioner later paid off the $ 5,000 note to the Company in cash. Petitioner's salary with the Company in 1969 began at $ 40,000 per year. It was raised to $ 50,000 in 1970, to $ 52,500 in 1972, and in 1973 and 1974 the petitioner was paid $ 60,000 per year. This salary was reduced for two months in 1975 when1981 Tax Ct. Memo LEXIS 134">138 the Company went into a chapter 11 bankruptcy proceeding. While the Company was active, the petitioner was its only manager. He devoted his full time and attention to the Company and he had no other employment. In 1970 the name of the Company was changed to U.S. Insulation Co., Inc. In 1972 the Company purchased Mr. Shofstall's stock for $ 17,000, which represented a return of the money contributed by him plus an interest factor of approximately 4-1/2 percent for the use of his money. In 1974 the certificates representing shares of stock issued to petitioner were destroyed in a fire along with most of the Company's records and some of the petitioner's bank records. No dividends were ever paid by the Company. There was never an active market for the Company's stock and, in petitioner's opinion, there was no prospect that it would appreciate in value. In 1974 the Company had buildings and other fixed depreciable assets having a book value, after an allowance for depreciation, in the amount of $ 41,401. Because of a change in the policy of its supplier, Dow Chemical, the Company went into bankruptcy in 1975, and its stock became worthless in that year. Petitioner's1981 Tax Ct. Memo LEXIS 134">139 only stock investments consisted of four open market purchases in 1972 totaling about $ 9,000. These were made on the advice of a friend and the stocks were sold at a loss by 1974. On his Federal income tax return for 1975 the petitioner claimed an ordinary loss of $ 20,000 on his shares of the Company's stock. In his notice of deficiency dated April 6, 1978, respondent disallowed the claimed loss deduction on the grounds that the petitioner had not established his basis in the stock and that, if there was a loss deduction, it was a capital loss subject to the limitation of section 1211. ULTIMATE FINDINGS OF FACT 1. Petitioner's basis in the shares of stock he owned in the Company is $ 20,000. 2. In 1969 and subsequently the petitioner was in the trade or business of being a salaried employee engaged in selling insulation materials for the Company. 3. Petitioner purchased and held the Company's stock as an integral and necessary act in the conduct of his business and with a predominant business, rather than investment, motive. OPINION I. Basis in StockThis is essentially a factual issue. In our judgment the petitioner has submitted sufficient evidence1981 Tax Ct. Memo LEXIS 134">140 to establish his $ 20,000 basis in the worthless stock of the Company.Respondent acknowledges on brief that his original determination is incorrect and that the petitioner has proved $ 11,000 of the claimed $ 20,000 of cash contributions he made in purchasing the Company's stock. However, he challenges two of the five contributions the petitioner made, namely, (1) the $ 4,000 in cash which he contributed when the articles of incorporation were amended in early 1970 and (2) the $ 5,000 in cash he used to pay off the note given to the Company when he purchased the stock. We reject his challenge to both cash contributions. We think the documentary evidence is consistent with and corroborates the petitioner's unequivocal and uncontradicted testimony. Therefore, the petitioner has satisfied his burden of proving his basis in the stock.See and compare Alameda Realty Corporation v. Commissioner, 42 T.C. 273">42 T.C. 273, 42 T.C. 273">283 (1964); Sharaf v. Commissioner, T.C. Memo. 1954-231, reversed on other grounds 224 F.2d 570">224 F.2d 570 (1st Cir. 1955). II. Nature of LossThere are no disputed facts with respect to the characterization of petitioner's loss as ordinary1981 Tax Ct. Memo LEXIS 134">141 or capital in nature. Only a legal interpretation is required. Under section 1652 and section 1.165-5(b), Income Tax Regs., if any security which is not a capital asset becomes worthless during the taxable year, the loss resulting therefrom may be deducted as an ordinary loss. In Corn Products Refining Co. v. Commissioner, 350 U.S. 46">350 U.S. 46 (1955), the Supreme Court concluded that losses resulting from the sale of securities held in connection with the everyday operations of a business are ordinary losses. Petitioner contends that (1) since he acquired and held the Company's stock in order to secure and protect his stream of income, the stock was not a capital asset, and the loss resulting from1981 Tax Ct. Memo LEXIS 134">142 its worthlessness is an ordinary loss; (2) he acquired and held the stock as an integral and necessary act in the conduct of his business; and (3) he purchased and held stock with a predominant business motive as opposed to a predominant investment motive. To the contrary, respondent argues that the petitioner did not purchase the stock as an integral and necessary act in the conduct of his business, but rather purchased it, placing funds at risk in the Company, because the funds were needed to begin operations. Thus, respondent argues, the petitioner's contributions were purely capital in nature and constituted the initial capitalization of the Company. Hence respondent contends that the stock was a capital asset and that the petitioner's loss is a capital loss. We agree with the petitioner. The main thrust of respondent's position is that petitioner's loss was capital in nature because his sole trade or business was being an employee of Sprinkmann and Sons. However, in our view the determination of whether the stock was purchased in connection with the petitioner's trade or business1981 Tax Ct. Memo LEXIS 134">143 is not so narrow or so mechanical. All that is required is that petitioner's "primary motivation" in making the contributions was to obtain employment with and to secure his salary from the Company. See Steadman v. Commissioner, 50 T.C. 369">50 T.C. 369, 50 T.C. 369">379-380 (1968), affd. 424 F.2d 1">424 F.2d 1 (6th Cir. 1970), cert. denied 400 U.S. 869">400 U.S. 869 (1970); Hirsch v. Commissioner, T.C. Memo. 1971-235. 3 These opinions have applied a two-pronged test requiring proof of the business necessity for the purchase of the stock and the potential source of salary income which would result from purchasing it. Here the petitioner has established to our satisfaction both essential elements. First, the business necessity is shown by the fact that his salary at Sprinkmann was insufficient to support his family, especially the college education of his four oldest children. Second, he has shown that the Company was a good potential source of income for him. See and compare analogous opinions under section 166 in LaStaiti v. Commissioner, T.C. Memo. 1980-547; Carter v. Commissioner, T.C. Memo. 1979-447; Haslam v. Commissioner, T.C. Memo. 1974-97.1981 Tax Ct. Memo LEXIS 134">144 We are convinced that the petitioner's primary motivation in organizing the Company and in purchasing its stock was to secure a salary.While the Company was active, he devoted his full time and energy to it and had no other employment. When the Company went bankrupt in 1975, he lost his salary. The evidence establishes that the petitioner fromed the Company and purchased its stock to enable him to carry on his trade or business in which he1981 Tax Ct. Memo LEXIS 134">145 was trained and experienced. The Company was run solely by him and he provided its only expertise in the insulation business. When he contributed his cash in exchange for stock, he did so in order to operate in his trained field of business in a manner which allowed him to receive a salary on which he and his family could live. His salary later increased to $ 60,000 per year as compared to the $ 35,000 he earned at Sprinkmann. The petitioner's agreement with Mr. Shofstall and his special credit arrangements with Dow Chemical for the purchase of necessary materials further establish that the purchase of the stock was an integral and necessary act in the conduct of petitioner's business. See Schlumberger Technology Corp. v. United States, 443 F.2d 1115">443 F.2d 1115 (5th Cir. 1971); Irwin v. United States, 558 F.2d 249">558 F.2d 249 (5th Cir. 1977); Booth Newspapers, Inc. v. United States, 170 Ct. Cl. 220">170 Ct. Cl. 220, 303 F.2d 916">303 F.2d 916 (1962). Significantly, there is no evidence in this record that the petitioner purchased or held the stock as an investment. No dividends were ever paid by the Company and there was never any prospect that a dividend would be paid. There1981 Tax Ct. Memo LEXIS 134">146 was also no market for the stock and no prospect that it would appreciate in value. In addition, the repurchase of Mr. Shofstall's stock shows a lack of investment potential in it.The purchase price in that arm's length transaction was determined by returning the amount that Mr. Shofstall had contributed to the Company plus an amount at the prevailing bank interest rates, to cover the cost of using his money.Neither the petitioner nor Mr. Shofstall viewed the stock they held in the Company as an investment. The mere fact that the Company needed petitioner's contributions to begin business did not render such contributions capital in nature. Petitioner's primary motivation is the critical inquiry, not the use to which the Company put the funds. Accordingly, we conclude that there was a proximate relationship between petitioner's business and the source of the loss. Hirsch v. Commissioner, supra. He has proved that his stock in the Company was an ordinary asset and that his resulting loss is an ordinary one deductible under section 165. To reflect concessions and our conclusions on the disputed issues, Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the year in issue, unless otherwise indicated.↩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) loss incurred in a trade or business;↩3. On brief respondent appears to concede that, since the stock was purchased prior to March 13, 1978, and became worthless prior to September 13, 1978, the "predominant business motive" standard of Rev. Rul. 75-13, 1975-1 C.B. 67, is applicable rather than the "substantial investment motive" standard, as adopted in Rev. Rul. 78-94, 1978-1 C.B. 58. See W.W. Windle Co. v. Commissioner, 65 T.C. 694">65 T.C. 694 (1976), appeal dismissed 550 F.2d 43">550 F.2d 43 (1st Cir. 1977), (stock purchased with a substantial investment purpose is a capital asset even if there is a more substantial business motive for the purchase); see also Bell Fibre Products Corp. v. Commissioner, T.C. Memo. 1977-42↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621017/	Vernon M. Bingham, Petitioner, v. Commissioner of Internal Revenue, RespondentBingham v. CommissionerDocket No. 56986United States Tax Court30 T.C. 900; 1958 U.S. Tax Ct. LEXIS 126; July 10, 1958, Filed 1958 U.S. Tax Ct. LEXIS 126">126 Decision will be entered for the petitioner. Transferee Liability -- Beneficiary of Life Insurance. -- The petitioner received proceeds of insurance as the beneficiary of policies on the life of her deceased husband. The laws of North Carolina exempt such proceeds from claims of creditors of the deceased husband in the absence of payment of premiums with intent to defraud creditors. There being no showing that any premiums were paid with intent to defraud creditors, it is held that the petitioner is not liable as a transferee for income taxes owed by decedent. Commissioner v. Stern, 357 U.S. 39">357 U.S. 39, followed. Thomas A. Uzzell, Jr.,1958 U.S. Tax Ct. LEXIS 126">127 Esq., for the petitioner.Richard C. Forman, Esq., for the respondent. Atkins, Judge. ATKINS30 T.C. 900">900 OPINION.The respondent determined that the petitioner is liable, to the extent of $ 10,175.29, as transferee of assets of her deceased husband, Irving W. Bingham, for deficiencies in income taxes 30 T.C. 900">901 and additions thereto (with interest thereon) determined against him for the calendar years 1945 to 1951, inclusive, as follows:Additions to taxYearIncome taxSec. 291 (a)Sec. 293 (b)Sec. 294 (d)Sec. 294 (d)(1) (A)(2)1945$ 2,194.54$ 1,097.2719462,300.741,150.3719475,449.97$ 1,362.492,959.6919484,572.141,143.042,286.071949756.79189.20378.4019502,581.96645.491,290.98$ 258.20$ 154.9219511,751.30437.83875.65105.08175.12It has been stipulated that these were the correct amounts of unpaid deficiencies at the time of the decedent's death.The amount of $ 10,175.29 determined by the respondent as the petitioner's liability as transferee represents the amount received by the petitioner as proceeds under policies of life insurance on the life of the decedent.The proceeding1958 U.S. Tax Ct. LEXIS 126">128 was submitted on a stipulation of facts under Rule 30. The facts stipulated are so found.Irving W. Bingham (herein referred to as Bingham or the decedent) died intestate a resident of Asheville, North Carolina, on September 21, 1953. His wife, Vernon M. Bingham, the petitioner herein, qualified and was appointed as administratrix of his estate in March 1954, by the Superior Court of Buncombe County, North Carolina.Bingham filed individual Federal income tax returns for the years 1945 and 1946 with the collector of internal revenue for the district of North Carolina. He failed to file income tax returns for the years 1947 through 1951. During the years 1945 through 1951 he received income from the practice of public accounting, from partnerships, salaries, and profits and income derived from miscellaneous transactions. He did not maintain books of account or other records reflecting his correct net income.The respondent's investigation of Bingham's income tax affairs began in the fall of 1951. Bingham had several conferences with the investigating agent and knew that deficiencies in tax were being set up against him. The respondent determined Bingham's net income for the 1958 U.S. Tax Ct. LEXIS 126">129 taxable years by the bank deposits method.On August 17, 1954, the petitioner, as administratrix of the estate of the decedent, executed a waiver of restrictions on assessment and collection of the deficiencies in tax and additions thereto in the aggregate of the amounts above set forth and those amounts were assessed by the respondent together with interest thereon on the respondent's October 7, 1954, assessment list. On January 20, 1955, the respondent 30 T.C. 900">902 filed proof of claim against the estate of Bingham for income taxes, additions thereto and interest for the years 1945 through 1951 in the total amount of $ 40,918.54.At the time of the decedent's death there were five life insurance policies, in total face amount of $ 20,663.60, on his life issued to him by Phoenix Mutual Life Insurance Company of Hartford, Connecticut, which were then owned by him and were in full force and effect. There were outstanding loans against each of the five policies. The aggregate cash surrender value of the policies, over and above the loans, was $ 1,998.14. The decedent retained the right to the cash surrender value up to the date of his death and also reserved the right to change the 1958 U.S. Tax Ct. LEXIS 126">130 beneficiary. The petitioner was the designated beneficiary of each policy and remained such. The net proceeds of the five policies, in the aggregate amount of $ 10,175.29, were paid to the petitioner after the death of the decedent, in accordance with the terms of the policies.The several insurance policies on the life of the decedent were issued on various dates from June 24, 1941, to December 1, 1945. On and before December 1, 1945, the date of issuance of the last of the five policies, the decedent was solvent. Thereafter he became insolvent and was insolvent at the date of his death, and his estate was also insolvent and unable and is still unable to pay the deficiencies in income taxes, additions to the tax, and interest thereon. The deficiencies have not been paid. By letter dated December 23, 1954, the respondent notified the petitioner of his determination of her liability as transferee.In the recent case of Commissioner v. Stern, 357 U.S. 39">357 U.S. 39, the Supreme Court held that the liability, at law or in equity, of a transferee of property of a taxpayer in respect of the income tax, which is to be enforced under section 311 of the Internal1958 U.S. Tax Ct. LEXIS 126">131 Revenue Code of 1939, is to be determined by reference to State law.The decedent at the time of his death was a resident of the State of North Carolina and his estate was administered in that State by his wife, the petitioner herein.Article X, Section 7 of the Constitution of North Carolina provides:The husband may insure his own life for the sole use and benefit of his wife and children, and in case of the death of the husband the amount thus insured shall be paid over to the wife and children, or to the guardian, if under age, for her or their own use, free from all the claims of the representatives of her husband, or any of his creditors. And the policy shall not be subject to claims of creditors of the insured during the life of the insured, if the insurance issued is for the sole use and benefit of the wife and/or children. * The General Statutes of North Carolina provide in material part as follows:30 T.C. 900">903 Section 58-206. Creditors deprived of benefits of life insurance policies except in cases of fraud. If a policy of insurance is effected by any person on his own life * * * the lawful beneficiary * * * shall be entitled to its proceeds and avails against creditors1958 U.S. Tax Ct. LEXIS 126">132 and representatives of the insured * * whether or not the right to change the beneficiary is reserved or permitted * * : Provided, that subject to the statute of limitations, the amount of any premiums for said insurance paid with the intent to defraud creditors, with interest thereon, shall inure to their benefit from the proceeds of the policy * .These provisions have been the subject of litigation in the courts of North Carolina and the Supreme Court of that State has carefully protected the rights of a wife, who is the beneficiary of a life insurance policy, against the claims of creditors of her deceased husband. See People's Building & Loan Assn. v. Swaim, 198 N. C. 14, 150 S.E. 668, and cases cited therein.Accordingly, under the decision of the Supreme Court in the Stern case, the petitioner is not liable as a transferee by virtue of having received the proceeds of the life insurance policies unless, and to the extent that, premiums for such insurance were paid with the intent to defraud creditors. If any premiums were so paid the establishment of that fact is part of the respondent's burden of proof under the1958 U.S. Tax Ct. LEXIS 126">133 provisions of section 1119 (a) of the Code.In the instant case there is no showing that any premiums were paid with the intent to defraud creditors. Actually there has been no showing when the premiums were paid or when the decedent became insolvent, except that he became insolvent at some time after the last policy was issued to him. For all that appears in the record all the premiums may have been paid prior to the time of his insolvency.We accordingly hold that the petitioner, as beneficiary of the several life insurance policies, is not liable as transferee for the deficiencies in income taxes, additions thereto and interest thereon, due from the decedent. See Becky Osborne Hampton, 30 T.C. 708, and Helen E. Myers, 30 T.C. 714. The taxes and additions thereto were not assessed prior to the date of the death of the decedent and no question with respect to liens is here present. Cf. United States v. Bess, 357 U.S. 51">357 U.S. 51.Decision will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621018/	DIEGO INVESTORS - IV, E. C. SMITH, TAX MATTERS PARTNER, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Diego Investors - IV v. CommissionerDocket Nos. 16947-87; 25289-87; 35488-87United States Tax CourtT.C. Memo 1990-102; 1990 Tax Ct. Memo LEXIS 102; 58 T.C.M. 1534; T.C.M. (RIA) 90102; February 28, 1990Mitchell B. Dubick, Sherri A. Groveman, Patrick J. Felix III, and Edward C. Smith, Jr., for the petitioners. Steven New, Zuzana Colaprete, Jeffrey A. Hatfield, Boris Siegel, and William H. Quealy, for the respondent. GERBERMEMORANDUM OPINION GERBER, Judge: This matter arises from petitioner James D. Mason's 2 Motion For Reconsideration, filed December 29, 1989, regarding , filed November 27, 1989. The reconsideration is sought with respect to our holding that the section 6659 3 addition to tax for overvaluation and the section 6653(a)(1) and (2) addition to tax for negligence are applicable. Respondent's Objection To The Petitioners' Motion For Reconsideration was filed February 12, 1990. Respondent counters1990 Tax Ct. Memo LEXIS 102">103 that our opinion was correct with respect to both matters. Section 6659 - Addition to Tax for OvervaluationInitially, petitioner contends that we made no finding with respect to whether the master recordings, which were the subject of deductions and credits, were placed in service in the year the credits were claimed. Petitioner argues that if the assets were not placed in service then section 6659 should not be imposed, citing , affd. . Respondent counters that the facts in this case are distinguishable from Todd because in this case respondent did not argue that the assets were not placed in service and it was not found that the assets were not placed in service. Petitioner is correct that our opinion did not include a specific finding that the masters were or were not placed in service. We find it incongruous that petitioner should now argue that the masters may not have1990 Tax Ct. Memo LEXIS 102">104 been placed in service. No such finding was requested or proven by petitioners, who bear the burden of proof in this case. To the contrary, petitioners offered evidence of the production and marketing of tapes for sale from the masters in question. Further, respondent, on brief, did not contend or argue that the masters were not placed in service. In that setting, we found it unnecessary to make a finding that the masters were placed in service, although our discussion of the various transactions and the valuation aspects implies the existence and use of the masters to produce tapes. Accordingly, without a finding (and in this case the possibility of a finding) that the masters were not placed in service, this case is distinguishable from Todd. Next, petitioner argues that even if the masters were placed in service, our "finding that the transactions were without economic substance requires that the Court not reach -- and therefore not impose * * " the addition to tax under section 6659. On this point petitioner asks us to focus upon the opinion of the United States Court of Appeals for the Fifth Circuit in ,1990 Tax Ct. Memo LEXIS 102">105 affg. , and . With respect to the opinion of the Court of Appeals for the Fifth Circuit, petitioner directs us to the court's rationale that the taxpayers "did not benefit from their tax shelter, since their depreciation deductions and investment tax credits were denied in full." . Petitioner, however, failed to distinguish the fact that the Tax Court opinion in Todd did not address the question of valuation in arriving at the holding that the taxpayers in that case were not entitled to depreciation deductions or investment tax credits. The holding in Todd was solely premised upon a finding that the assets were not placed in service. In our opinion in this case, however, we stated: Because the fair market value of the master recording is an integral part of the fair market value of the lease, crucial to our lack of economic substance determination, the understatement linked to the disallowed credits is attributable to a valuation overstatement. * * * Diego Investors - 1990 Tax Ct. Memo LEXIS 102">106 (slip opinion at 41). Moreover, the Court of Appeals for the Fifth Circuit, in addressing the Government's policy concerns that taxpayers should not be allowed to overvalue without suffering the addition to tax for overvaluation, stated: Further, it is probable that Congress was balancing competing policies when it determined how to apply [section] 6659. First, Congress may not have wanted to burden the Tax Court with deciding difficult valuation issues where a case could be easily decided on other grounds. Second, Congress may have wanted to moderate the application of the [section] 6659 penalty so that it would not be imposed on taxpayers whose overvaluation was irrelevant to the determination of their actual tax liability. [Fn. refs. omitted.] . The opinion of the Court of Appeals provides supporting rationale for our finding that section 6659 is applicable in the setting of this case. We were required to consider the question of value in order to decide whether the transactions had or lacked economic substance. Petitioner argues that , also supports his contention1990 Tax Ct. Memo LEXIS 102">107 that the section 6659 addition is not applicable in this case. In Smith "research and development and interest deductions in issue [were disallowed] because [of the conclusion] that the partnerships were not in a trade or business that would support the deductions claimed, and the Koppelman Process activity lacked economic substance." Accordingly, the underpayments were not attributable to a valuation overstatement. . Again, in Smith we did not have to reach the valuation issue to decide the case, whereas in this case the question of valuation was seminal and "crucial to our lack of economic substance determination * * ." Diego Investors - (slip opinion at 41). Because of the circumstances in this case, we were compelled to consider the valuation aspect and specifically held that the values of the various master tapes were grossly overinflated. We found that the master tapes in issue had a fair market value of either $ 15,000 or $ 20,000, depending upon the tape, whereas the same tapes were reported, for tax purposes, at values in excess of $ 200,000 per tape. Our findings1990 Tax Ct. Memo LEXIS 102">108 are not only necessary to the proper analysis of the issues in this case, but also present compelling reasons for upholding respondent's determination of a valuation overstatement under section 6659. We do not here intend to modify or change the holdings of Todd and Smith to include or embrace the result urged by petitioner in this case. This case presents a situation where, unlike Todd and Smith, we have based our holding on the question of valuation. We did not make the value determinations "in this case only because of the disputes over the additions to tax." See . See also ; ; ; . Section 6653(a)(1) and (2) - Addition to Tax for NegligencePetitioner contends that our opinion focused upon the promoter's and not the investor's shortcomings in regard to the transaction. Further, petitioner contends that he relied on the promoter and, accordingly, 1990 Tax Ct. Memo LEXIS 102">109 should not be held liable for the addition to tax under section 6653(a)(1) and (2). Our memorandum opinion adequately addressed petitioner's contentions, as follows: The partnerships and investors relied on Smith to make all the business decisions regarding the master recording venture. This included the value of the master tapes upon which the feasibility of the entire venture rested. Further, both Smith [the promoter] and Mason [petitioner] knew that the value of the master recordings was critical to the amount of the investment ITC claimed on the returns. Neither Smith nor petitioner attempted to obtain any independent appraisals of the leases or the masters themselves. In addition, Smith was not experienced in the production or distribution of audio cassette tapes. * * Finally, the master recording venture promised approximately $ 21,000 in tax credits and $ 14,000 in deductions for a $ 14,000 investment. No reasonable person would have trusted this scheme to work without some independent support. , affg. a Memorandum Opinion of this Court; .1990 Tax Ct. Memo LEXIS 102">*110 [Diego Investors - , slip opinion at 40.] In this case petitioner relied upon the promoter of the transaction who stood to gain from petitioner's participation in the promoter's venture. Petitioner cited , in support of his position on this point. That case is inapposite because the reliance there was upon the taxpayer's attorney, who was compensated to give expert and independent advice on the matter there involved. In view of the foregoing, An appropriate order denying petitioner's Motion for Reconsideration will be issued. Footnotes1. Cases of the following petitioners are consolidated herewith: Beach Investors 400, James Maxham, Vernon L. and Phyllis Payton, Frank and Rosemary Mendoza, A Partner Other Than the Tax Matters Partner, docket No. 25289-87; and James D. Mason, docket No. 35488-87.↩2. For purposes of this opinion James D. Mason shall be referred to as "petitioner." ↩3. Section references are to the Internal Revenue Code, as amended and in effect for the years in issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621019/	Ida P. Huggins v. Commissioner.Huggins v. CommissionerDocket No. 109539.United States Tax Court1943 Tax Ct. Memo LEXIS 359; 1 T.C.M. 904; T.C.M. (RIA) 43172; April 17, 19431943 Tax Ct. Memo LEXIS 359">359 Glenn Y. Davidson, C.P.A., Gulf Bldg., Houston, Tex., for the petitioner. Wilford H. Payne, Esq., for the respondent. ARNOLD Memorandum Opinion ARNOLD, Judge: The respondent determined a deficiency of $1,731.48 in petitioner's income tax for the year 1939 as the result of several adjustments in her return. Her address is 1017 Chronical Building, Houston, Texas, and her return was filed with the collector of internal revenue for the first district of Texas, Austin, Texas. The only question involved arises from the different treatment by the parties of an amount of $12,087.85 received by petitioner upon the sale of certain land and the improvements thereon. No question is raised as to the other adjustments. The case was presented upon stipulated facts which are found as stipulated. The pertinent parts are restated below. [The Facts] In 1917 petitioner's mother acquired certain improved residential property located at 4208 San Jacinto Street, Houston, Texas, at a cost of $9,000, of which $2,500 was allocated to the land and $6,500 to the improvements thereon. In 1923 the foregoing residential property was acquired by petitioner as a gift from her mother and was thereafter occupied1943 Tax Ct. Memo LEXIS 359">360 as petitioner's personal residence until on or about March 1, 1937, at which time petitioner vacated the premises and converted the same to rental property. It was thereafter rented to a tenant and used for residential purposes. The fair value of the improvements at the time of conversion to rental property was determined by petitioner to be $5,000 and this value was accepted by the Bureau of Internal Revenue as the correct basis for the computation of allowable depreciation on said improvements. The property was rented continuously from March 1, 1937 to the time of its sale in January, 1939. From March 1, 1937 to December 31, 1937, it was rented for $125 per month, and throughout the year 1938 and until the date of sale in January, 1939, it was rented for $100 per month. For the year 1938 the property was assessed for local real estate tax purposes at a value of $3,300 for the improvements and at a value of $4,420. for the land. On or about January 5, 1939, the foregoing improved real estate was sold by petitioner to Sears Roebuck & Co. for a net sales price of $12,087.85. The correct adjusted basis of the improvements on the property at date of sale was $4,755.85 and the correct1943 Tax Ct. Memo LEXIS 359">361 basis for the land was $2,500. The property was included in approximately four square blocks of residential properties acquired by Sears Roebuck & Co. during the years 1938 and 1939 as a site for the erection of a large retail store, together with an automobile accessory and service station and adjacent surfaced parking lots for the convenience of the customers. The project represented a substantial new commercial development in that section of the city of Houston, Texas. Shortly after the acquisition of the foregoing property from the petitioner, Sears, Roebuck & Co. sold the improvements thereon for $550 as salvage, and the purchaser immediately razed and removed the residence and related structures. The land acquired from petitioner became a part of the surfaced parking lot used by customers of Sears, Roebuck & Co.The respondent, in computing the gain derived by petitioner from the sale of the improved property in 1939, allocated the selling price between the land and improvements and determined the resulting profit therefrom in the following manner: LandImprovementsTotalSales price$7,332.00$4,755.85$12,087.85Adjusted basis2,500.004,755.857,255.85Profit (or loss)$4,832.00$ 4,832.00Portion taxable under section 117, In-ternal Revenue Code$2,416.00$ 2,416.00Petitioner contends that the profit or loss should be computed as follows..LandImprovementsTotalSales price$7,332.00$4,755.85$12,087.85Adjusted basis2,500.004,755.857,255.85 lProfit (or loss)$9,037.85($4,205.85)$ 4,832.00Portion taxable (or deductible) under sec-tion 117, Internal Revenue Code$4,518.92($4,205.85)$ 313.071943 Tax Ct. Memo LEXIS 359">362 [Opinion] The question to be decided is whether respondent erred in allocating $4,755.85 of the total amount petitioner received for the property to the improvements and $7,332. to the land. Petitioner contends the allocation should be $550 to the improvements and $11,537.85 to the land, as shortly after the sale the improvements were disposed of by her purchaser as salvage $550for. She claims she suffered a loss of $4,205.85 upon the sale of the improvements, representing the difference between the $550 and $4,755.85, the adjusted basis of the improvements at time of sale. Petitioner's argument, in brief, is (1) that the lump sum sales price should be allocated between the land and the improvements on the basis of their respective values to the purchaser at the time of the sale, and (2) that the value of the land to the purchaser was the entire purchase price, less what could be derived from the sale of the improvements for salvage. Petitioner cites no authorities for the first proposition, and for the second she cites Union Bed & Spring Co. v. Commissioner ( C.C.A. 7th Cir., 1930), 39 Fed. (2d) 383, and Milwaukee Woven Wire Works, 16 B.T.A. 75">16 B.T.A. 75.1943 Tax Ct. Memo LEXIS 359">363 The respondent's position is that his allocation was a reasonable one, in view of all the facts, and that petitioner has failed to rebut the presumption of correctness which attaches to the determination of the Commissioner of Internal Revenue, Helvering v. Taylor, 293 U.S. 507">293 U.S. 507 (1935); Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Lucas v. Kansas City Structural Steel Co., 281 U.S. 264">281 U.S. 264 (1930); Wickwire v. Reinecke, 275 U.S. 101">275 U.S. 101 (1927). In presenting the case, the parties have treated the gain or loss applicable to the improvements as ordinary gain or loss, taxable or deductible in full, as the case may be without regard to the capital gains and losses provisions of section 117, Internal Revenue Code. The case involves a question of fact and the burden of proof is upon the petitioner to show that the Commissioner erred in his determination. 293 U.S. 507">Helvering v. Taylor, supra;290 U.S. 111">Welch v. Helvering, supra;281 U.S. 264">Lucas v. Kansas City Structural Steel Co., supra;275 U.S. 101">Wickwire v. Reinecke, supra;1943 Tax Ct. Memo LEXIS 359">364 Rule 32, Rules of Practice, before The Tax Court of the United States. The improvements were a part of the land at the time of sale to Sears Roebuck & Co. and no allocation was made or attempted to be made as between the value of the improvements and the value of the land by the parties to that transaction. The entire property was sold for a lump sum of $12,087.85. Petitioner's contention that $550 only should be allocated to the improvements because Sears Roebuck & Co., after the purchase, sold the improvements for that amount is untenable. The price for which Sears Roebuck & Co. sold the improvements, admittedly salvage, after the sale has but little if any weight in determining the relative value between the improvements and the land at time of sale. The improvements were not suitable to the purposes for which Sears Roebuck & Co. purchased the property, and had it given them away, petitioner's argument would lead to the absurd conclusion they were without value. The cases cited petitioner are not in point. Evidently, it was the improvements on the land that enabled petitioner to realize the favorable rentals received from the property while she owned it. In view of the rentals1943 Tax Ct. Memo LEXIS 359">*365 which they brought in, the improvements certainly had a value considerably more than what they could be sold for as salvage. G. Wildy Gibbs, 28 B.T.A. 18">28 B.T.A. 18. The respondent allocated to the improvements an appreciably smaller amount than would be arrived at by apportioning the sales price between the land and improvements upon the ratio of their respective bases, and the relative values placed thereon by the assessing authorities for local tax purposes as in J. S. Cullinan, 5 B.T.A. 996">5 B.T.A. 996. We conclude the evidence in the record is not sufficient to overcome respondent's determination. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621021/	GARNETT W. NEIL and DOROTHY M. NEIL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentNeil v. CommissionerDocket Nos. 16436-81, 29287-81.United States Tax CourtT.C. Memo 1982-562; 1982 Tax Ct. Memo LEXIS 196; 44 T.C.M. 1237; T.C.M. (RIA) 82562; September 23, 1982. Garnett W. and Dorothy M. Neil, pro se. Kevin M. Bagley, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined deficiencies in petitioners' income tax and additions to tax for the years and in the amounts as follows: Additions to TaxCalendarDeficiency inI.R.C. 1954YearIncome TaxSection 6653(a)1977$6,928$346.4019783,200160.001979 14,479224.001982 Tax Ct. Memo LEXIS 196">197 Some of the issues raised by the pleadings have been disposed of by the parties leaving for our decision the following: (1) whether petitioners are entitled to deduct the cost of a concrete block wall built on petitioners' rental property or are required to capitalize the cost of the wall and depreciate it and, if it is to be depreciated, over what number of years is it properly depreciable; (2) whether petitioners are entitled to include in their medical expense deduction the cost of vitamins which were prescribed for them by a physician; (3) whether petitioners are entitled to deductions they claimed as contributions to the Universal Life Church, Inc., in the amount of $19,328 in 1977 and $11,093 in 1978; (4) whether petitioners are entitled to deduct in 1978 either as a tax or a contribution an amount which they estimated was the extra cost of items of food which they contend sold at a premium because of being approved by the Council of Rabbis; and (5) whether petitioners are liable for the addition to tax under section 6653(a)2 for each of the years 1977 and 1978. 1982 Tax Ct. Memo LEXIS 196">198 FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioners, husband and wife, who resided in San Diego, California, at the time of the filing of the petitions in this case, filed joint Federal income tax returns for the calendar years 1977 and 1978. During 1977 and 1978, petitioners owned a piece of rental property. They had owned the property for some years and used it as rental property for approximately 20 years prior to the years here in issue. There had been a wooden wall on the property that kept it from eroding. In 1977, the wall was in total disrepair and petitioners commenced the building of a concrete block wall to replace the wooden wall. They paid a total of $2,177 for the wall of which $1,150 was paid in 1977 and $1,027 in 1978. The wall was completed in January 1978. The house on the rental property on which the wall was built was shown on the depreciation schedule of petitioners' 1977 tax return as having been acquired on May 21, 1958, at a cost of $6,500, and depreciation was taken on a straight-line basis and a useful life of 30 years. The wooden fence which had previously been on the property was made from redwood. 1982 Tax Ct. Memo LEXIS 196">199 It had been placed on the property in 1958 and had remained in good shape for approximately 10 years. After that, it had been in such poor condition that the property had begun to erode from the heavy rains that occurred at certain times of the year. The property on which the fence was placed was located about one block from an earthquake fault line and there was earthquake activity, although the quakes were minor, affecting the property from time to time. This earthquake activity had a tendency to break up or crack a concrete block fence. Also, there is a considerable amount of flooding in the area in which the property is located and the flooding tends to settle the foundation of a concrete block wall and make it more susceptible to cracking at the time of earthquakes. During the years here in issue, Mr. Neil suffered from a heart condition and Mrs. Neil suffered from arterial sclerosis. During the years here in issue and for some years prior thereto, Mr. and Mrs. Neil consulted regularly with H. Rudolph Alsleben, M.D. Dr. Alsleben was interested in the Alsleben-Shute Foundation for Nutritional Research of Anaheim, California. He advised both Mr. and Mrs. Neil that massive1982 Tax Ct. Memo LEXIS 196">200 doses of vitamins would alleviate their medical problems. He prescribed large doses of various vitamins including B-complex vitamins, calcium, protein vitamins, vitamins C, E, and other types of vitamins for Mrs. Neil and similar type vitamins for Mr. Neil as well as A/G Pro and Enzaid vitamins for Mr. Neil. Petitioners purchased and consumed these vitamins in accordance with Dr. Alsleben's prescriptions. During 1977, the total cost of the vitamins purchased and consumed by petitioners pursuant to Dr. Alsleben's prescriptions was $1,023. The total cost of the vitamins purchased and consumed by petitioners during 1978 under the instructions and prescriptions of Dr. Alsleben was $1,718. Sometime prior to January 1, 1977, Mr. Neil contacted representatives of the Universal Life Church, Inc., Modesto, California, with respect to obtaining a charter for a church and congregation and his credentials as a minister. Under date of January 1, 1977, Mr. Neil was sent a document headed at the top "Universal Life Church, Inc." and underneath that heading, "Charter." The document stated that "GARNETT W. NEIL ULC, INC., DEL MONTE CONGREGATION" of San Diego, California, had been granted1982 Tax Ct. Memo LEXIS 196">201 a charter by Universal Life Church, Inc., Modesto, California. He was also sent a document headed "Universal Life Church, Inc.," Modesto, California, "Credentials" which stated that "This is to certify that * * GARNETT W. NEIL * * * has been ordained by Universal Life Church * * * [on] Jan. 1, 1977" and a document headed "Universal Life Church, Inc.," Modesto, California, "CONGREGATION" which stated that "This is to certify that a Congregation of the Universal Life Church, Inc. is started * * * [on] JANUARY 1, 1977 at 5019 DEL MONTE AVENUE * * * SAN DIEGO * * * CALIFORNIA." The address 5019 Del Monte Avenue was the residence of petitioners. Attached to the document sent to Mr. Neil by the Universal Life Church, Inc., Modesto, California, entitled "CHARTER" was a document entitled "Charter Agreement" which provided that the congregation at 5019 Del Monte Avenue, San Diego, California, "will report quarterly to International Headquarters." This document stated that the report would include, among other things, income, disbursements, and balance of the treasury of the church. On four different occasions during 1977, Mr. Neil gave cash to Mrs. Neil to1982 Tax Ct. Memo LEXIS 196">202 put in a safe in their home. Three of the amounts of cash were $5,000 each, and the other amount was $4,328. In 1978, on four different occasions, Mr. Neil gave Mrs. Neil cash to put in the safe in their home and the total of the cash given to Mrs. Neil in 1978 was $11,093. Mrs. Neil had the combination to this safe and she was the individual who could open the safe and take out the cash in it as she saw fit. Mr. Neil, in the quarterly reports he made to the Universal Life Church, Inc., would record the money he had given to Mrs. Neil to put in the safe as contributions to his congregation. At the time of the trial of this case, the cash Mrs. Neil had put into the safe was still in the safe and it was her intent, when her husband retired from the work he was doing during 1977 and 1978, that she and Mr. Neil would begin to use some of the money as salary for him to do full-time work as a minister and for enlarging their home or building a new home which they considered to be a church building. Mr. and Mrs. Neil bought their groceries and related items from a supermarket. They read an article which stated that where a can or package in a supermarket was marked with a "K" or a1982 Tax Ct. Memo LEXIS 196">203 "U," it meant that the item was acceptable as Kosher food. Mr. Neil was of the opinion that, when a can or box had a "K" or "U" on it, the price was greater than it would have been if the food were not approved by the Council of Rabbis as Kosher food. In buying the food, he had no intention to make a contribution to any religious organization but it was his view that in shopping at a supermarket he had no choice except to buy food which was higher priced because of having been approved as Kosher food. Petitioners, on their Federal income tax return for 1977, claimed a deduction of $1,150 for a replacement fence. On their Federal income tax return for the calendar year 1978, they claimed a deduction of $1,027 as fence replacement. Petitioners on their 1977 Federal income tax return claimed total medical expenses of $4,189 which they reduced by $1,160 as 3 percent of their adjusted gross income leaving an amount of $3,029 to which they added $150 of hospital insurance premiums making a total of $3,179 that they claimed as deductible. On their 1978 Federal income tax return, petitioners claimed total medical expenses of $2,406 which they reduced by $677 or 3 percent of their adjusted1982 Tax Ct. Memo LEXIS 196">204 gross income leaving $1,729 to which they added $150 as hospital insurance premiums making a total claimed deduction of $1,879. Petitioners on their 1977 Federal income tax return claimed a charitable contribution deduction of $19,328 to the Universal Life Church, Inc., and on their 1978 return claimed a deduction of $11,093 as a contribution to the Universal Life Church, Inc. These amounts represented the amounts of cash which Mr. Neil had given Mrs. Neil to put in the safe in their home. Petitioners on their 1978 Federal income tax return claimed a deduction for $200 under the designation "Kosher Food Tax." Respondent in his notice of deficiency to petitioners determined that the fence replacement which petitioners made on rental property was a capital improvement and that no deduction was allowable for the fence replacement in 1977, and in 1978 only a $73 depreciation deduction was allowable. The $73 amount was arrived at by using a 30-year useful life for the fence. Respondent in his notice of deficiency to petitioners for the year 1977 determined that petitioners had verified $3,222 of medical expenses rather than $4,189. Respondent redetermined the medical expense deduction1982 Tax Ct. Memo LEXIS 196">205 to which petitioners were entitled in 1977 by computing 3 percent of corrected adjusted gross income which was subtracted from $3,222. The item considered unverified by respondent in recomputing petitioners' medical expenses for 1977 was the $1,023 paid by petitioners for vitamins. 3 Respondent determined that petitioners' medical expenses for the year 1978 should be disallowed to the extent of $1,699 which included unsubstantiated medical expenses and "disallowance of vitamins." Respondent in the year 1977 disallowed petitioners' claimed charitable contribution to the Universal Life Church, Inc., of $19,328 and for the year 1978 disallowed petitioners' claimed contribution to the Universal Life Church, Inc., of $11,093. 1982 Tax Ct. Memo LEXIS 196">206 Respondent in his notice of deficiency to petitioners for the year 1978 also disallowed the $200 claimed by petitioners to be deductible as "Kosher Food Tax." OPINION Section 263 provides generally that no deduction shall be allowed for any amount paid out for permanent improvements or betterments made to increase the value of the property. 4Clearly the fence placed by petitioners on their rental property was an improvement or betterment made to increase the value of the property. For this reason, respondent properly disallowed the deductions claimed by petitioners for the amounts expended in the building of the fence in 1977 and 1978. However, both parties agree that the fence was completed in January 1978 and that for the year 1978 petitioners are entitled to deduct depreciation on the fence1982 Tax Ct. Memo LEXIS 196">207 based on its useful life. The total cost of the fence is not in issue. Respondent offered the testimony of the revenue agent who determined a 30-year useful life for the fence. This agent testified that he never saw the fence. In his opinion, a 30-year useful life was too long and normally he would have used a 20-year useful life for this type of fence. He stated that he had asked Mr. Neil about the fence and Mr. Neil had said he had built it so well it should last forever and that he replied that he could not depreciate it on a basis of forever and Mr. Neil said that maybe the fence would last 30 years. Mr. Neil testified that he did not deny that he may have said to the revenue agent that the fence would last forever or for 30 years but that he was not thinking in terms of its being useful for the purpose for which he placed it on the property when he made the statement. Mr. Neil stated that he was an engineer and that in his opinion, considering the breakage caused by even small earthquakes in concrete block fences and the need for the fence to remain unbroken and uncracked to serve its purpose, the fence would have a useful life for the purpose for which it was installed of1982 Tax Ct. Memo LEXIS 196">208 approximately 15 years. The record is certainly not as clear as it might be as to the economic useful life of the concrete block fence. However, considering the length of time the wooden fence remained in good condition, the age of the house on the property on which the fence was placed, and Mr. Neil's testimony as to his opinion of the useful life of the fence as well as the agent's testimony that in his opinion a 30-year useful life was too long, we have concluded that the preponderance of the evidence here is that the useful life of the fence is 15 years. Therefore, depreciation to be deducted by petitioners in the year 1978 should be based on the total cost of the fence and a useful life of the fence of 15 years. The record is not completely clear with respect to respondent's reason for disallowing the deduction claimed by petitioners as a part of medical expenses for vitamins that they purchased pursuant to the direction of their doctor. Respondent in a memorandum filed with the Court points out that Rev. Rul. 55-261, 1955-1 C.B. 307, 312, states that-- if the prescribed1982 Tax Ct. Memo LEXIS 196">209 food or beverage is taken solely for the alleviation or treatment of an illness, is in no way a part of the nutritional needs of the patient, and a statement as to the particular facts and to the food or beverage prescribed is submitted by a physician, the cost of such food or beverage may be deducted as a medical expense. * * * The particular circumstance being considered in Rev. Rul. 55-261 was whiskey prescribed by a physician for the relief of angina pain and the cost of special food prescribed by a physician for a taxpayer who is on an ulcer diet. The record here shows that petitioners' doctor prescribed the vitamins they took for Mr. Neil's heart condition and Mrs. Neil's arterial sclerosis. Although the testimony on the subject is not stated in precise words, the indication from the record is that the vitamins were not a substitute for food or beverage which would normally be consumed by a person to satisfy his nutritional requirements. Respondent pointed out that the doctor who prescribed the vitamins for Mr. and Mrs. Neil was interested in nutritional research and that some of the same vitamins were prescribed for both Mr. and Mrs. Neil. In effect, respondent1982 Tax Ct. Memo LEXIS 196">210 is suggesting that perhaps the doctor's advice to Mr. and Mrs. Neil was not professionally sound. Mr. Neil was firm in his belief that the vitamins prescribed for him by Dr. Alsleben had proved to be helpful to his heart condition and that the vitamins prescribed for Mrs. Neil had been helpful to her arterial sclerosis. Considering the evidence as a whole, we conclude that the cost of the vitamins purchased by petitioners pursuant to the prescriptions of Dr. Alsleben in each of the years here in issue is properly to be included in the medical expenses of petitioners in determining the amount of medical expense deduction to which petitioners are entitled. 5 Here, an M.D. prescribed the vitamins for petitioners as a cure, mitigation, or prevention of disease and therefore these vitamins fall within the definition of medical expenses. See Randolph v. Commissioner,67 T.C. 481">67 T.C. 481 (1976). 1982 Tax Ct. Memo LEXIS 196">211 Section 170(c) provides that the term "charitable contribution" means a contribution of gift to or for the use of a corporation or foundation created or organized exclusively for religious, charitable, scientific, literary, or educational purposes no part of the net earnings of which inures to the benefit of any private shareholder or individual. 61982 Tax Ct. Memo LEXIS 196">212 Since petitioners are claiming a charitable deduction, the burden is on them to show that they made contributions which meet the standards specified in section 170(c). Petitioners have totally failed to show that the amounts they put in their safe met the requirements of section 170(c) for a charitable deduction. Petitioners, claiming their First Amendment rights, refused to testify with respect to any aspect of their so-called church or congregation. Because of this refusal, they have totally failed to meet the requirement that they show that a contribution was made to an organization operated exclusively for religious or charitable purposes. Further, it is clear that petitioners actually made no contribution to any organization of the funds put in the safe by Mrs. Neil during the years 1977 and 1978. The most that has been shown is that at some juncture or some time in the future they intended to use this cash to make a contribution. However, in attempting to prove this fact, petitioners showed that in the future when the money was to be used they expected it to be used to pay Mr. Neil's salary and perhaps to make improvements to petitioners' home. Both of these uses would1982 Tax Ct. Memo LEXIS 196">213 be for the benefit of petitioners. It is so clear here that petitioners never in the years here in issue placed any funds beyond their control into the control of any organization, we do not deem it necessary to go into further detail in stating that petitioners have totally failed to carry their burden of proof that they made any contributions to the Universal Life Church, Inc., which are properly deductible in the years here in issue. See Oakknoll v. Commissioner,69 T.C. 770">69 T.C. 770 (1978). In this case, when petitioners refused to answer any questions asked them by respondent's counsel as to the nature of the activities of their church and its membership claiming their First Amendment rights, the Court informed them that it was necessary for them to establish that any funds they had contributed were to an organization operated exclusively for charitable and religious purposes. The Court further informed them that although the First Amendment protected their religious freedom, this protection did not extend to allowing them to take a charitable deduction with no explanation of the nature of the organization to which the contribution was made.On their return, they claimed1982 Tax Ct. Memo LEXIS 196">214 a contribution was made to the Universal Life Church, Inc. However, from the testimony, it was obvious that no funds were given by petitioners to the Universal Life Church, Inc., Modesto, California, and that petitioners' only contention was that the funds were given to the church "chartered" by Mr. Neil as the "Del Monte Congregation." The record is devoid of any evidence about the "Del Monte Congregation" except that the only members were Mr. and Mrs. Neil and their son and that Mrs. Neil referred to the home where she and Mr. Neil lived as the "church building." Petitioners refused to answer any other question about the organization. As was pointed out in United States v. Holmes,614 F.2d 985">614 F.2d 985, 614 F.2d 985">989-990 (5th Cir. 1980)-- Plaintiff is free to espouse his religious doctrine and to solicit support for his cause. He simply must allow the government access to information in order to determine whether the church remains within the criteria for a lighter tax burden. The church may, of course, forego the exemption and limit IRS access to church records. [Fn. ref. omitted.] Petitioners in this case refused to furnish any information about their church activities1982 Tax Ct. Memo LEXIS 196">215 to respondent or to the Court. We conclude that petitioners have totally failed to establish that they are entitled to the deductions of $19,328 in 1977 and $11,093 in 1978 which they claimed as contributions to the Universal Life Church, Inc.The record is totally devoid of any evidence to substantiate petitioners' claimed deduction of $200 for "Kosher Food Tax" either as a tax or as a charitable contribution. Petitioners totally failed to show that any food they bought was "Kosher" food and, if it were, that it cost any more than any other food would have cost. What the record shows is that petitioners read some article that stated that certain foods marked in a certain manner were Kosher foods and for this reason cost more than other foods because they had been approved by the Council of Rabbis. Petitioners did not know whether or not this article was accurate. No evidence was received that any foods purchased by petitioners were Kosher foods since petitioners had no competent evidence of this fact to offer. We therefore sustain respondent in his disallowance of the $200 deduction claimed by petitioners as "Kosher Food Tax" because of petitioners' total failure of proof. 1982 Tax Ct. Memo LEXIS 196">216 When respondent determines an addition to tax under section 6653(a), the burden is on the taxpayer to show that no part of the deficiency was due to their negligence. Enoch v. Commissioner,57 T.C. 781">57 T.C. 781, 57 T.C. 781">802 (1972), and cases there cited. Petitioners offered no satisfactory evidence to explain the reasons for a number of the errors in their returns. Because of petitioners' failure of proof, we sustain respondent's determination of the additions to tax under section 6653(a). Decision will be entered under Rule 155.Footnotes1. Petitioners' tax liability for the year 1979 was disposed of entirely by agreement of the parties.↩2. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the years here in issue.↩3. Obviously the $1,023 plus the $3,222 considered as verified does not total $4,189. The addition is not correct if the $150 of claimed hospital insurance premiums is added into the amount. However, the parties at the trial agreed that the amount which was stated in the notice of deficiency not to be verified as paid for qualifying medical expenses consisted of the amounts petitioners paid for vitamins and that the amount they paid in 1977 was $1,023.↩4. Sec. 263(a) provides in part as follows: SEC. 263. CAPITAL EXPENDITURES. (a) General Rule.--No deduction shall be allowed for-- (1) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate. * ↩5. In Hammons v. Commissioner, a Memorandum Opinion of this Court entered Nov. 24, 1953, we held that an amount paid by a taxpayer for vitamins was properly a part of deductible medical expenses. In Sampson v. Commissioner,T.C. Memo. 1970-212, we stated: After carefully evaluating his testimony, we remain unconvinced that petitioners expended any amounts for medical expenses and charitable contributions other than $173.04 for doctors, hospital service, and the like and possibly $60.00 for vitamins. n2 Neither of these amounts is sufficient to entitle petitioners to any deduction. Footnote 2 stated: We express no opinion as to whether vitamins purchased without a doctor's prescription constitute medical expenses. Cf. Marshall J. Hammons [Dec. 19, 998(M)], a Memorandum Opinion of this Court dated Nov. 24, 1953; Rev. Rul. 55-261, 1955-1 C.B. 307. Cf. Lingham v. Commissioner,T.C. Memo. 1977-152, in which we stated: Petitioner claimed sizeable medical deductions for vitamins and food. She prescribes the dosages of vitamins for herself and claims to limit her diet to organic foods. Vitamins consumed pursuant to a self-imposed plan are not deductible as medical costs. * *↩6. Sec. 170(c) provides in part as follows: (c) Charitable Contribution Defined.--For purposes of this section, the term "charitable contribution" means a contribution or gift to or for the use of-- (2) A corporation, trust, or community chest, fund, or foundation-- (A) created or organized in the United States or in any possession thereor, or under the law of the United States, any State, the District of Columbia, or any possession of the United States; (B) organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provisions of athletic facilities or equipment), or for the prevention or cruelty to children or animals; (C) no part of the net earnings of which inures to the benefit of any private shareholder or individual; and A contribution or gift by a corporation to a trust, chest, fund, or foundation shall be deductible by reason of this paragraph only if it is to be used within the United States or any of its possessions exclusively for purposes specified in subparagraph (B).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621022/	LINDLEY R. POTEET and PATRICIA R. POTEET, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentPoteet v. CommissionerDocket No. 317-78.United States Tax CourtT.C. Memo 1979-123; 1979 Tax Ct. Memo LEXIS 400; 38 T.C.M. 562; T.C.M. (RIA) 79123; April 4, 1979, Filed Lindley R. Poteet and Patricia R. Poteet, pro se. James M. Eastman, for the respondent. QUEALYMEMORANDUM FINDINGS OF FACT AND OPINION QUEALY, Judge: Respondent determined a deficiency of $390 in the joint Federal income tax return of petitioners for the taxable year 1975. The sole issue presented for our decision is whether petitioners are liable for the tax imposed on self-employment income under the provisions of sections 1401 and 1402. 11979 Tax Ct. Memo LEXIS 400">401 FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Petitioners Lindley R. and Patricia R. Poteet, husband and wife, filed a joint Federal income tax return for the taxable year 1975. At the time of the filing of the petition herein, petitioners resided in Mission Viejo, California. 2Petitioner's Internal Revenue Service Forms W-2 for the taxable year 1975 indicated that he earned wages of $6,181.50 while employed by R. M. Engineering Company and American Business Service Corporation. Petitioner also worked as a free-lance mechanical designer for Baker Filtration, Inc., during 1975, thus receiving net earnings for self-employment in the amount of $5,926. Petitioner paid no self-employment tax during the taxable year 1975. Petitioner does not claim to be exempt from the self-employment tax, under section 1402(h). In the notice of deficiency to petitioner for the taxable year 1975, respondent1979 Tax Ct. Memo LEXIS 400">402 determined a deficiency of $390 in petitioner's income tax based upon the petitioner's liability for the self-employment tax. 3OPINION Petitioner earned net self-employment income of $5,926 in the taxable year 1975 and paid no self-employment tax on this income. Petitioner claimed no exemption from the tax under section 1402(h). The sole issue for decision is whether sections 1401 and 1402 are constitutional. Petitioner contends that the self-employment tax is unconstitutional because some persons are exempt from the provisions of sections 1401 and 1402. Petitioner also asserts that the self-employment tax violates his constitutional right of providing for his own retirement plan. The courts have previously upheld the constitutionality of these statutes and the exemptions1979 Tax Ct. Memo LEXIS 400">*403 included therein. ; ; ; ; ; ; . Sections 1401 and 1402 are in keeping with the acknowledged authority of Congress to provide for the overall public welfare through the Social Security Act. ; ; , cert. denied, . Petitioner is liable for the payment of the tax on his income from self-employment. Decision will be entered for the respondent.Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended.↩2. Patricia R. Poteet is a petitioner herein only by virtue of having filed a joint return with her husband, Lindley R. Poteet, for the year in question.↩3. Respondent determined that petitioner was liable for self-employment tax in the amount of $468 on net self-employment income of $5,926. The deficiency at issue is only $390 because respondent also determined that petitioner was entitled to additional transportation and home-office expense deductions in the respective amounts of $330 and $68 and an additional medical expense deduction of $14.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621025/	Lewis F. Jacobson, Petitioner, v. Commissioner of Internal Revenue, RespondentJacobson v. CommissionerDocket No. 4189United States Tax Court6 T.C. 1048; 1946 U.S. Tax Ct. LEXIS 193; May 10, 1946, Promulgated 1946 U.S. Tax Ct. LEXIS 193">193 Decision will be entered under Rule 50. 1. Petitioner is the owner in Chicago, Illinois, of a leasehold and buildings thereon. In 1925 petitioner borrowed $ 90,000 on the property and executed his negotiable bonds therefor. Some of the bonds have been paid off and retired from time to time and the interest has at all times been paid. On January 1, 1938, $ 51,750 of such bonds was still outstanding. In the years 1938, 1939, and 1940 petitioner acquired some of these bonds at less than their face value. Some of them were acquired by petitioner directly from the bondholders themselves after negotiations with them. Some were acquired by purchases through the secretary of a bondholders' committee and through security houses. Held that, as to the bonds acquired by petitioner through direct negotiations with the bondholders, he is not taxable on the gain therefrom under the doctrine of Helvering v. American Dental Co., 318 U.S. 322">318 U.S. 322; held, further, that petitioner is taxable on the gain realized in the purchases from bondholders through the secretary of the bondholders' committee and the security dealers, under the doctrine of the Supreme1946 U.S. Tax Ct. LEXIS 193">194 Court in United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1, he being at all times solvent.2. On the evidence, held, petitioner is entitled to a deduction in each of the taxable years 1939 and 1940 for $ 750 expended in entertaining clients in the course of his law business and paying for meals for employees for which he was not reimbursed by his law firm.3. On the evidence, held, the expenses of operating petitioner's automobile in 1939 and 1940 were incurred one-half for petitioner's personal use and the use of his family, which expenses are not deductible, and one-half in its use for business purposes, which expenses are deductible. Sidney C. Nierman, Esq., for the petitioner.David F. Long, Esq., for the respondent. Black, Judge. Smith, J., dissents. Kern, J., dissenting. 1946 U.S. Tax Ct. LEXIS 193">195 Turner, Leech, Arnold, and Harlan, JJ., agree with this dissent. BLACK 6 T.C. 1048">1048 The Commissioner has determined deficiencies in petitioner's income tax for the years 1938, 1939, and 1940, respectively, of $ 842.99, $ 708.19, 6 T.C. 1048">1049 and $ 2,416.79. The petitioner contests parts of these deficiencies by the following assignments of error:(a) The Commissioner erred in failing to allow automobile and entertainment expenses in connection with his practice of law, aggregating $ 597.97 for 1938, $ 793.34 for 1939 and $ 750.55 for 1940.(b) The Commissioner erred in holding that the acquisition by the petitioner of his mortgage obligations, at a price lower than the face value thereof during each of the years in question, represented taxable income to the petitioner during any of said years.(c) The Commissioner erred in failing to hold that the holders of the bonds, being creditors of the petitioner, gratuitously and because of debtor's straitened circumstances, diminishing security and other facts, accepted from petitioner an amount less than the face value thereof.(d) The Commissioner erred in failing to hold that the payment for said bonds at an amount less than the face1946 U.S. Tax Ct. LEXIS 193">196 value thereof did not create any taxable income to the petitioner.At the hearing petitioner abandoned his assignment of error as to the $ 597.97 automobile and entertainment expenses disallowed by the Commissioner for the year 1938. He continues to press his assignment of error as to the disallowance by the Commissioner of such expenses of $ 793.34 for 1939 and $ 750.55 for 1940. Several adjustments made by the Commissioner in his deficiency notice were not contested in the petition.FINDINGS OF FACT.The petitioner is an individual who resides in Chicago, Illinois. He filed his income tax returns with the collector of internal revenue for the first district of Illinois.In June 1922 petitioner purchased a half interest in the building located at the northwest corner of 47th Street and Drexel Boulevard, Chicago, Illinois, and leasehold running for 99 years from May 1, 1914, and in March 1923, he purchased the remaining half interest therein. In December 1925 a substantial addition was made to the building. The total cost to the petitioner of the leasehold and improvements and the addition was $ 116,580.56. When the petitioner became the owner of all the interest in the above1946 U.S. Tax Ct. LEXIS 193">197 leasehold and building, he allocated, for the purpose of depreciation, $ 76,580.56 to the building and $ 40,000 to the leasehold.On or about May 1, 1925, petitioner borrowed the sum of $ 90,000 from the South Side Trust & Savings Bank, and petitioner and his wife executed 200 bonds secured by a mortgage trust deed on the leasehold and building to evidence and secure the payment of the loan. The proceeds of the loan were used to pay off the existing encumbrance on the property, to pay for an addition to the building which cost $ 16,250, and to pay the necessary brokerage commission and expenses in connection with the loan, leaving a small surplus over and above the several items above enumerated, which was paid to the petitioner.6 T.C. 1048">1050 The bonds were payable at the rate of $ 2,500 semiannually to and including November 1, 1931, and the balance of $ 57,500 on May 1, 1932, with interest at 6 1/2 percent per annum. All of the bonds which became due up to and including November 1, 1931, were paid at or about their respective maturity dates.On June 8, 1931, the South Side Trust & Savings Bank failed to open its doors.A bondholders' committee was formed for the bondholders who 1946 U.S. Tax Ct. LEXIS 193">198 had purchased bonds on petitioner's building. On May 1, 1932, petitioner applied to the bondholders' committee and the bondholders themselves for an extension of the time of payment of this loan. He communicated with the individual bondholders, as well as the committee, and procured an extension to May 1, 1937, for the payment of the principal of the bonds. At no time did petitioner default in the payment of interest on the bonds.During this extended period checks for interest were issued by petitioner directly to the holders of the bonds and were delivered to them by R. W. Gerding, secretary of the committee. Bondholders frequently visited the petitioner at his office in connection with the collection of their interest and to find out the status of the property. Petitioner kept a list of the bondholders, the dates of payment of their interest, the numbers of their bonds, and their addresses, and he was fully informed as to who his creditors on this bond issue were and where they were, and they were kept informed, from time to time, as to petitioner's general financial condition.In 1937 petitioner again procured an extension of time for the payment of the bonds to 1942, and 1946 U.S. Tax Ct. LEXIS 193">199 in that connection he paid 10 percent on account of the principal of the bonds, leaving an unpaid balance of $ 51,750 as of January 1, 1938.On April 9, 1938, petitioner purchased $ 450 of bonds from Beatrice Johnson and Margaret Finn, owners thereof, and paid therefor $ 202.50. The checks of Sidney C. Nierman (a partner of the petitioner, whose office was the same as petitioner's) were issued to the owners of the bonds with an endorsement that they were in full payment of the purchase price of said bonds. Petitioner reimbursed Sidney C. Nierman for this payment, as Nierman was acting for petitioner in the transaction and the owners of the bonds knew that he was.On June 9, 1938, petitioner purchased $ 3,600 of bonds from Beatrice Johnson and Margaret Finn, owners thereof, under the same circumstances as shown in the foregoing paragraph, and paid $ 1,620 therefor.On August 17, 1938, petitioner purchased $ 900 of bonds from Beatrice Johnson, owner thereof, under the same circumstances as shown in the foregoing paragraphs and paid $ 405 therefor.Summarizing the transactions in 1938, the total unpaid principal amount of the bonds purchased by petitioner during 1938 was the 6 T.C. 1048">1051 1946 U.S. Tax Ct. LEXIS 193">200 sum of $ 4,950 and the amount paid therefor was $ 2,227.50, or a difference of $ 2,722.50.In 1938 petitioner purchased bonds from Dr. Kemp in the unpaid principal sum of $ 900 for $ 957. The Commissioner (by evident mistake) included the sum of $ 43 as income in connection with this Kemp purchase on the assumption that the unpaid amount of the bonds was $ 1,000 instead of $ 900, and on that assumption included in income for the year 1938 the sum of $ 2,767.50, instead of $ 2,722.50 shown above.On February 15, 1939, petitioner purchased $ 1,800 of bonds owned by H. N. Samuels through McGraw & Co., who were representing Samuels in the transaction, and paid $ 900 therefor.On June 16, 1939, petitioner purchased $ 450 of bonds directly from Dolly Stoecker, the owner thereof, and paid $ 225 therefor.On October 23, 1939, petitioner purchased $ 180 of bonds of which Ernest Zentner was the owner, at the price of $ 86.50. The purchase was made through the brokerage firm of Anderson, Plotz & Co. Petitioner paid the firm a fee of $ 10 for making the purchase.Summarizing the transactions of 1939, the total unpaid principal amount of bonds purchased by the petitioner was the sum of $ 2,4301946 U.S. Tax Ct. LEXIS 193">201 and the amount paid therefor was the sum of $ 1,211.50, or a difference of $ 1,218.50.On April 4, 1940, petitioner purchased through R. W. Gerding, secretary of the bondholders' committee, $ 270 of bonds of which Jens Hendrickson was the owner, and paid therefor the sum of $ 130. A fee of $ 7.50 was paid by petitioner to Gerding for making the purchase.On May 21, 1940, petitioner purchased $ 450 of bonds of which Garnet Grayson was the owner and paid the sum of $ 210. The transaction was handled by R. W. Gerding, secretary of the bondholders' committee and a service charge of $ 7.50 was paid to Gerding for his services.On May 23, 1940, petitioner purchased $ 2,700 of bonds of which Edna Mary Griffin was the owner and paid the sum of $ 1,080. The transaction was handled by R. W. Gerding, secretary of the bondholders' committee and a service charge of $ 27 was paid to Gerding for his services.On June 19, 1940, petitioner purchased $ 1,800 of bonds of which Mary Melody was the owner and paid the sum of $ 720. The transaction was handled by R. W. Gerding, secretary of the bondholders' committee and a service charge of $ 18 was paid him for his services.On July 1, 1940, petitioner1946 U.S. Tax Ct. LEXIS 193">202 purchased $ 450 of bonds of which William Verhey was the owner and paid the sum of $ 200. The bonds were purchased through Anderson, Plotz & Co. The $ 200 which petitioner paid for these bonds included a fee of $ 15 to Anderson, Plotz & Co. for their services.On July 3, 1940, petitioner purchased $ 450 of bonds of which John F. Sullivan was the owner and paid the sum of $ 200. The purchase 6 T.C. 1048">1052 was made through Anderson, Plotz & Co. and the purchase price of $ 200 included a fee of $ 25 to Anderson, Plotz & Co. for their services.On July 10, 1940, petitioner purchased $ 450 of bonds of which Edward Foley was the owner and paid the sum of $ 184.50. The purchase was made through Anderson, Plotz & Co. Petitioner paid a fee of $ 4.50 to Anderson, Plotz & Co. for making the purchase.On September 23, 1940, petitioner purchased $ 450 of bonds of which Edward Foley was the owner and paid the sum of $ 185. The purchase was made through Anderson, Plotz & Co. and petitioner paid that firm a fee of $ 5 for making the purchase.Summarizing the transactions in 1940, the total unpaid principal amount of the bonds purchased during 1940 by petitioner was the sum of $ 7,020 and the amount1946 U.S. Tax Ct. LEXIS 193">203 paid therefor was the sum of $ 2,950, or a difference of $ 4,065.There was never any listing of the bonds or a quoted price. Nobody was buying these bonds except petitioner.The gross income from the real estate located at 47th Street and Drexel Boulevard, Chicago, Illinois, in 1926 was $ 34,105.61 and the net income was $ 15,335.81. The gross income and net income from the property depreciated from year to year from 1926 through 1940, so that in 1938, 1939, and 1940 the income was as follows:193819391940Gross income$ 16,550.00$ 16,520.75$ 15,578.50Net income1,233.951,107.111,719.41The above amounts of net income were after deduction of expenses, depreciation, and interest on the bonds.The fair market value of this leasehold and buildings for the year 1938 was the sum of $ 80,000. It was the same in 1939 and 1940, less depreciation on the buildings which accrued subsequent to January 1, 1938. At all times during the years 1938, 1939, and 1940 the value of the buildings and leasehold exceeded the bonded indebtedness against the property.In addition to the rental income from the above mentioned leasehold and buildings, petitioner had gross income1946 U.S. Tax Ct. LEXIS 193">204 during the years 1938, 1939, and 1940, as follows:From ChicagoYearFromInterestDividendsTitle &TotalpartnershipTrust Co.1938$ 35,613.41$ 812.50$ 1,964.94$ 38,390.85193932,686.90863.382,094.5035,644.78194026,900.11819.784,672.20$ 2,887.5035,279.59Total95,200.422,495.668,731.642,887.50109,315.226 T.C. 1048">1053 Petitioner owned considerable other property in Chicago outside of the leasehold and buildings here in question. The details of this other property which petitioner owned in the taxable years are in the record, but it is deemed unnecessary to set forth further details as to such property here. On the strength of the showing of petitioner's assets and liabilities, we find petitioner was solvent during each of the taxable years 1938, 1939, and 1940.Entertainment Expenses for Clients, etc.In each of the years 1939 and 1940 petitioner was a partner of the firm of Jacobson, Nierman & Silbert, attorneys at law. Petitioner received from this firm for each of these years the aggregate sum of $ 2,850 in cash, which was charged to his account on the firm's books. Petitioner used these cash sums1946 U.S. Tax Ct. LEXIS 193">205 withdrawn from his firm for his own day-to-day personal expenses and for expenses in connection with the business of petitioner for the payment of lunch and supper for employees of his law firm and for the entertainment of clients. Petitioner expended at least $ 750 in each of the taxable years 1939 and 1940 in the entertainment of employees and clients and was not reimbursed therefor by the firm or by the clients. He kept no itemized account of these expenditures.All of petitioner's household, living and family expenses and major personal expenses were paid by checks of petitioner and are not here involved.The gross income of the firm, of which petitioner produced most of the business during each of these years, was between $ 75,000 and $ 80,000.Automobile Expenses.In 1939 petitioner expended for operating his automobile the sum of $ 1,030.04 and in 1940 the sum of $ 1,051.66, and he deducted in his returns two-thirds of that expense as business expense. The Commissioner in his determination of the deficiencies allowed only one-third of these deductions. One-half of these automobile expenses was incurred in the personal use of the automobile by petitioner and his family. 1946 U.S. Tax Ct. LEXIS 193">206 One-half of such expenses was incurred by petitioner in the use of the automobile for business purposes for his law firm in making trips to see clients, to interview witnesses, and other similar uses. Petitioner received no reimbursement from his law firm or his clients for these expenditures.OPINION.The main issue in this proceeding, which is common to all three of the taxable years, is whether petitioner is taxable on the difference between the face value of certain bonds upon which 6 T.C. 1048">1054 he was liable as the issuer and the price for which he purchased some of these bonds during each of the taxable years. The facts as to the amounts of such bonds purchased and the price which was paid for them are not in dispute. The controversy between the parties concerns itself only with the manner, form, and effect of the purchases.It is respondent's contention that it is a case controlled by , and petitioner is taxable on all the gain realized. On the other hand, petitioner contends that the bonds were all purchased under such circumstances and arrangements with the creditors as to bring the case within1946 U.S. Tax Ct. LEXIS 193">207 Supreme Court's decision in , a later case than Kirby Lumber Co. We have endeavored to set out in our findings of fact a full statement of the facts and circumstances connected with each purchase in each of the taxable years. We shall not repeat those facts here. Suffice it to say the facts show that some of the bonds were acquired by petitioner through direct conferences and negotiations between him and the bondholders, with whom he was acquainted. These conferences were either between petitioner and the bondholders personally or between petitioner's half-brother and law partner, Sidney Nierman, representing petitioner, and the bondholder. As to these purchases, we hold that the doctrine of the American Dental Co. decision applies and petitioner is not taxable on that part of the gain which the Commissioner has determined.The facts also show that petitioner acquired a number of the outstanding bonds through R. W. Gerding, secretary of a bondholders' committee, and through two security houses in Chicago and paid commissions on such purchases. As to those bonds, we think the situation is1946 U.S. Tax Ct. LEXIS 193">208 analogous to that in , where the taxpayer acquired certain of its debentures at discount figures on the open market. As to such purchases, we held that the doctrine of American Dental Co. did not apply.It is petitioner's contention in the instant case that there was no open market for the sale of his bonds. It is true that there was no open market for the bonds in the sense that they were bought and sold on any securities exchange or in an over-the-counter market. However, the manner in which petitioner acquired a number of his bonds through R. W. Gerding, secretary of the bondholders' committee, and through the security dealers, Anderson, Plotz & Co., and through McGraw & Co., bears close resemblance to purchase in the open market, if, indeed, it does not properly fall within that classification. As to these purchases, the personal element we think necessary to make a gift within the meaning of the American Dental Co. case was absent.6 T.C. 1048">1055 As an example of what we mean by the above statement, one of the transactions involved in the instant case was the purchase by petitioner, through1946 U.S. Tax Ct. LEXIS 193">209 R. W. Gerding, secretary of the bondholders' committee, of $ 2,700 face value of bonds owned by Edna Mary Griffin at 40 cents on the dollar, amounting to $ 1,080. Petitioner paid Gerding $ 27 for making this purchase in his behalf and claims that we should not recognize the gain to him, under the doctrine of the American Dental Co. case, supra. With reference to this transaction, George D. Griffin, husband of Edna Mary Griffin, testified on behalf of respondent. His testimony in substance was that he had practiced medicine in Chicago, Illinois, for 37 years; that he had custody of his wife's bonds, kept them in a vault, and always represented his wife in bond transactions; that he negotiated the sale in question with the bondholders' committee and received for the bonds 40 cents on the dollar flat. He further testified he was not acquainted with the petitioner and probably had never seen him before. While Griffin was the only witness called by respondent to testify as to any particular bond transaction, we think this testimony is illustrative of the nature of the purchases which were made for petitioner's account by Gerding and by the two firms which were dealers in securities. 1946 U.S. Tax Ct. LEXIS 193">210 On the basis of the evidence in the record, we can not hold that these purchases fall within the ambit of the American Dental Co. case. Therefore, applying what we have said above to petitioner's bond purchases for each of the respective taxable years, we make the following holdings:As to 1938 petitioner has proved that all the bonds which he purchased in that year were after direct negotiations and agreements with the bondholders. He did not purchase through any third party and paid no commissions or other fees. We hold that the doctrine of the American Dental Co. case applies to these purchases.As to 1939, only $ 450 face value of the bonds purchased in that year for $ 225 falls within the above classification. This purchase was made by petitioner after direct negotiation with the owner of the bond, Dolly Stoecker. All the rest of the purchases which petitioner made in 1939 were either through R. W. Gerding, secretary of the bondholders' committee, or through the two dealers in securities which we have named in our findings of fact. In each instance, save one, in making these purchases petitioner paid a fee to the one making the purchase in his behalf. For reasons1946 U.S. Tax Ct. LEXIS 193">211 already stated, we hold that petitioner is taxable on the gain which the Commissioner has determined resulted from these particular purchases, except the one made direct from Dolly Stoecker.As to 1940, the evidence shows that all the purchases made by petitioner in that year were made either through R. W. Gerding, secretary 6 T.C. 1048">1056 of the bondholders' committee, or through Anderson, Plotz & Co., security dealers. In each instance petitioner paid a fee to the one acting for him in making the purchase. No bonds were purchased in 1940 by petitioner in dealing directly with the owners. Therefore, for reasons already stated, we sustain the Commissioner as to all purchases in 1940.Petitioner contends, in the alternative, that at the time he purchased said bonds he was insolvent and that he was still insolvent after the purchases were made, citing . It requires no citation of authorities, of course, that in establishing this contention the burden of proof is on petitioner. We think he has failed to sustain that burden. It is true that petitioner did establish by the evidence1946 U.S. Tax Ct. LEXIS 193">212 that there had been considerable decline in the value of property which he owned and in the revenues which it had been producing, but petitioner failed to establish to our satisfaction that he was insolvent. In fact, we think that the weight of the evidence establishes that he was solvent in each of the taxable years, and we have so found. Considering the property in question against which the bonded indebtedness existed, it yielded petitioner a small net income in each of the taxable years, after all expenses, depreciation, and the interest on the bonds were deducted. Also, petitioner had considerable net income in each of the taxable years from his law practice, as shown in our findings of fact.We hold, after considering all the evidence, that petitioner was solvent in each of the taxable years and that the doctrine of the Dallas Transfer & Terminal Warehouse Co. case, supra, has no application. Petitioner's alternative contention is not sustained.Entertainment Expenses for Clients and Employees.The testimony of petitioner is to the effect that in each of the taxable years 1939 and 1940 he drew $ 2,850 from his law firm to defray certain personal expenses of his1946 U.S. Tax Ct. LEXIS 193">213 own, such as taking meals downtown while working at nights and expenses of entertaining clients and employees of the firm. Petitioner testified that he expended not more than $ 1,000 of this amount in each of the taxable years for his own meals, tips, etc., and that the balance was expended in entertaining customers and in paying for lunches and suppers of employees of the firm for which he was not reimbursed by the firm. While petitioner in effect claims that he spent $ 1,850 in each of the taxable years for these purposes, he only claims a deduction of $ 750 in each of the taxable years 1939 and 1940 therefor. Petitioner did not keep any record of separate items of these expenditures. However, he has testified at 6 T.C. 1048">1057 length as to them and as to the circumstances under which he made them, and we are convinced that he expended at least $ 750 for these purposes, and we have so found in our findings of fact.In a computation under Rule 50 the Commissioner should allow petitioner a deduction of a total of $ 750 in each of the taxable years 1939 and 1940 for these entertainment expenses. Of this amount, we do not know how much the Commissioner has already allowed in his determination1946 U.S. Tax Ct. LEXIS 193">214 of the deficiencies. The detailed statement which usually accompanies the deficiency notice is not attached to the petition. Some of the statement is attached, but the details which show the adjustments that the Commissioner has made have been omitted from the statement.Automobile Expenses.The uncontradicted evidence in the record is that petitioner expended $ 1,030.04 in the operation of his automobile during 1939 and $ 1,051.66 in 1940 for the same purpose. Petitioner claims that at least two-thirds of these expenditures was incurred in the firm's business, for which he was not reimbursed, and that not more than one-third was incurred in operating the automobile for the personal use of petitioner and his family. Respondent's contention is that petitioner kept no record of his automobile expenses, except as to amounts expended for all purposes, and that he fails, for a lack of evidence, to support the deductions which he claims.We have carefully examined and considered petitioner's testimony as to these automobile expenses and have decided that one-half of the total amount expended in 1939 and 1940 should be attributed to personal expenses, which are not deductible, and1946 U.S. Tax Ct. LEXIS 193">215 one-half should be attributed to use for business purposes, which are deductible. Apparently the Commissioner in his determination of the deficiencies has allowed as a deduction one-third of these expenses and has disallowed two-thirds. In a recomputation under Rule 50 one-half of such expenses should be allowed as a deduction and the other one-half should be disallowed because incurred for petitioner's own personal benefit and convenience and that of his family. Cf. .Decision will be entered under Rule 50. KERN Kern, J., dissenting: In its opinion in Helvering v. American Dental Co., 318 U.S. 322">318 U.S. 322, the Supreme Court cited, with approval, United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1, and unmistakably indicated 6 T.C. 1048">1058 that it considered that the two cases were distinguishable. I submit that the majority opinion is in error in finding the distinction to be the impersonal character of the transaction and in applying to the facts of the instant case the sole criterion of whether "the bonds were acquired by petitioner through direct conferences1946 U.S. Tax Ct. LEXIS 193">216 and negotiations between him [taxpayer's agent] and the bondholders with whom he was acquainted," for the purpose of determining whether the doctrine of the American Dental Co. case or the doctrine of the Kirby Lumber Co. case should be controlling.The true point of distinction between the two cases is, to my mind, found in the following language in the American Dental Co. opinion: * * Gifts however, is a generic word of broad connotations * * . Its plain meaning in its present setting denotes, it seems to us, the receipt of financial advantages gratuitously. * * ** * * The fact that the motives leading to the cancellations were those of business, or even selfish, if it be true, is not significant. The forgiveness was gratuitous, a release of something to the debtor for nothing and sufficient to make the cancellation here gifts within the statute. [Emphasis supplied.]Thus, the criterion to be applied in determining whether the American Dental Co. case or the Kirby Lumber Co. case controls the transactions here in question is not whether the bonds were acquired by petitioner through direct conferences and negotiations with bondholders who were1946 U.S. Tax Ct. LEXIS 193">217 personal acquaintances, but whether the acquisition of these bonds by petitioner at prices below their face value constituted "the receipt of financial advantages gratuitously," so that it might be said that "the forgiveness [of the excess of the face value over the price paid] was gratuitous * * and sufficient to make the cancellation here gifts within the statute."Applying the criterion of distinction to the facts of the instant case, it is apparent that none of the transactions here in question was gratuitous. Petitioner's bonds which he acquired were not payable until 1942. He purchased them in 1938, 1939, and 1940 by paying to the bondholders an amount smaller than the amount which he would have been obliged to pay if the bonds had been held until maturity. The payment of a part of a debt before it is due constitutes consideration which will support a promise of the creditor to waive or forgive the balance of the debt. See ; Williston on Contracts, Rev. Ed. 1936, vol. 1, sec. 121. Since a consideration existed by reason of the equivalent of the payment of an obligation before maturity, the transactions1946 U.S. Tax Ct. LEXIS 193">218 can not be considered as gratuitous within the meaning of the American Dental Co. case, regardless of the fact that petitioner's officers were personally acquainted with the bondholders who received these payments.6 T.C. 1048">1059 The majority opinion appears to go on the theory that all transactions carried on directly with personal acquaintances must be gratuitous. It is my opinion that, while all gratuitous transactions will normally be carried on directly between personal acquaintances, not all transactions carried on directly between personal acquaintances are gratuitous. The instant case is an example.To make the tax consequences to petitioner of the acquisition of his bonds before maturity at less than their face value depend on each case of acquisition of a bond solely upon the degree of acquaintance shown to exist with the particular bondholder and the personal or impersonal character of the negotiations leading to their acquisition, is to give an effect to the American Dental Co. decision which, in my opinion, was not intended by the Supreme Court and which its opinion does not compel.It may also be pointed out that the basic facts here presented show a typical 1946 U.S. Tax Ct. LEXIS 193">219 Kirby Lumber Co. case: The borrowing of money, the issuance of bonds to evidence the indebtedness thereby created, and the acquisition of these bonds by the debtor from the bondholders for payments less than those called for on the face of the bonds, at a time when the value of the assets of the debtor was in excess of his liabilities. Such a state of facts can not be said to be analogous to "a reduction of sale price" to be "treated as a readjustment of the contract rather than as a gain." The Supreme Court said in the American Dental Co. case: * * In , the taxpayer purchased its own bonds at a discount. It was held taxable on the increase in net assets which resulted.It later used language in its opinion which may be construed as characterizing the Kirby Lumber Co. case as one of "financial betterment through the purchase by a debtor of its bonds in an arm's length transaction." If we combine the two characterizations, we find the Supreme Court considering the Kirby Lumber Co. case as one in which the debtor corporation purchased its own bonds in an arm's length transaction at a1946 U.S. Tax Ct. LEXIS 193">*220 discount and thus bettered itself financially. The instant case can be accurately described in exactly the same words. Only by distorting the meaning of "an arm's length transaction" can this case be distinguished. It is impossible for me to believe that the Supreme Court intended the words "an arm's length transaction" to exclude those transactions carried on "through direct conferences and negotiations" between the officers of the debtor corporation and bondholders with whom they happened to be personally acquainted.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621027/	Estate of Edna V. T. Peters, Deceased, T. Graham Peters, Executor, Petitioner, v. Commissioner of Internal Revenue, RespondentPeters v. CommissionerDocket No. 4203-64United States Tax Court46 T.C. 407; 1966 U.S. Tax Ct. LEXIS 84; June 22, 1966, Filed 1966 U.S. Tax Ct. LEXIS 84">84 Decision will be entered under Rule 50. Decedent inherited real property from her husband which had a value at that time of approximately $ 33,000. A number of years later when the property had a value of approximately $ 64,000, she created by gift a joint tenancy of this property with her son. Thereafter and prior to decedent's death, the son expended from his own funds approximately $ 16,000 in improvements and additions to the property. At the time of decedent's death the property had a value of $ 95,000. Held, under the facts of this case, the amount to be included in decedent's gross estate on account of this property is the sum of $ 95,000 minus an amount equal to the expenditures made thereon by the surviving joint tenant from his own funds in the approximate amount of $ 16,000. G. Kibby Munson, for the petitioner.Eugene I. Meyers, for the respondent. Kern, Judge. KERN 46 T.C. 407">407 Respondent determined a deficiency in the Federal estate tax of petitioner in the amount of $ 17,798.69. The sole issue for our decision is the extent to which a certain piece of improved realty, which was jointly owned by the decedent and her son as of the date of her death, is includable in her gross estate.FINDINGS OF FACTAll of the facts have been stipulated, and the stipulation of facts, together with the exhibit attached thereto, is incorporated herein and made a part of our findings by reference.46 T.C. 407">408 Edna V. 1966 U.S. Tax Ct. LEXIS 84">86 T. Peters (hereinafter sometimes referred to as decedent) died testate on February 1, 1960. Decedent was a resident of Bethesda, Montgomery County, Md.Decedent's heirs were her son, T. Graham Peters, two grandsons, David S. Peters and Robert G. Peters, a granddaughter, Katherine J. Peters, and a cousin, Louella Peters. On April 19, 1960, the Orphans' Court for Montgomery County, Md., granted letters testamentary to the executor herein, T. Graham Peters.An estate tax return, Form 706, was filed on August 1, 1961, for the estate with the district director of internal revenue at Baltimore, Md. The valuation of the decedent's property for estate tax purposes was made as of the date of death.One of the adjustments in the statutory notice of deficiency, whereby the taxable estate of the decedent was increased by the value of realty known as 4717 S. Chelsea Lane, Bethesda, Md., is conceded by respondent. It is agreed by the parties that no part of this realty is includable in decedent's estate for Federal estate tax purposes.The adjustment in the statutory notice which is in controversy involves the property known as 1236 Mt. Olivet Road, NE., Washington, D.C., in which the decedent1966 U.S. Tax Ct. LEXIS 84">87 admittedly had an interest at the date of her death. That property at the date of death was included on decedent's estate tax return as an asset of her estate at a value of $ 47,500 for decedent's interest therein. The respondent has determined that the value of decedent's interest in this property should have been listed on the estate tax return at a higher value, namely $ 95,000 (i.e., the entire value of the property).On Schedule E of the estate tax return, the following appears with respect to the property in question:DescriptionValue at date of deathImproved Real Estate1236 Mt. Olivet Road, NE.141/55 Washington, D.C.One-half appraised value$ 47,500.(Acquired by decedent by devise in 1942 (Estate Tax paid; Estateof Orville S. Peters) and deeded by decedent to self and son jointlyin February, 1948 (U.S. Gift tax paid, April 11, 1951)The "appraised value" mentioned refers to a 1952 appraisal of the property which determined values for the land and improvements thereon.The fair market value of the property (i.e, land and the improvements thereon) known as 1236 Mt. Olivet Road, NE., Washington, D.C., on February 1, 1960, was $ 95,000.The land1966 U.S. Tax Ct. LEXIS 84">88 which is part of the property at 1236 Mt. Olivet Road was acquired by Orville S. Peters, deceased husband of decedent and father of T. Graham Peters, by purchase in 1937. In that year, 1937, Orville Peters had a building constructed on this land at a cost of 46 T.C. 407">409 $ 26,589.64. The entire consideration paid for the land and improvements thereon prior to 1942 was furnished by Orville Peters, and no part thereof was contributed by the decedent or by T. Graham Peters.Orville Peters died on August 23, 1942, and title to the Mt. Olivet Road property passed to Edna V. T. Peters under the terms of the will of her husband. The realty and improvements were valued at $ 33,653.76 in the estate tax return of Orville Peters, said valuation being as of August 23, 1942, the date of death of Orville Peters. This valuation properly reflected the fair market value of the property at the date of death of Orville Peters.During the year 1946, a garage was constructed on the Mt. Olivet Road premises at a cost to Edna V. T. Peters of $ 1,650.On or about February 18, 1948, Edna V. T. Peters created a joint tenancy in the Mt. Olivet Road property between herself and T. Graham Peters. The creation1966 U.S. Tax Ct. LEXIS 84">89 of the joint tenancy was a gift from Edna V. T. Peters to T. Graham Peters, and a U.S. gift tax return was filed by Edna V. T. Peters for the calendar year 1948 on which she reported this gift. The following statement appears on the gift tax return:In February 1948 when I was the sole owner of parcel 141/55 improved by premises 1236 Mt. Olivet Road, N.E., I caused the title to be conveyed to myself and my son, Thos. G. Peters, as joint tenants. The total cost of the improvements then on the property was:Manufacturing Building Built 1937$ 26,589.00Garage Built 19461,650.00Messrs. Beasley & Beasley, Inc., 711 14th St. NW., have appraised the property as of 1948 at the total sum of $ 66,033.00. At the date of the conveyance there was a debt against the property of $ 1,481.38 leaving a net value of $ 64,551.62 and a value for the gift of $ 32,275.81.The fair market value of the entire Mt. Olivet property (land and improvements) at the date of the gift (i.e., creation of the joint tenancy) to T. Graham Peters was $ 66,033. The net value of the property for gift tax purposes was $ 64,551.62. The gift tax return was filed delinquent in June 1952, and a gift tax 1966 U.S. Tax Ct. LEXIS 84">90 of $ 14.64 was paid.On February 24, 1948, the sum of $ 24,000 was borrowed by Edna V. T. and T. Graham Peters from the Perpetual Building Association, Washington, D.C. Of the total sum so borrowed, $ 1,481.85 1 was used to pay off the existing indebtedness on the property, and the additional sum of $ 22,375 was used to construct an addition to the building which was located on the Mt. Olivet premises. The $ 24,000 loan was secured by a first deed of trust on the Mt. Olivet property.In February 1948, at the time of the creation of the joint tenancy in 46 T.C. 407">410 the Mt. Olivet property, the $ 66,033 fair market value of such property was comprised of the following:Land value$ 27,614Building, replacement less depreciation36,739Garage1,680Total66,033In late 1948, immediately after the addition1966 U.S. Tax Ct. LEXIS 84">91 to the property costing $ 22,375 was constructed, the Mt. Olivet property, as improved, had a fair market value of $ 88,408, which sum was comprised of the following:Land value$ 27,614Building (original) less depreciation36,739New addition22,375Garage1,680Total88,408In 1952, the fair market value of the Mt. Olivet property, as improved, was $ 95,588.50, which sum was comprised of the following, as determined by an appraisal of the property:Land value$ 34,517.50Building (original) less depreciation39,116.00Building (addition) less depreciation20,955.00Garage1,000.00Total95,588.50In February 1953, certain air-conditioning equipment was installed in the premises at 1236 Mt. Olivet Road, NE., at a cost of $ 1,914, one-half of which was paid by Edna V. T. Peters and the other half, in the amount of $ 957, was paid by T. Graham Peters.In August 1953, a water tower was constructed on the Mt. Olivet premises at a total cost of $ 739.50. This improvement to the property was paid for by Edna V. T. and T. Graham Peters. Thus, one-half of such amount, or $ 369.75, was paid by Edna V. T. Peters and one-half of the amount, or $ 369.75, 1966 U.S. Tax Ct. LEXIS 84">92 was paid by T. Graham Peters.T. Graham Peters paid $ 15,158.44 out of his funds and Edna V. T. Peters paid $ 8,841.56 out of her funds in repayment of the $ 24,000 loan obtained from the Perpetual Building Association, this loan having been paid off in full prior to the date of decedent's death.It is agreed between the parties that the $ 507.50, representing real property taxes imposed by the District of Columbia which had accrued on the property herein at issue as of the date of decedent's death, shall be apportioned between the value of such property which is includable in decedent's estate and the property value which we may find to be properly excludable therefrom.46 T.C. 407">411 OPINIONThe question presented for our decision is the extent to which the fair market value of jointly owned improved realty is includable in the gross estate of one of the joint tenants. The relevant statute is section 2040 of the 1954 Code 21966 U.S. Tax Ct. LEXIS 84">94 and the regulation thereunder which is pertinent to our inquiry is section 20.2040-1, Estate Tax Regs., 3 both of which we have set out in the margin. We are aware 46 T.C. 407">412 of no decided cases which have considered the precise problem presented by the facts in1966 U.S. Tax Ct. LEXIS 84">93 the instant proceeding.1966 U.S. Tax Ct. LEXIS 84">95 Briefly stated, those facts are as follows: The decedent inherited improved realty from her husband upon his death. As of the date of his death, August 23, 1942, an appraisal of this property fixed its fair market value at $ 33,653.76. In 1946, the decedent spent $ 1,650 to construct a garage on the property. This expenditure represented her initial individual capital outlay with respect to the property. During the entire period August 23, 1942, through February 17, 1948, the decedent was the sole owner of the property in question. On February 18, 1948, the decedent by gift created a joint tenancy of the property between herself and her son, T. Graham Peters. At the time of the establishment of the joint tenancy, the property had a fair market value of $ 66,033. Subsequent to the creation of the joint tenancy, the decedent and her son provided the sums of $ 10,168.31 and $ 16,485.19, respectively, for improvements to the property and for the payment of approximately a $ 1,481 mortgage thereon. As of the time of the decedent's death on February 1, 1960, the property in question had a fair market value of $ 95,000.Petitioner's argument is based on one sentence in subparagraph1966 U.S. Tax Ct. LEXIS 84">96 (2) of section 20.2040-1(a), Estate Tax Regs., dealing with the question of what portion of the fair market value of a joint tenancy is to be excluded from the estate of one of the joint tenants. The pertinent part of this sentence is:Such part of the entire value is that portion of the entire value of the property at the decedent's death * * * which the consideration in money or money's 46 T.C. 407">413 worth furnished by the other joint owner or owners bears to the total cost of acquisition and capital additions. * Petitioner first contends that since the property was originally acquired by the decedent under the will of the husband "without actual cost to her," only the ratio of the cash expended by the decedent and by the other joint tenant is to be considered in the above-quoted formula. Consequently, petitioner makes the first alternative argument to the effect that since the total cash expenditures by the two joint tenants was $ 28,303.50, $ 11,818.31 of which was expended by the decedent, 11,818.31/28,303.50 or 41.756 percent of the property's $ 95,000 fair market value should be included in decedent's gross estate.Petitioner makes the second alternative argument that1966 U.S. Tax Ct. LEXIS 84">97 the term "cost of acquisition" in the regulation should be considered to be her basis in the property (which would be the fair market value as of decedent's husband's death pursuant to section 1014), and accordingly the prescribed ratio would be:$ 33,653.76+$ 11,818.31/$ 45,472.07+$ 16,485.19 = Decedent's "cost" + her cost of improvements/Total of numerator + surviving joint tenant's cost of improvementsor 73.393 percent of the fair market value of the property as of the time of decedent's death. This argument would result in the inclusion in decedent's gross estate of 73.393 percent of the fair market value of the property as of the date of her death.Respondent argues that both of the alternative positions taken by the petitioner are completely unwarranted not only by section 2040 of the Internal Revenue Code of 1954, but also by the terms of the regulations taken in their entirety. Respondent points out that if petitioner were correct in the argument that the decedent had a zero "cost of acquisition," then any donee or legatee could avoid the Federal estate tax upon property inherited or acquired as a gift by contributing such property to a joint tenancy and having the coowner1966 U.S. Tax Ct. LEXIS 84">98 make minimal capital improvements.Respondent further contends that petitioner's alternative argument which would recognize the decedent's "cost of acquisition" to be the $ 33,653.76 value as of her husband's death is incorrect because of its failure to recognize the appreciation from that figure to $ 66,033, which was the fair market value of the property at the time of the creation of the joint tenancy.Respondent's solution of the problem is to include in the decedent's gross estate the total fair market value of the property as of the time of her death ($ 95,000) minus the sum of $ 14,196.43. He arrives at this latter sum by the application of a formula or ratio of his own. Although T. Graham Peters, the surviving joint tenant, has expended 46 T.C. 407">414 the sum of $ 16,485.19 from his own funds, respondent relies on an appraisal of the property made in 1952, 8 years prior to decedent's death, in an amount approximately equal to $ 95,000 as establishing the fact that the subsequent additions of the air-conditioning equipment and water tower had no value; and that because T. Graham Peters' sole expenditure which affects the 1952 valuation was in the amount of $ 15,158.44 for an addition1966 U.S. Tax Ct. LEXIS 84">99 to a building, the total cost of which was $ 22,375, and because this addition was valued at $ 20,955 in the 1952 appraisal, the only amount to be excluded from the $ 95,000 total value should be computed as follows:X/$ 15,158.44 = $ 20,955/$ 22,375X = $ 14,196.43The arguments of both parties are largely directed to a proper construction of the third sentence in section 20.2040-1(a)(2), Estate Tax Regs., as applied to the situation presented by the instant case. However, it is our opinion that, as suggested on brief by respondent, the regulation in question was not written by respondent with this situation in mind and was not intended to and does not apply to the problem before us. It is obvious to us that in this case there was no "total cost of acquisition." The decedent acquired her interest in the property by inheritance and the surviving joint tenant acquired his interest by gift from the decedent. None of the examples given in the regulation is pertinent to this situation. To apply this sentence of the regulation on the assumption that the decedent's cost was zero or that her "cost of acquisition" was her basis (i.e., the fair market value of the property at the time 1966 U.S. Tax Ct. LEXIS 84">100 of her husband's death) would require us to make a forced and unnatural construction of the sentence which would result in the circumvention of the obvious intendment of the statute and a contravention of the broad purposes stated in the first and fourth sentences of section 20.2040-1(a) of the regulations.The purpose of the statute, as plainly stated therein, is to include in a decedent's gross estate "the value of all property * * * to the extent of the interest therein held as joint tenants by the decedent and any other person * * * except such part thereof as may be shown to have originally belonged to such other person and never to have been received or acquired by the latter from the decedent for less than an adequate and full consideration in money or money's worth." Our problem in the instant case is to determine what part of the interest in the property held as joint tenants at the time of decedent's death has been "shown to have originally belonged to" the surviving joint tenant. In our opinion that part of the additions and improvements on the property (including the payment of a small mortgage) which were paid for by the surviving partner out of his own funds is to be1966 U.S. Tax Ct. LEXIS 84">101 considered as having "originally belonged to" the surviving joint 46 T.C. 407">415 tenant and "never to have been received or acquired by [him] from the decedent for less than an adequate and full consideration in money or money's worth."The problem then arises of determining the amount of money representing such property or interest which "originally belonged to" the surviving joint tenant which should be deducted from the stipulated value of the property of the joint tenancy at the time of decedent's death. Limiting ourselves strictly to the facts of the instant case, it is our opinion that the record before us warrants a conclusion that the sum of money which fairly represents the property or interest originally belonging to the surviving joint tenant is the amount of money actually expended by him therefor or $ 16,485.19. There has been no showing by the petitioner that such property or interest has appreciated in value over its cost 4 and no testimony adduced by respondent to weaken the evidence of cost as representing value. 5 It follows that the amount to be included in decedent's gross estate on account of the value of the property "held as joint tenants by the decedent" and1966 U.S. Tax Ct. LEXIS 84">*102 the surviving joint tenant is $ 78,514.81 ($ 95,000 minus $ 16,485.19).Decision will be entered under Rule 50. Footnotes1. Although this figure was stipulated, it differs from the amount stipulated to be set out in the statement appearing on the gift tax return, $ 1,481.38. Nothing in the record explains this discrepancy.↩2. SEC. 2040. JOINT INTERESTS.The value of the gross estate shall include the value of all property (except real property situated outside of the United States) to the extent of the interest therein held as joint tenants by the decedent and any other person, or as tenants by the entirety by the decedent and spouse, or deposited, with any person carrying on the banking business, in their joint names and payable to either or the survivor, except such part thereof as may be shown to have originally belonged to such other person and never to have been received or acquired by the latter from the decedent for less than an adequate and full consideration in money or money's worth: Provided, That where such property or any part thereof, or part of the consideration with which such property was acquired, is shown to have been at any time acquired by such other person from the decedent for less than an adequate and full consideration in money or money's worth, there shall be excepted only such part of the value of such property as is proportionate to the consideration furnished by such other person: Provided further↩, That where any property has been acquired by gift, bequest, devise, or inheritance, as a tenancy by the entirety by the decedent and spouse, then to the extent of one-half of the value thereof, or, where so acquired by the decedent and any other person as joint tenants and their interests are not otherwise specified or fixed by law, then to the extent of the value of a fractional part to be determined by dividing the value of the property by the number of joint tenants.3. Sec. 20.2040-1. Joint interests.(a) In general. A decedent's gross estate includes under section 2040 the value of property held jointly at the time of the decedent's death by the decedent and another person or persons with right of survivorship, as follows:(1) To the extent that the property was acquired by the decedent and the other joint owner or owners by gift, devise, bequest, or inheritance, the decedent's fractional share of the property is included.(2) In all other cases, the entire value of the property is included except such part of the entire value as is attributable to the amount of the consideration in money or money's worth furnished by the other joint owner or owners. See § 20.2043-1 with respect to adequacy of consideration. Such part of the entire value is that portion of the entire value of the property at the decedent's death (or at the alternate valuation date described in section 2032[)] which the consideration in money or money's worth furnished by the other joint owner or owners bears to the total cost of acquisition and capital additions. In determining the consideration furnished by the other joint owner or owners, there is taken into account only that portion of such consideration which is shown not to be attributable to money or other property acquired by the other joint owner or owners from the decedent for less than a full and adequate consideration in money or money's worth.The entire value of jointly held property is included in a decedent's gross estate unless the executor submits facts sufficient to show that property was not acquired entirely with consideration furnished by the decedent, or was acquired by the decedent and the other joint owner or owners by gift, bequest, devise, or inheritance.(b) Meaning of "property held jointly". Section 2040 specifically covers property held jointly by the decedent and any other person (or persons), property held by the decedent and spouse as tenants by the entirety, and a deposit of money, or a bond or other instrument, in the name of the decedent and any other person and payable to either or the survivor. The section applies to all classes of property, whether real or personal, and regardless of when the joint interests were created. Furthermore, it makes no difference that the survivor takes the entire interest in the property by right of survivorship and that no interest therein forms a part of the decedent's estate for purposes of administration. The section has no application to property held by the decedent and any other person (or persons) as tenants in common.(c) Examples. The application of this section may be explained in the following examples in each of which it is assumed that the other joint owner or owners survived the decedent:(1) If the decedent furnished the entire purchase price of the jointly held property, the value of the entire property is included in his gross estate;(2) If the decedent furnished a part only of the purchase price, only a corresponding portion of the value of the property is so included;(3) If the decedent furnished no part of the purchase price, no part of the value of the property is so included;(4) If the decedent, before the acquisition of the property by himself and the other joint owner, gave the latter a sum of money or other property which thereafter became the other joint owner's entire contribution to the purchase price, then the value of the entire property is so included, notwithstanding the fact that the other property may have appreciated in value due to market conditions between the time of the gift and the time of the acquisition of the jointly held property;(5) If the decedent, before the acquisition of the property by himself and the other joint owner, transferred to the latter for less than an adequate and full consideration in money or money's worth other income-producing property, the income from which belonged to and became the other joint owner's entire contribution to the purchase price, then the value of the jointly held property less that portion attributable to the income which the other joint owner did furnish is included in the decedent's gross estate;(6) If the property originally belonged to the other joint owner and the decedent purchased his interest from the other joint owner, only that portion of the value of the property attributable to the consideration paid by the decedent is included;(7) If the decedent and his spouse acquired the property by will or gift as tenants by the entirety, one-half of the value of the property is included in the decedent's gross estate; and(8) If the decedent and his two brothers acquired the property by will or gift as joint tenants, one-third of the value of the property is so included.↩4. If such a showing had been made, it might have been necessary for us to devise a formula or ratio of our own.↩5. It is stipulated that the fair market value of the entire property when decedent died in 1960 was $ 95,000. An appraisal of the property in 1952 placed a valuation on four components of the property (the land value, the value of the original building, the value of the additional building and the value of the garage) in the total amount of $ 95,588.50, which included the value of $ 20,955 placed on the additional building. Respondent's contention that this valuation should be taken as establishing the value of the additional building and the complete lack of value of the air-conditioning equipment and water tower in 1960 is without merit.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621028/	Lamar Creamery Company, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentLamar Creamery Co. v. CommissionerDocket No. 7425United States Tax Court8 T.C. 928; 1947 U.S. Tax Ct. LEXIS 214; April 30, 1947, Promulgated 1947 U.S. Tax Ct. LEXIS 214">214 Decision will be entered under Rule 50. Petitioner is engaged in the business of manufacturing dairy products and bottling fluid milk at Paris, Texas. It paid excess profits tax for the years 1941 and 1942 and filed applications for relief under section 722, I. R. C., for both years, which applications the Commissioner has disallowed. Held, petitioner failed to establish that its excess profits tax for the calendar years 1941 and 1942, computed without the benefit of section 722, I. R. C., as amended, was excessive and discriminatory because of the factors mentioned in section 722 (b) (2), but has established that its said tax was excessive and discriminatory because of the factors mentioned in section 722 (b) (4); held, further, petitioner has established a fair and just amount representing normal earnings mentioned in section 722 (a) to be used as a constructive average base period net income in lieu of the actual average base period net income otherwise determined. S. G. Winstead, Esq., and J. P. Jackson, Esq., for the petitioner.Irene F. Scott, Esq., J. D. Bierman, Esq., and R. E. Maiden, Jr., Esq., for the respondent. Black, Judge. BLACK 1947 U.S. Tax Ct. LEXIS 214">215 8 T.C. 928">929 This proceeding is for a review of the respondent's disallowance of petitioner's applications for excess profits tax relief under section 722 of the Internal Revenue Code, as amended, for the taxable years ended December 31, 1941 and 1942, in the respective amounts of $ 4,264.48 and $ 47,756.89. The notice of disallowance was sent and the petition for redetermination was filed in accordance with section 732 of the code. Attached to the notice of disallowance is a "Statement" by the respondent, which is in part as follows:Excess Profits Tax Liability for the Taxable Years EndedDecember 31, 1941 and 1942YearLiabilityAssessedOverassessmentDeficiency1941$ 4,264.48$ 4,264.48 (1)NoneNone194247,756.8947,756.89 (2)NoneNone1947 U.S. Tax Ct. LEXIS 214">216 (1) Assessed:Original account #400308$ 4,544.74Less previous allowance280.26Net assessment$ 4,264.48(2) Assessed:Original account #99349$ 48,403.76Less previous allowance646.87Net assessment$ 47,756.89It is held that you have not established: (1) that your normal operations in the base period were interrupted or diminished because of the occurrence, either immediately prior to or during the base period, of events unusual and peculiar in your experience; (2) that your average base period net income does not reflect normal earnings for the entire base period because of the change in character of your business during the base period; and (3) that there were any other factors affecting your business which may reasonably be considered as resulting in an inadequate standard of your normal earnings during the base period.In view of the foregoing it is held that you have not established that the taxes computed for the taxable years 1941 and 1942 under subchapter E of chapter 2 of the Internal Revenue Code without the benefit of section 722 of the Code result in excessive and discriminating taxes within the provisions of 8 T.C. 928">930 sections 7221947 U.S. Tax Ct. LEXIS 214">217 (a) and 722 (b) of the Code, and that you have not established what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purpose of an excess profits tax based upon a comparison of normal earnings and earnings during the excess profits tax years 1941 and 1942.Accordingly, the claims for refund contained in your applications for relief under section 722 of the Internal Revenue Code for the years 1941 and 1942 which were filed on September 15, 1943 under Bureau Serial Numbers 19686 and 19687, are disallowed. Notice of such disallowances is hereby given in accordance with the provisions of section 732 of the Internal Revenue Code.Petitioner, in its amended petition, assigns as error the following:4. The Commissioner of Internal Revenue committed error in denying to petitioner relief from excess profits taxes in accordance with the provisions of Section 722 (b) (1), (2), (4) and ( 5) of the Internal Revenue Code.In schedule B of the above mentioned applications for relief, sometimes referred to herein as claims for refund, petitioner did not check section 722 (b) (2) as one of the "reasons" for relief, but 1947 U.S. Tax Ct. LEXIS 214">218 did check as reasons section 722 (b) (1), (4), and (5). In view, however, of the "general information" furnished in the applications, the respondent does not object to petitioner assigning error as to section 722 (b) (2). In its brief, petitioner apparently abandons its claims as far as section 722 (b) (1) and (5) are concerned and relies primarily upon section 722 (b) (2) and (4).FINDINGS OF FACT.Petitioner is a corporation, organized during 1928 under the laws of the State of Texas for the purpose of engaging in the business of manufacturing dairy products and bottling fluid milk. Its principal place of business is Paris, Texas. Its returns for the years in question were filed with the collector for the second district of Texas at Dallas.Petitioner is entitled to use the excess profits credit based on income pursuant to section 713 of the code, as amended. Its "base period" as that term is defined in section 713 (b) is the period consisting of the four calendar years 1936 to 1939, inclusive. Its "average base period net income" as that term is defined in section 713 (d) (1) and determined under subsection (f) (without the benefit of section 722) is $ 11,397.59, and petitioner1947 U.S. Tax Ct. LEXIS 214">219 used this amount in computing its excess profits tax in its excess profits tax returns for the years 1941 and 1942.Petitioner filed with the respondent applications for relief under section 722 on Form 991 for the calendar years 1940, 1941, and 1942. Petitioner paid no excess profits tax for the calendar year 1940. In these applications petitioner claimed a "constructive average base period net income" under section 722 (a) for each of the years 1941 8 T.C. 928">931 and 1942 of $ 45,515.53 in lieu of the above mentioned actual average base period net income of $ 11,397.59.Petitioner's claims filed for the taxable years 1941 and 1942 incorporate by reference the material submitted in the claim filed for the year 1940. Under schedule B of the claims, filed for all three years, petitioner, among other things, stated:After two years of operation under program heretofore outlined, taxpayer agreed it would be advisable to set up a substation at Greenville, Texas, for the purpose of buying milk in truck tanks for the daily use of the Paris plant. In order to attempt to defray the expense of operation of this expected source of supply, taxpayer thought it advisable to distribute fluid milk1947 U.S. Tax Ct. LEXIS 214">220 in the City of Greenville. Installation of equipment was made and operations were begun in 1935. This entailed contacting farmers and selling them on the idea of producing whole milk for market instead of sour cream. The undertaking did not prove successful. The losses sustained in 1936 were $ 4,361.22 and in 1937 $ 6,144.09.In the spring of 1936 the Carnation Company opened a plant at Sulphur Springs, Texas. As previously stated in this memorandum, milk production had not been developed in this section; so the Carnation Company paid farmers in this locality fifteen to twenty per cent more than the market price in order to encourage farmers to produce milk. This procedure caused taxpayer to meet such competition thereby being forced to expend funds over and above the normal price. A summary of the excess costs paid by taxpayer is as follows:1936: 305,106 lbs at 3 cents$ 9,153.181937: 347,583 lbs. at 3 cents10,427.491938: 288,595 lbs. at 3 cents8,657.851939: 397,015 lbs. at 3 cents11,910.48Four year average$ 10,037.25The condition outlined above forced the taxpayer to conclude that discontinuance of the substation plant at Greenville was advisable1947 U.S. Tax Ct. LEXIS 214">221 although seemingly badly needed as a source of supply.Taxpayer having been forced to meet Carnation Company's prices although not being able to increase the price of products manufactured, it seemed advisable to seek a new product whereby some of the losses might be recovered. This necessity brought forth the idea to manufacture ice cream mix products. In the spring of 1938 the development of the idea to include the manufacture of ice cream mix was put into being. A representative was sent into the field to contact farmers and counter freezer operators. On January 1, 1939 a separate department was installed to provide for the manufacture of the new product. The records disclose that this department has had steady and continuous growth in succeeding years.Bedford B. Harlan originally organized petitioner and is its president and general manager. Harlan is a chemical engineer, having studied chemical engineering for three years at the University of Kansas. He was associated with three ice cream companies from 1921 until he organized petitioner in 1928.8 T.C. 928">932 At the time petitioner was organized the supply of raw milk in and around Paris, which is in Lamar County, was inadequate. 1947 U.S. Tax Ct. LEXIS 214">222 The principal crop in that area was cotton.In order for petitioner to establish its business and enlarge its operations on a profitable basis, it undertook a program of education and encouragement of farmers to buy calves, raise feed, improve their herds, and increase their production of milk. Petitioner was unable to obtain a sufficient supply of milk to operate on a satisfactory basis until 1936. During this period there were a number of independent companies operating in this area and all of these companies followed the same pattern of developing milk production. Subsequently all of these companies were sold to national companies, with the exception of petitioner and Meadolake Foods, Inc., of Sherman, Texas, hereinafter sometimes referred to as Meadolake.Facts Bearing Upon Section 722 (b) (2) Ground for Relief.In 1935 the Carnation Co., hereinafter sometimes referred to as Carnation, established a plant at Sulphur Springs, Texas, which is approximately 40 miles south of Paris in the adjoining county of Hopkins. At the time the Carnation plant was opened, petitioner was buying milk in that area and continued to buy milk in competition with Carnation throughout1947 U.S. Tax Ct. LEXIS 214">223 the base period.After opening its plant at Sulphur Springs, Carnation faced the situation of developing and enlarging its operations in the same manner as petitioner had done by paying the normal price for milk and going into a long period of education and encouragement of farmers to improve their herds and thereby increase milk production. Carnation, however, did not adopt this policy, but did adopt a policy of developing its milk supply by paying more than the market prices then paid in its territory.The policy adopted by Carnation forced petitioner to pay prices for milk in excess of prices previously paid. Petitioner continued to pay these excess prices throughout the base period. In many instances Carnation paid more for milk than the milk products sold for. Because of Carnation's buying policy, petitioner could not have operated successfully without making changes.Petitioner opened a plant at Greenville, Texas, in 1935. Greenville is about 31 miles west of Sulphur Springs. The reason for opening the Greenville plant was that at the time petitioner was not getting sufficient milk for its Paris plant, and the idea was conceived of establishing a milk station in Greenville1947 U.S. Tax Ct. LEXIS 214">224 for the purpose of buying and cooling milk there and hauling it to Paris for processing. In addition, petitioner decided to pasteurize and bottle some milk there and sell it 8 T.C. 928">933 in Greenville with the hope that this would help pay the operating cost of that station. Carnation, however, was likewise operating in the Greenville area and petitioner had to buy its milk in that area in competition with Carnation. It was because of this competition and the resulting losses that petitioner decided to close its Greenville plant on December 31, 1937.During 1936 and 1937 petitioner conducted its operations under three main departments, namely, the pasteurizing department, the condensing department, and the Greenville plant. The operating profits or (losses) from these departments were as follows:19361937Pasteurizing department$ 5,553.18 $ 9,958.66 Condensing department2,080.83 (1,152.01)Greenville plant(3,838.12)(6,030.17)Miscellaneous sales129.21 253.08 Operating profit3,925.10 3,029.56 Taking into consideration other income and deductions, the losses of the Greenville plant for 1936 and 1937 were $ 4,361.22 and $ 6,144.09, respectively. 1947 U.S. Tax Ct. LEXIS 214">225 The type of plant established by Carnation was the kind that would be expected to be permanent. This plant had a capacity of about 200,000 gallons of milk per day, as compared to petitioner's capacity of 50,000. After the establishment of the Carnation plant in Sulphur Springs in 1935, Carnation became a permanent competitor of the petitioner in the milk-buying field.Every company which operated in the same area with Carnation was likewise affected by competition with Carnation, particularly Meadolake and Texas Milk Products Co. Because of Carnation's buying policy, Meadolake was forced to discontinue its operations in the territory where it was in competition with Carnation. Texas Milk Products Co. was forced to discontinue its plant at Sulphur Springs on account of competition with Carnation, and to pay higher prices generally throughout its buying territory. The policy of Texas Milk Products Co. was to pay the same general scale throughout its entire buying territory, which included the Sulphur Springs, Mt. Pleasant, Longview, Tyler, and Texarkana areas, all in Texas.Petitioner has not shown that its average base period net income is an inadequate standard of normal earnings1947 U.S. Tax Ct. LEXIS 214">226 because petitioner's business was depressed in the base period because of temporary economic circumstances unusual in the case of the petitioner or because of the fact that an industry of which petitioner was a member was depressed by reason of temporary economic events unusual in the case of such industry.8 T.C. 928">934 Facts Bearing Upon Section 722 (b) (4) Ground for Relief.In 1935, 1936, and 1937 petitioner sold small quantities of ice cream mix to ice cream counter freezer operators. These operators were usually small concerns such as drug stores. Usually petitioner sold such operators milk and the operators would buy ice cream mix from some other concern. However, in some instances where petitioner's customer could not obtain ice cream mix from such other concern, petitioner made small sales of ice cream mix to such customer solely as an accommodation. This practice of accommodation sales was followed by almost every manufacturer of ice cream products in Texas. Prior to 1938 petitioner had never solicited any customers for ice cream mix.In 1938 petitioner decided to establish an ice cream mix business, with the primary idea of soliciting ice cream manufacturers. 1947 U.S. Tax Ct. LEXIS 214">227 Petitioner had determined that many small ice cream manufacturers making less than 1,000 gallons a year could profitably buy ice cream mix from an established ice cream mix manufacturer. During 1938 petitioner sold 490,515 pounds of ice cream mix and received therefor $ 34,744.61. At the beginning of 1939 it established a separate department in its business, called the ice cream mix department. During that year petitioner sold 994,834 pounds of ice cream mix and received therefor $ 64,770.97. The resulting operating profit from petitioner's separate departments during 1938 and 1939 was as follows:19381939Pasteurizing department$ 6,255.11$ 940.39Condensing department902.777,547.52Ice cream mix department1,531.13Miscellaneous sales483.05436.53Operating profit7,640.9310,455.57During the base period years ice cream production in Texas was as follows:YearGallons19367,524,00019378,331,00019389,663,00019399,988,000During the base period years the average price per cwt. paid producers by condenseries for milk testing 3.5 per cent butterfat f. o. b. factory in the United States was as follows:1936$ 1.5619371.5719381.2519391.241947 U.S. Tax Ct. LEXIS 214">228 8 T.C. 928">935 At the beginning of 1938 petitioner owned ice cream mix equipment consisting of machinery, vaults, cans, and trucks, which equipment had cost petitioner $ 921.41. During 1938 petitioner established a laboratory for making accurate tests in connection with the manufacture of ice cream mix, which laboratory included a so-called Minnesota reactor. At this time petitioner did considerable analytical work in connection with the manufacture of ice cream mix. During 1938 and 1939 it purchased additional ice cream mix equipment costing $ 4,580.84 and $ 2,152.95, so that by the end of the base period (December 31, 1939) it owned ice cream mix equipment which had cost a total of $ 7,655.20.In 1938, following the establishment of its ice cream mix business, petitioner adopted new methods of merchandising. New customers were solicited for ice cream mix in 1938 and 1939. A great deal of the soliciting was done in new territory. The largest expansion of petitioner's ice cream mix business resulted from sales to ice cream manufacturers who had not been petitioner's customers prior to 1938. The establishment of the ice cream mix business changed petitioner from a small business 1947 U.S. Tax Ct. LEXIS 214">229 operator to one of the largest in the Paris area. Before the end of 1939 petitioner expanded its ice cream mix business from a few miles around Paris to east Texas, and parts of Arkansas, Louisiana, Oklahoma, and Mississippi.The production of ice cream mix required the same general type of labor as the production of petitioner's other products, but the ice cream mix department heads had to be trained, particularly in the manufacture of ice cream mix. These men were given special training by Harlan, and some of them were sent to A. & M. College at College Station, Texas, for short courses. In connection with Harlan's previous experience from 1921 to 1928 with ice cream manufacturing, Harlan made a study of the costs which go into the manufacture of ice cream mix.The establishment of the ice cream mix department helped petitioner's other departments to dispose of their products because the ice cream mix department could use such products. For example, petitioner's other departments manufactured sweet cream and serum solids, some of which were used by the ice cream mix department and, therefore, constituted an additional outlet over and above their regular sales, reducing cost of1947 U.S. Tax Ct. LEXIS 214">230 the other departments. The establishment of the ice cream mix department also enabled petitioner to adopt a more aggressive buying policy and to maintain better its position in the price field.The ice cream mix business flourishes in the months from March 15 to October 15, and usually May through September are the best months for such business. May through September are likewise months of 8 T.C. 928">936 peak production of raw milk. Thus, petitioner was able to purchase more milk during these peak months by reason of the fact that these months are also peak months of ice cream consumption.Petitioner's ice cream mix department had not reached by the end of the year 1939 the earning level which it would have reached if petitioner had made this change two years earlier. Petitioner's actual sales of ice cream mix in 1938 and 1939 show that in 1939 sales increased more than 100 per cent in volume over 1938. Actual sales by months in 1938 and 1939 show a corresponding increase.If petitioner's ice cream mix business had been established two years earlier, that is to say, in 1936 rather than in 1938, petitioner would have manufactured and sold 2,000,000 pounds of ice cream mix in 1939. 1947 U.S. Tax Ct. LEXIS 214">231 On the same assumption petitioner would have manufactured and sold 1,506,600 pounds in 1936, 1,668,200 pounds in 1937, and 1,934,920 pounds in 1938. Ample markets existed in each of these years for the said number of pounds of ice cream mix petitioner would have manufactured and sold if this department of petitioner's business had been established two years earlier.On the basis of the above number of pounds of ice cream mix which petitioner would have manufactured and sold if its ice cream mix business had been established two years earlier, petitioner's sales per unit and in the aggregate, petitioner's cost of sales per unit and in the aggregate, and petitioner's operating profit per unit and in the aggregate for each of the base period years would have been as follows:PER UNITSalesCost of salesYearPoundsAmountIngredientsProcessing19361,506,600$ 0.0819089$ 0.0626874$ 0.004500019371,668,200.0824337.0630300.004500019381,934,920.0708329.0501832.003500019392,000,000.0651073.0497820.0035000AGGREGATE1936Same$ 123,403.95$ 94,444.84$ 6,779.701937Same137,515.90105,146.657,506.901938Same137,055.9997,100.486,772.221939Same130,214.6099,564.007,000.001947 U.S. Tax Ct. LEXIS 214">232 PER UNITSalesCost of salesOperatingprofitYearOperatingTotal1936$ 0.0090000$ 0.0761874$ 0.00572151937.0090000.0765300.00590371938.0080000.0616832.00914971939.0080000.0612820.0038253AGGREGATE1936$ 13,559.40$ 114,783.94$ 8,620.01193715,013.80127,667.359,848.55193815,479.36119,352.0617,703.93193916,000.00122,564.007,650.60In 1936, 1937, 1938, and 1939 it would have been possible for petitioner to obtain the necessary supplies and ingredients to produce the reconstructed volume and it could have been sold at profitable prices.Petitioner's average base period net income is an inadequate standard of normal earnings because during the base period petitioner changed the character of its business by adding a new product in the form of 8 T.C. 928">937 ice cream mix and the average base period net income does not reflect the normal operation for the entire base period of petitioner's business.Petitioner's excess profits tax liability computed without the benefit of section 722 results in an excessive and discriminatory tax.Petitioner's constructive average base period net income to be used in1947 U.S. Tax Ct. LEXIS 214">233 computing the credit for the taxable years 1941 and 1942 is the amount of $ 15,975.53, computed as follows:1936193719381939Net income as reported$ 2,859.72$ 2,524.46$ 5,420.70$ 11,570.82Eliminate actual profit from icecream mix1 765.561,531.13Balance2,859.722,524.464,655.1410,039.69Add constructive profit from icecream mix as determined above8,620.019,848.5517,703.937,650.60Constructive net income11,479.7312,373.0122,359.0717,690.29Constructive average base periodnet income (general average)15,975.53OPINION.The question presented is whether petitioner is entitled to any relief from excess profits tax for the calendar years 1941 and 1942 under the provisions of section 722 of the Internal Revenue Code, as amended, the material provisions of which are in the margin. 21947 U.S. Tax Ct. LEXIS 214">234 8 T.C. 928">938 Under the statute petitioner must establish (1) that the tax computed without the benefit of section 722 results in an excessive and discriminatory tax and (2) a fair and just amount representing normal earnings to be used as a constructive average base period net income. See East Texas Motor Freight Lines, 7 T.C. 579. If petitioner establishes these two requirements, then the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income of $ 11,397.59 otherwise determined under the statute. In this particular instance the $ 11,397.59 was determined under section 713 (f) of the code. Petitioner's actual average base period net income for the four base period years was $ 5,593.92, but by reason of the provisions of 713 (f), commonly known as the "growth formula," it is entitled to use and has used as a credit in determining its excess profits tax for each of the taxable years an average base period net income of $ 11,397.59. In determining (2) above no regard shall be had to events or conditions affecting petitioner, the industry of which it is a member, or taxpayers generally1947 U.S. Tax Ct. LEXIS 214">235 occurring or existing after December 31, 1939, with certain exceptions not applicable here.We shall first consider whether petitioner has established (1) above. Under section 722 (b) the tax computed without the benefit of section 722 "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" of the existence of one or more of the factors thereafter mentioned in subsection (b). The parties agree that petitioner is entitled to use the excess profits credit based on income pursuant to section 713. The parties differ on whether petitioner has shown the existence of the factors mentioned in subsections (b) (2) and (4) of the statute.We first take up petitioner's contention that it is entitled to relief under section 722 (b) (2). The essential elements of this subsection are: (1) the "business of the taxpayer" (or the business of the industry of which it is a member) must be "depressed"; (2) the depression of business must be caused by a temporary economic circumstance; and (3) such circumstance1947 U.S. Tax Ct. LEXIS 214">236 must be "unusual in the case of the taxpayer" or of its industry. Petitioner does not contend that the industry of which it was a member was depressed. Petitioner does contend, however, that under section 722 (b) (2) it has shown that its own business 8 T.C. 928">939 was depressed in the base period because of its competition with Carnation; that this competition was a temporary economic circumstance unusual in the case of petitioner; that if it had not been for this competition petitioner would not have suffered the losses at its Greenville plant and would not have had to pay as much for its ungraded B milk as it did pay; and that because of these things its average base period net income is an inadequate standard of normal earnings.We find ourselves unable to agree with these contentions. It is true that when Carnation opened its plant at Sulphur Springs it paid more for milk than petitioner and other milk companies in that territory had been paying and as a result thereof petitioner had to pay more for its milk thereafter. But can such competition be considered as a temporary economic circumstance unusual in the case of petitioner or of the industry of which petitioner was a member? 1947 U.S. Tax Ct. LEXIS 214">237 We do not think it can be so considered. Competition is present in almost any business. Instead of it being something unusual, it is quite common. It is of the very essence of our capitalistic system. Petitioner's competition with Carnation can hardly be considered as a temporary event, notwithstanding Harlan's testimony that it was temporary. Carnation had come to Sulphur Springs to stay. It built a plant at Sulphur Springs having a capacity four times that of petitioner's plant, and, in our opinion, it became in a very real sense a permanent competitor of the petitioner in the milk-buying field. We do not think petitioner has shown that its average base period net income is an inadequate standard of normal earnings because of the factors mentioned in subsection (b) (2), and we have so found as one of our ultimate findings of fact. See sec. 35.722-3 (b), Regulations 112; Monarch Cap Screw & Manufacturing Co., 5 T.C. 1220; and Fish Net & Twine Co., 8 T.C. 96.Petitioner introduced in evidence a schedule showing a summary of milk prices per 100 pounds of 4.5 per cent butterfat test for the years 1936 to 1939, 1947 U.S. Tax Ct. LEXIS 214">238 inclusive, paid by Meadolake Foods, Inc., of Sherman, Texas, one of its competitors. Petitioner also introduced a schedule showing a comparison of petitioner's average cost and Meadolake's average cost of ungraded milk purchased per 100 pounds of 4.5 per cent butterfat test. In view of our holding that on the facts petitioner has not proved its right for relief under section 722 (b) (2), we have not incorporated these schedules in our findings of fact, as it is believed they would serve no useful purpose. Petitioner does not claim these facts would be relevant under section 722 (b) (4), which we presently discuss.Section 722 (b) (4) Relief.Petitioner also relies upon section 722 (b) (4) and contends that it has shown that during the base period petitioner changed the character of its business by adding a new product in the form of ice cream mix, 8 T.C. 928">940 so that its average base period net income did not reflect the normal operation for the entire base period; that petitioner's business did not reach, by the end of the base period, the earning level which it would have reached if it had made this change in the character of its business two years before it did 1947 U.S. Tax Ct. LEXIS 214">239 so; and that because of this showing petitioner's average base period net income is an inadequate standard of normal earnings. We think the evidence offered by petitioner supports these contentions and we have so found in our findings. Section 722 (b) (4) provides in part that the tax shall be considered to be excessive and discriminatory if the taxpayer's 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 * * * 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 * * * made the change in the character of the business two years before it did so, it shall be deemed to have * * * made the change at such earlier time. For the purposes of this subparagraph, the term "change in the character of the business" includes * * * a difference in the products * * * furnished * * .In 1938 petitioner commenced to manufacture and sell ice cream1947 U.S. Tax Ct. LEXIS 214">240 mix on a quantity basis. We think this represented a difference in the products furnished and hence a change in the character of petitioner's business during the base period. Section 35.722-3 (d), Regulations 112, relating to "Commencement or change in character of business," reads in part:* * * A change in the character of the business for the purposes of section 722 (b) (4) must be substantial in that the nature of the operations of the business affected by the change is regarded as being essentially different after the change from the nature of such operations prior to the change. No change which businesses in general are accustomed to make in the course of usual or routine operations shall be considered a change in the character of the business for the purposes of section 722 (b) (4). * A change in the character of the business includes changes resulting from the following activities: * * (2) A difference in the products or services furnished. A product or service is different from another product or service if the trade custom or practice treats it as a product or service of a different class. A mere improvement in the product or service does not constitute a 1947 U.S. Tax Ct. LEXIS 214">241 difference in the product or service. For example * * * Another taxpayer manufactured and sold a variety of products, some under patents it had developed. During the base period it engaged in extensive research, developed new products, perfected and obtained a patent, and employed new marketing methods, enabling it to sell a leading product never before sold in the new markets. A difference in the products furnished is deemed to have resulted.8 T.C. 928">941 We think the addition to its business by petitioner in 1938 of a new product, namely, ice cream mix in quantity production, brings petitioner within the ambit of the foregoing regulations. We think the same reasoning would apply here as we used in 7- Up Fort Worth Co., 8 T.C. 52, where we held that the character of taxpayer's business, that of a soft drink manufacturer manufacturing a drink called "7-Up," was changed by the addition of a new product, "Nesbitt's Orange Beverage."It is not enough, however, for petitioner to establish merely that during the base period it changed the character of its business. It must also establish that "the average base period net income does not reflect the normal1947 U.S. Tax Ct. LEXIS 214">242 operation for the entire base period of the business." East Texas Motor Freight Lines, supra.The actual earning level reached by petitioner in its ice cream mix department for the calendar year 1939, which was the last year of the base period, was $ 1,531.13. Petitioner contends that it has proved that, if it had made this change in the character of its business two years earlier, its operating profit from its ice cream mix department for the last year of its base period would have been $ 17,475.90. Harlan testified that in his opinion if the change had been made two years earlier petitioner would have manufactured and sold 3,000,000 pounds of mix during 1939. This estimated production of 3,000,000 pounds forms the basis for the calculation of a reconstructed profit in 1939 for ice cream mix of $ 17,475.90. During that year it actually manufactured and sold 994,834 pounds for $ 64,770.97, which was at the rate of $ .0651073 per pound.The respondent contends that Harlan's estimate of 3,000,000 pounds is not justified on the facts that were known at the end of the base period. In his brief the respondent insists "that any amount greater than 2,000,0001947 U.S. Tax Ct. LEXIS 214">243 pounds is clearly and obviously unreasonable on the proof adduced." Petitioner actually manufactured and sold 490,515 pounds in 1938 and 994,834 pounds in 1939, which represents an increase in 1939 of 504,319 pounds over 1938. If this result had been pushed back two years and an additional two years added at the same rate of increase, the production for 1939 would have reached approximately 2,003,472 pounds. We are, therefore, of the opinion that Harlan's estimate of 3,000,000 pounds is too high. We think these figures are too optimistic when only facts existing at the end of 1939 are taken into consideration. And it is only these that we can take into account. We can not take into account the swollen demand which was created in the war years. It was this very sort of thing which Congress sought to avoid in the enactment of the last sentence of section 722 (a), to which we have already referred. Of this prohibition, House Report No. 2333, 77th Cong., 2d sess., had this to say at page 142:8 T.C. 928">942 In order to eliminate consideration of the effects of the war, it is provided that, in determining the constructive average base period net income, no regard shall be had to events1947 U.S. Tax Ct. LEXIS 214">244 or conditions affecting the taxpayer, an industry of which it is a member, or taxpayers generally, occurring or existing after December 31, 1939. Thus high war prices, swollen demand, and other factors which would not be normal prior to the imposition of the excess profits tax shall be eliminated in the computation of the normal or average earning capacity of the taxpayer.We, therefore, agree with the respondent that the evidence does not warrant a finding of any amount greater than 2,000,000 pounds of ice cream mix at the end of 1939, and we have so found in our findings of fact. In arriving at the reconstructed operating profit on a production of 2,000,000 pounds, we have used the same selling price per pound of $ .0651073 which petitioner actually experienced in 1939 on the sale of the 994,834 pounds. The respondent contends in his brief that we should find that of the 2,000,000 pounds, 490,515 pounds should be considered as if it had been sold to small counter freezers at $ .0702662 per pound and the balance, or 1,509,485 pounds, should be considered as if it had been sold to ice cream manufacturers at $ .0600896 per pound. The record does not support this contention. We1947 U.S. Tax Ct. LEXIS 214">245 think the evidence shows that the 2,000,000 pounds could have been sold for $ .0651073 per pound and we have so found in our findings. As to the cost of sales, the respondent contends in his brief that for 2,000,000 pounds we should find an ingredient cost of $ .049782 per pound, a processing cost of $ .0035 per pound, and an operating cost of $ .008 per pound. We think the evidence supports this contention and have made a finding to that effect. On the basis of these costs and a selling price per pound of $ .0651073 we have found that the operating profit on 2,000,000 pounds would have been $ 7,650.60. This amount represents the earning level petitioner would have reached in its ice cream mix department by the end of the base period if it had made the change two years earlier. Since the amount is in excess of the actual earning level that was reached by the end of the base period, petitioner, under the statute, "shall be deemed to have * * * made the change at such earlier time."Before it can be determined whether the average base period net income does reflect the normal operation for the entire base period, we think it is necessary to determine what the normal operation for1947 U.S. Tax Ct. LEXIS 214">246 the entire base period would have been on the assumption, which must be made, that the change occurred two years earlier, and then compare that normal operation with the average base period net income of $ 11,397.59.We have found that on the assumption that petitioner would have manufactured and sold 2,000,000 pounds of mix in 1939, it would have manufactured and sold 1,506,600 pounds in 1936, 1,668,200 pounds 8 T.C. 928">943 in 1937 and 1,934,920 pounds in 1938. 3 We have also found that the selling price per pound in 1938 was $ .0708329. This was the actual selling price of the 490,515 pounds which petitioner actually manufactured and sold in 1938. We have also found that the selling prices per pound in 1936 and 1937 were $ .0819089 and $ .0824337, respectively. This is in accordance with Harlan's testimony to that effect and is in harmony with the average price of milk paid producers in the United States during those years as compared with the same prices paid in 1939. The parties are agreed upon the ingredient costs per unit set out in our findings. The processing and operating costs per unit which we have found in our findings are those suggested by the respondent and are substantially1947 U.S. Tax Ct. LEXIS 214">247 the same as the costs requested by petitioner, except that they are a little higher, due to our finding of a much lower production for those years than petitioner had requested. The evidence showed that those costs increased as production decreased and vice versa. These findings all add up to the result that, if petitioner had made the change two years earlier, an assumption which must be made, the normal operation of petitioner's ice cream mix business for the entire base period would have shown operating profits for those years of $ 8,620.01, $ 9,848.55, $ 17,703.93, and $ 7,650.60, respectively. When these amounts are added to petitioner's income from its other departments and compared with the average base period net income of $ 11,379.59, we think petitioner has shown that its average base period net income does not reflect the normal operation for the entire base period and that its average base period net income is an inadequate standard of normal earnings. It follows that its tax computed without the benefit of section 722 shall be considered excessive and discriminatory and we have so found as ultimate facts in our findings.1947 U.S. Tax Ct. LEXIS 214">248 Much of what we have already found goes to the establishment of (2) mentioned at the beginning of this opinion, namely, a fair and just amount representing normal earnings to be used as a constructive average base period net income under section 722 (a). Petitioner has requested us to find that its constructive average base period net income to be used in lieu of its actual average base period net income for both the taxable years here involved is $ 37,536.39, computed as follows: 8 T.C. 928">944 19361937Net income as reported$ 2,859.72$ 2,524.46Eliminate:Losses from operation of Greenville plant4,361.226,144.09Actual profit from ice cream mixBalance7,220.948,668.55Add:Excess cost of milk due to competition11,129.325,879.15Constructive profit from ice cream mix18,251.6320,614.95Constructive net income36,601.8935,162.65Constructive average base period net income(general average)19381939Net income as reported$ 5,420.70$ 11,570.82Eliminate:Losses from operation of Greenville plantActual profit from ice cream mix765.561,531.13Balance4,655.1410,039.69Add:Excess cost of milk due to competition5,740.449,618.99Constructive profit from ice cream milk30,850.8417,475.90Constructive net income41,246.4237,134.58Constructive average base period net income(general average)37,536.391947 U.S. Tax Ct. LEXIS 214">249 The respondent, in his brief, while contending that petitioner has not established that it is entitled to reconstruct its average base period net income for Greenville book losses or the commencement of the manufacturing of ice cream mix, nevertheless argues that, even conceding that petitioner had established its right to both (b) (2) and (b) (4) grounds, its constructive average base period net income would be $ 11,787.51 to be used in lieu of the $ 11,397.50 allowed petitioner under section 713 (f). Respondent, in his brief, gives the details of his computation in arriving at the above figure of $ 11,787.51 constructive average base period net income, but they need not be set out here. Suffice it to say we do not agree with the computation of respondent, nor do we agree with the one which petitioner has made.As disclosed in our findings of fact, we are unable to find that petitioner has established a constructive average base period net income of $ 37,536.39. Instead of this amount, we have found in the last paragraph of our findings that petitioner has established a constructive average base period net income for the taxable years 1941 and 1942 in the amount of $ 15,975.53. 1947 U.S. Tax Ct. LEXIS 214">250 In making this finding, we have not permitted petitioner to eliminate the losses from the operation of the Greenville plant or to add as constructive net income any amount for excess cost of milk due to competition, as petitioner has done in its above computation, for the reason that in our opinion petitioner has not shown that its average base period net income is an inadequate standard of normal earnings because of the factors mentioned in section 722 (b) (2).The respondent in his computation of the constructive average base period net income has added as "Constructive profit from ice cream mix" the amounts of $ 5,501.97 for 1936; $ 5,570.61 for 1937; $ 2,886.21 for 1938; and $ 2,606.98 for 1939. These amounts are considerably less than the amounts which petitioner contends should be added as constructive profit from ice cream mix, and we think they are too low. For reasons which we have already stated, we have found that the constructive profit from ice cream mix for each of the base period years was $ 8,620.01, $ 9,848.55, $ 17,703.93, and $ 7,650.60, respectively. We 8 T.C. 928">945 hold that these amounts should be added in place of the amounts contended for by the parties. 1947 U.S. Tax Ct. LEXIS 214">251 These computations have been made in our findings and, as there indicated, we have found that petitioner's constructive average base period net income to be used in computing credit in the taxable years 1941 and 1942 is $ 15,975.53 instead of $ 37,536.39 contended for by petitioner and instead of $ 11,787.51 computed by respondent in his brief.In his brief the respondent suggests that, once having determined the constructive net income for the year 1939, "a much more reasonable approach to a reconstruction" for all the base period years would be to use a general business index method, as was done in East Texas Motor Freight Lines, supra. On January 23, 1947, the Excess Profits Tax Council E. P. C. 8, Internal Revenue Bulletin No. 6, page 4, refers to Mimeograph 5807, 1945 C. B. 273, and to our holding in the East Texas Motor Freight Lines case, and says in part: "Only when no better, more appropriate, data are available should a general business index be used." Petitioner has supplied that "better, more appropriate, data" in the instant case, namely, it has proved "detailed reconstruction of sales, costs, or expenses" (Bulletin, 1947 U.S. Tax Ct. LEXIS 214">252 part V, subpart II (C) (4) (b) (i), page 110 and quoted in the East Texas case at 7 T.C. 594) for all the base period years. That being true, we are of the opinion and so hold that a general business index method should not be used in the instant case.Petitioner's excess profits tax liabilities for the calendar years 1941 and 1942 should be redetermined by using a constructive average base period net income credit for both years of $ 15,975.53 in lieu of the actual average base period net income of $ 11,397.59 which petitioner used in its excess profits tax returns for those years.Reviewed by the Special Division.Decision will be entered under Rule 50. Footnotes1. Since petitioner did not have a separate department for ice cream mix in 1938, both parties have estimated the actual profit for that year as being one-half of the actual profit for the year 1939.↩2. 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 a 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 * * .(b) Taxpayers Using Average Earnings Methods. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because -- * * (2) the business of the taxpayer was depressed in the base period because of temporary economic circumstances unusual in the case of such taxpayer or because of the fact that an industry of which such taxpayer was a member was depressed by reason of temporary economic events unusual in the case of such industry, * * (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 purposes 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, a difference in the ratio of nonborrowed capital to total capital, and the acquisition before January 1, 1940, of all or part of the assets of a competitor, with the result that the competition of such competitor was eliminated or diminished. * ** * * *↩3. This finding is arrived at by applying to 1939 poundage the ratio that production of ice cream in Texas during the years 1936, 1937, and 1938 bears to such production in 1939. This method was used by both petitioner and respondent in their reconstructions, as will be seen from the following quotation from respondent's brief: "The respondent has made a reconstruction of petitioner's sales of ice cream mix on the basis of sales of 2,000,000 pounds in 1939. The pounds sold in the years 1936, 1937 and 1938 are arrived at by the same method used by petitioner, i. e., applying to 1939 poundage the ratio that production of ice cream in Texas in the years 1936, 1937, and 1938 bears to such production in 1939." As both parties use the same general method in their suggested reconstructions, we have adopted it.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621029/	JOHN N. DERSCHUG, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Derschug v. CommissionerDocket No. 18064.United States Board of Tax Appeals15 B.T.A. 306; 1929 BTA LEXIS 2877; February 11, 1929, Promulgated 1929 BTA LEXIS 2877">2877 1. In 1919 the petitioner received $45,000 in consideration of an agreement to transfer on January 2, 1920, certain shares of stock owned by him in the Syracuse Washer Corporation. In his income-tax return for 1919 he returned the $45,000 thus received as taxable income and paid the tax due upon such return. The Commissioner has held this amount to be taxable income of the petitioner for 1920. Held, that the $45,000 in question was taxable income for the year 1919. 2. In part consideration of the contract above referred to, the petitioner, in 1920, received 10,010 shares of class A common stock of the Syracuse Washing Machine Corporation which he returned in his income-tax return in 1920 as having a fair market value at the date of receipt of $1 per share. The respondent has held that this stock had a fair market value on the date of receipt of $10.94 a share. Held, that the fair market value of the stock at the date of receipt was not in excess of $1 per share. Edmund H. Lewis, Esq., for the petitioner. Arthur Carnduff, Esq., for the respondent. SMITH 15 B.T.A. 306">306 This is a proceeding for the redetermination of a deficiency in income1929 BTA LEXIS 2877">2878 tax for 1920 of $89,340.63. The points in issue are (1) whether $45,000 received by the petitioner in 1919 was income of that year or of the year 1920, and (2) whether 10,010 shares of class A common stock of the Syracuse Washing Marchine Corporation received by the petitioner in 1920 had any fair market value at the date of receipt, and, if so, how much. FINDINGS OF FACT. The petitioner and one Guy C. Wilkinson were in 1919 the sole owners of the entire outstanding capital stock of the Syracuse Washer Corporation, which was engaged at Syracuse, N.Y., in the manufacture of washing machines. The corporation had very limited capital, 15 B.T.A. 306">307 crude machinery and equipment, and restricted facilities and quarters. During 1919 its business developed very rapidly and gave such attractive promise of earning power that numerous promoters representing engineering and banking interests endeavored to induce the petitioner and Wilkinson to join them in plans for providing additional capital and for enlarging the corporation's operations through the organization of a new corporation with larger capital resources. A syndicate was organized by Bioren & Co., bankers of New York City, 1929 BTA LEXIS 2877">2879 to organize a new corporation by the name of Syracuse Washing Machine Corporation. On December 19, 1919, Bioren & Co. addressed a letter to the board of directors of the Syracuse Washing Machine Corporation, in which it offered to subscribe or to obtain subscriptions for $999,000 par value of the authorized convertible preferred stock of this new corporation at par and the banking concern agreed "that $99,000 in par value thereof shall be subscribed and paid for in cash on December 22nd, 1919, and the balance thereof subscribed and paid for on January 2nd, 1920." On December 18, 1919, the petitioner and Wilkinson addressed a letter to the board of directors of the new corporation, which provided as follows: SYRACUSE, NEW YORK, December 18th, 1919.To the Board of Directors of Syracuse Washing Machine Corporation.DEAR SIRS: In consideration of the payment by you to us of the sum of $73,000. ($45,000 to be paid to John N. Derschug and $28,000 to be paid to Guy C. Wilkinson) on the 22nd day of December, 1919, we hereby offer to transfer or cause to be transferred to your Corporation on the 2nd day of January, 1920, the entire capital stock, being 600 full paid nonassessable1929 BTA LEXIS 2877">2880 shares without nominal or par value of Syracuse Washer Corporation, a New York corporation. This transfer shall be free and clear of debt against said Syracuse Washer Corporation or said capital stock thereof, except the ordinary trade accounts payable and accruals of said Syracuse Washer Corporation, and a note signed by us at The Syracuse Trust Company to the amount of $46,000, with interest at the rate of 6% per annum from September 30, 1919. The payment of such note and interest to be made by you on January 2nd, 1920, contemporaneously with our delivery of said 600 shares, and you thereupon to receive the entire number of said shares. Upon the delivery of said certificates representing said 600 shares, the Syracuse Washer Corporation shall deliver to you a bill of sale, transferring to your Corporation all its fixed plant and equipment, inventories, cash, bank accounts, accounts receivable, trade acceptances receivable, contracts in course of performance, unexpired insurance and other prepaid or deferred items, books of account, files, records, all patents and other rights for the United States, and the one-half interest in the patent rights for foreign countries now owned1929 BTA LEXIS 2877">2881 by said Syracuse Washer Corporation, as well as all other tangible and intangible assets then owned by said Syracuse Washer Corporation, and the business of said Syracuse Washer Corporation as a going concern. 15 B.T.A. 306">308 In consideration for such transfer, there shall be issued to us contemporaneously therewith 12,510 shares of the Class A Common Stock of your Corporation in two certificates therefor; one for 10,010 shares in the name of the undersigned John N. Derschug, and 2,500 shares in the name of the undersigned Guy C. Wilkinson, and the further payment to the undersigned of $73,000 in cash, of which cash $45,000 shall be paid by a check to the order of the undersigned John N. Derschug and $28,000 by a check to the order of the undersigned Guy C. Wilkinson, and as further consideration for said transfer it is understood that your Corporation shall be liable for payment of excess profits and income taxes, as well as all other taxes resulting from the manufacturing operations of said Syracuse Washer Corporation up to January 1, 1920. (Signed) JOHN N. DERSCHUG (Signed) GUY C. WILKINSON. The offer in the above-mentioned letter was accepted by the corporation, which made1929 BTA LEXIS 2877">2882 payment of $45,000 to the petitioner and $28,000 to Wilkinson by checks on the Syracuse Trust Co. dated December 22, 1919. The petitioner received his check for $45,000 and deposited it to his personal credit in the Syracuse Trust Co. on December 23, 1919. This amount was charged to the payor's account by said trust company on the same date. The petitioner kept his books of account and made his income-tax returns for 1919 and 1920 upon a cash receipts and disbursements basis. In his 1919 return he accounted for the $45,000 received by him on December 22, 1919, and paid the tax shown to be due by his return. On January 2, 1920, all of the several parties to the above referred to offer and acceptance performed the same in absolute harmony with all the requirements set forth in the letter above quoted, dated December 18, 1919. The Syracuse Washer Corporation was liquidated and in due course it was dissolved and its charter canceled. Additional transactions were also carried out on January 2, 1920, as follows: (1) The corporation sold 14,000 shares of its preferred stock having a par value of $100 each for $1,362,500. (2) The corporation induced the petitioner to execute1929 BTA LEXIS 2877">2883 a so-called employment contract obligating him to give his services exclusively to it for a period of five years beginning January 1, 1920, and for a salary consideration therein specified. Execution of this contract by the petitioner was accompanied by a certain deed of trust, executed contemporaneously by the corporation and the petitioner and the Syracuse Trust Co., pursuant to which $270,000 was paid over on that date to the trust company for the sole benefit of and for eventual absolute delivery to petitioner. On the same date and in the same manner $68,000 was paid "in trust" to the same trust company to secure execution of a similar employment contract by 15 B.T.A. 306">309 Wilkinson. The total amount of money thus paid out by the corporation on January 2, 1920, to secure the execution of the two so-called service contracts was $338,000. (3) On the same date the corporation created and set up on its balance sheet as assets: Good will$200,000Patents300,000(The cost of the patents to the Syracuse Washer Corporation was $2,824.) (4) On January 2, 1920, the corporation issued 6,000 shares of class A common stock for a consideration of $1 per share, certain1929 BTA LEXIS 2877">2884 creditors of the corporation receiving the stock in lieu of cash in liquidation of a bona fide and recorded credit given by the corporation for personal and professional services actually rendered in connection with the organization of the corporation and the acquiring of the old corporation. On December 22, 1919, the corporation charged the expenditure ($45,000 to Derschug and $28,000 to Wilkinson - total $73,000) to an account styled "Syracuse Washer Contract with J. N. Derschug and G. C. Wilkinson." On January 2, 1920, when the obligations created by the agreement or contract were duly satisfied by performance, the above account was closed by transfer to an account created on that date and styled "Cost of Syracuse Washer Corporation Stock and Assets," which account was in turn and on the same date dissolved by charges and credits which created miscellaneous asset and liability accounts. After January 2, 1920, there was no sale of the new corporation's common stock earlier than December, 1920. During this interval the corporation's preferred stockholders had been clamoring for dividends upon their stock and, in December, 1920, the common stockholders to keep the corporation1929 BTA LEXIS 2877">2885 from being placed in the hands of a receiver purchased 10,000 additional shares of common stock at $25 per share. Prior to that date no market could be found for 30 shares of the common stock owned by a widow, which were acquired by inheritance. The corporation's officers refused to purchase them. The following circumstances confronted the corporation on January 2, and later during 1920: (1) From the date of its organization the corporation was obligated on written contracts made by the old corporation for the purchase of 100,000 motors at $17 each, a total of $1,700,000, and for 840,000 pounds of copper contracted for at the peak prices of 1919. (2) Sales of washing machines declined gradually from 1,800 in December, 1919, to 800 by the new corporation in December, 1920. 15 B.T.A. 306">310 The fair market value on January 2, 1920, of the class A common stock of the Syracuse Washing Machine Corporation was not in excess of $1 per share. OPINION. SMITH: The petitioner kept his books of account and made his income-tax returns for 1919 and 1920 upon the basis of cash receipts and disbursements. On December 22, 1919, he received $45,000 as a consideration for entering into1929 BTA LEXIS 2877">2886 a contract by which he agreed to dispose of his shares of stock in the Syracuse Washer Corporation for an agreed amount of cash, a given number of shares of class A common stock of a new corporation, and an undertaking on the part of the new corporation to pay a note to a bank upon which he was jointly liable. He considered this to be income received in the year 1919 and treated it accordingly. At the hearing of this proceeding counsel for the respondent stated that the theory upon which the respondent held it to be income of 1920 was: * * That it is a payment on a 1920 contract consummated in the year 1920, otherwise the $45,000 would be a payment on an option to purchase the stock and the assets of the Washer Corporation, and inasmuch as it was a substantial payment, it was a payment on account of the purchase and not a payment of an option, being a part of the purchase price it was income for 1920, as the contract of sale was closed in 1920, consummated in 1920. A reference to the letter of the petitioner and Wilkinson to the board of directors of the Syracuse Washing Machine Corporation dated December 18, 1919, does not show that the $45,000 was to be received as part1929 BTA LEXIS 2877">2887 payment for the assets to be sold by Derschug and Wilkinson. It clearly was not so understood by the petitioner. To secure the $45,000 the petitioner parted with nothing. True, he had undertaken for a consideration named to do certain things on January 2, 1920, that is, to transfer certain assets to the Syracuse Washing Machine Corporation for a named consideration. For a breach of such agreement the petitioner would undoubtedly have been liable for damages. But this does not mean that the $45,000 received was a part payment for the assets sold. It was no part of the consideration named to be received in exchange for assets. If the $45,000 was income to the petitioner, we think it was income in the year 1919 when the petitioner received it and placed it to his credit upon his own books of account. The second point in issue is whether the 10,010 shares of class A common stock of the Syracuse Washington Machine Corporation received by the petitioner in 1920 had a fair market value in 1920 and, if so, how much. In his income-tax return for 1920 and petitioner 15 B.T.A. 306">311 returned the stock as having a value of $1 per share. Presumably this was predicated upon the fact that1929 BTA LEXIS 2877">2888 6,000 shares of the stock were sold on January 2, 1920, for $6,000. The petitioner now contends that the stock had no ascertainable fair market value at the date of receipt within the meaning of section 202(b) of the Revenue Act of 1918, which provides in part as follows: When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any; but when in connection with the reorganization, merger, or consolidation of a corporation a person receives in place of stock or securities owned by him new stock or securities of no greater aggregate par or face value, no gain or loss shall be deemed to occur from the exchange, and the new stock or securities received shall be treated as taking the place of the stock, securities, or property exchanged. The transaction between the petitioner and the Syracuse Washing Machine Corporation was more than an exchange of stock for stock. The petitioner exchanged his shares of stock in the Syracuse Washer Corporation and undertook to perform certain services for the new corporation in exchange for cash1929 BTA LEXIS 2877">2889 and a certain number of shares of class A common stock of the new corporation. The transaction is governed by the first clause of section 202(b) of the 1918 law, above quoted. If the value of the shares of stock received in exchange was in excess of the basis laid down by the statute the excess, in our opinion, constituted taxable income of the petitioner of 1920. The evidence with respect to the value of the class A common stock at the date of receipt by the petitioner is in detail. The Syracuse Washer Corporation had obligated itself to purchase supplies for manufacture beyond its immediate needs. It had likewise obligated itself to employ the petitioner and Wilkinson on five-year contracts at large salaries. In order to produce a surplus upon its balance sheet it had set up good will at a value of $200,000 and had appreciated its patent account to the extent of nearly $300,000. There were no sales of the class A common stock of the new corporation in the open market during 1920 and one holder of 30 shares of the stock acquired by inheritance could find no market for it. Soon after the beginning of 1920 operating conditions became bad and it was questionable whether the1929 BTA LEXIS 2877">*2890 corporation could escape receivership. The corporation sold 6,000 shares of its common stock at $1 per share on January 2, 1920. We think that this evidence indicates that the fair market value of the common stock was $1 per share at the date of receipt. Petitioner's tax liability for 1920 should be redetermined accordingly. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621030/	PERRY L. HALL AND JANICE R. HALL, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Hall v. CommissionerDocket Nos. 25574-86; 25811-86; 26259-86.United States Tax CourtT.C. Memo 1989-187; 1989 Tax Ct. Memo LEXIS 187; 57 T.C.M. 232; T.C.M. (RIA) 89187; April 26, 1989; As corrected April 26, 1989 1989 Tax Ct. Memo LEXIS 187">187 Held, reasonable litigation costs awarded. Dale C. Allen, for the petitioners. Kirk S. Chaberski, for the respondent. NIMSMEMORANDUM OPINION NIMS, Chief Judge: This matter is before the Court on petitioners' Motion to Revise Decision Regarding Rule 231 Motion For Award of Reasonable Litigation Costs filed on October 19, 1988 ("Motion to Revise Decision"). (All Rule references are to the Tax Court Rules of Practice and Procedure. Similarly, all section references are to sections of the Internal Revenue Code as in effect for the year at issue.) Petitioners on whose behalf this Motion was filed are Perry L. and Janice R. Hall, Ray D. and Lily M. Hall, and Kenneth D. and Judy L. Travis and are hereinafter referred to collectively as petitioners. Petitioners previously filed a Motion for Award of Reasonable Litigation Costs pursuant to Rule 231 on November 16, 1987 ("Motion for Costs"). Respondent filed a response to petitioners' Motion for Costs on February 8, 1988. On September 20, 1988, we1989 Tax Ct. Memo LEXIS 187">189 issued a Memorandum Opinion denying petitioners' Motion for Costs. Hall v. Commissioner,T.C. Memo. 1988-450. Respondent originally determined the following deficiencies and additions to tax: Additions to TaxPetitionersYearDeficiencySec. 6653(b)(1)Sec. 6653(b)(2)Perry L. Hall and1982$ 2,925.99$ 1,463.0050% of interestJanice R. Hallon $ 2,925.99Ray D. Hall and198210,848.805,424.4050% of interestLily M. Hallon $ 10,848.80Kenneth D. Travis and19823,786,231,893.1250% of interestJudy L. Travison $ 3,786,23Factual BackgroundPetitioners resided in Morristown, Tennessee, at the time they filed their petitions in this case. Petitioners supplemented their incomes by forming a joint venture called T & H Investments, which was engaged primarily in a refund discounting or purchasing operation. Petitioners' operation generated revenues by purchasing Federal income tax refunds from third-party taxpayers at a discount. Each refund check purchased would then be mailed directly from respondent to petitioners' business address. 1989 Tax Ct. Memo LEXIS 187">190 Petitioners timely filed their own returns with the Memphis Service Center. Respondent performed an internal audit of petitioners' returns using a computer program which produces a list of all refund checks over $ 300 going to a single address known as a "Cumulative Duplicate Address File Printout." Respondent's program generated a list which stated that some 40 checks totaling over $ 100,000 had been sent to petitioners. The printout alerted respondent to petitioners' refund discounting operation which apparently almost automatically resulted in an audit. Petitioners and respondent were unable to come to a settlement agreement. On April 2, 1986, petitioners' files were turned over to District Counsel in Nashville, Tennessee. Respondent issued statutory notices of deficiency on April 14, 1986. Petitioners filed their petitions herein on July 7, 1986. On September 16, 1986, respondent filed his answer in docket No. 25574-86. On September 18, 1986, respondent filed his answers in docket Nos. 25811-86 and 26259-86. Petitioners filed a Motion to Compel Discovery on October 2, 1987. Petitioners' cases were consolidated for trial on November 4, 1987. In preparation for trial, 1989 Tax Ct. Memo LEXIS 187">191 on July 13, 1987, respondent's counsel contacted the Memphis Service Center in an attempt to produce the 40 checks listed on the computer printout. The Memphis Service Center produced only eight checks. It is apparently agreed that the computer program erred in listing 40 checks totaling over $ 100,000. Respondent's counsel thereafter reached a settlement agreement with petitioners. The stipulated settlement agreement provided for the following deficiencies and additions to tax: Additions to TaxPetitionersYearDeficiencySec. 6653(b)(1)Sec. 6653(b)(2)Perry L. Hall and1982$ 1,932.47----Janice R. HallRay D. Hall and1982------Lily M. HallKenneth D. Travis and19822,647.00----Judy L. TravisWe originally denied petitioners' Motion for Costs on the ground that petitioners failed to comply with section 7430(c)(2)(A)(iii) (now section 7430(c)(4)(A)(iii)) which through the mechanism of 5 U.S.C. section 504(b)(1)(B) (1982) requires that a petitioner seeking reasonable litigation costs must be "an individual whose net worth did not exceed $ 2,000,000 at the time the adversary1989 Tax Ct. Memo LEXIS 187">192 adjudication was initiated." In response to our Opinion petitioners filed the Motion to Revise Decision herein, along with individual affidavits for the consolidated petitioners asserting that their individual net worths are "significantly less than" the $ 2,000,000 ceiling. DiscussionWe took under advisement petitioners' Motion to Revise Decision, the essence of which is that petitioners' failure to attach affidavits of their net worths to their Motion for Costs "was excluded by Petitioners' counsel by oversight," with the implication being that such oversight should not bar the Court from reaching the merits of petitioners' claim for costs. Upon due consideration, we agree with petitioners. Although set forth in section 7430(c)(2)(A)(iii), the net worth requirement is not listed in the detailed Motion requirements of Rule 231. Therefore, even though petitioners' counsel erred in his oversight, upon further reflection we agree that it would be unduly harsh in this particular instance to dismiss petitioners' claim before having reached its merits. See Egan v. Commissioner,91 T.C. 705">91 T.C. 705 (1988). Section 7430(c)(2) sets forth the definitional requirements1989 Tax Ct. Memo LEXIS 187">193 of the term "prevailing party" as used in section 7430(a). Section 7430(a) establishes that a taxpayer must satisfy the prevailing party test of section 7430(c)(2) to be entitled to "reasonable litigation costs." Section 7430(c)(2), as amended by the Tax Reform Act of 1986, lists the following three requirements: (1) the government's position in the proceeding was "not substantially justified;" (2) the taxpayer must have "substantially prevailed with respect to the amount in controversy, or [have] substantially prevailed with respect to the most significant issue or set of issues presented;" and (3) the taxpayer, an individual, must have a net worth not exceeding $ 2 million. As discussed above, we now accept the fact that petitioners, respectively, satisfy the net worth requirement. Petitioners, however, must also prove that they satisfy the remaining two tests of section 7430(c)(2) by a preponderance of the evidence. Rule 142. As outlined above, petitioners must first show that respondent's position in the proceeding was not substantially justified. Section 7430(c)(2)(A)(i) (now section 7430(c)(4)(A)(i)). Our analysis proceeds from the time at which District Counsel became1989 Tax Ct. Memo LEXIS 187">194 involved in the dispute and does not include any administrative actions prior to that time. 91 T.C. 705">Egan v. Commissioner, supra; cf. Weiss v. Commissioner,850 F.2d 111">850 F.2d 111 (2d Cir. 1988), affg. 88 T.C. 1036">88 T.C. 1036 (1987), revg. 89 T.C. 779">89 T.C. 779 (1987). We note that the Technical and Miscellaneous Revenue Act of 1988, Pub. L. 100-647, 102 Stat. 3342, inter alia, amended section 7430(a) to confer jurisdiction on this Court to review proceedings and issue a decision therein granting or denying an award for reasonable administrative costs for cases commenced after November 10, 1988. Gantner v. Commissioner,92 T.C. 192">92 T.C. 192, 92 T.C. 192">196 (1989). District Counsel first became involved in this case on April 2, 1986, at which time he proceeded primarily on the basis of the erroneous Memphis Service Center computer printout. District Counsel affirmatively denied in his answer petitioners' assertion that the computer printout was erroneous. Instead of examining the underlying checks, District Counsel questioned, without factual support, petitioners' assertions and continued to allege fraud. Neither District Counsel's answer nor his continuation1989 Tax Ct. Memo LEXIS 187">195 of the case at this point were substantially justified. Stieha v. Commissioner,89 T.C. 784">89 T.C. 784 (1987). Additionally, District Counsel was not substantially justified in his failure to produce checks supporting his computer printout. Respondent's inaction led petitioners to file a Motion to Compel Discovery on October 2, 1987, over one year after District Counsel filed respondent's answer. The Memphis Service Center produced only eight checks, on October 28, 1987, over one year after respondent's answer was filed and over one and one-half years after respondent had first determined additions to tax for fraud against petitioners. Such delay should have put respondent's counsel on notice as to the quality of the evidence involved, or the lack thereof. Although District Counsel requested the checks from the Memphis Service Center on July 13, 1987, and its delay in responding was not necessarily District Counsel's fault, respondent's response and the protracted nature of this litigation support the view that the position of the United States in this case was not substantially justified. The term "position of the United States" includes the position taken by the United1989 Tax Ct. Memo LEXIS 187">196 States in the civil proceeding, and any administrative action or inaction by the District Counsel of the Internal Revenue Service (and all subsequent administrative action or inaction) upon which such proceeding is based. Section 7430(c)(4). (For proceedings commenced after November 10, 1988, see section 7430(c)(7).) The proceeding herein was based on District Counsel's inaction insofar as producing the alleged 40 refund checks from the Memphis Service Center, or for that matter the eight checks which were produced, in a timely fashion. District Counsel explains in his response to petitioners' Motion for Costs that he requested "copies of each refund check which had allegedly been mailed" to petitioners only after it became clear that settlement negotiations would fail and further evidence would be necessary for trial. District Counsel's explanation leads us to conclude that he filed his answer (in which fraud was alleged), and disregarded petitioners' assertion that the computer printout was inaccurate, primarily as an attempt to encourage a settlement most favorable to the government. The computer error in this case highlights the inappropriateness of District Counsel's proceeding1989 Tax Ct. Memo LEXIS 187">197 on the basis of facts presumed true, but unsupported by evidence. Respondent was "not substantially justified" in proceeding with his case when he had no supporting evidence. Petitioners also satisfy the requirements of section 7430(c)(2)(A)(ii) (now section 7430(c)(4)(A)(ii)). They both "substantially prevailed with respect to the amount in controversy" and "substantially prevailed with respect to the most significant issue." Respondent originally asserted a total of $ 17,561.02 in deficiencies and in excess of $ 8,780.52 in additions to tax for fraud against all of the petitioners. The final settlements resulted in a combined liability of $ 4,579.47 for two of the three sets of petitioners and none for the third, or 17 percent of the original determinations in the deficiency notices. Importantly, none of the settlement amount was attributed to fraud as originally determined. Petitioners, jointly and severally, substantially prevailed with respect to the amount in controversy. The most significant issue was whether petitioners failed to report 40 refund checks totaling over $ 100,000. Petitioners "substantially prevailed" with respect to this issue since not 40, but eight1989 Tax Ct. Memo LEXIS 187">198 refund checks were produced by respondent. The 40 refund checks originally alleged must be attributed to computer error in respondent's "Cumulative Duplicate Address File Printout." The final issue to be resolved is the amount, if any, of reasonable litigation costs to be awarded to petitioners. Petitioners' counsel claims $ 5,831.76 in litigation costs. Although we agree that some award is proper, we do not agree with the claimed amount. Petitioners' counsel lists the following amounts billed to petitioners for his services: Date of BillBill NumberAmount8/4/86927$ 1,008.2812/3/861353647.412/3/8717524,470.786/3/872342328.2210/6/872886599.9011/3/8729991,027.17November 88750.00Petitioner's counsel states in his affidavit that the "bulk" of his first four bills were "for preparing for two major appeals conferences and the collection and preparation of follow-up materials requested by the Appellate [Appeals] Division." We reject petitioners' claim for the costs of these four bills. Although District Counsel was involved in petitioners' case by the time these bills were submitted (but not at1989 Tax Ct. Memo LEXIS 187">199 the time the services were rendered), we refrain from awarding costs associated with administrative actions as being outside of the statutory guidelines of section 7430 as it applied for the year at issue. See 91 T.C. 705">Egan v. Commissioner, supra.In addition, we feel that it would be improper to allow the $ 750.00 November 1988 bill which we infer is petitioners' counsel's charge for the Motion to Revise Decision herein. As petitioners' counsel stated in such Motion, his failure to attach net worth affidavits to petitioners' original Motion for Costs was due to his oversight. It would be inappropriate to impose those costs on the government, which costs are the direct result of petitioners' counsel's admitted oversight. This brings us to our final calculation. Petitioners' counsel states that his bills of October 6, 1987, and November 3, 1987, relate to his "efforts in dealing with District Counsel." These bills total $ 1,627.07. We award such amount as reasonable litigation costs within the statutory framework of section 7430. Per Order dated this day, Hall v. Commissioner,T.C. Memo. 1988-450, has been withdrawn. For the foregoing reasons, petitioners' 1989 Tax Ct. Memo LEXIS 187">*200 Motion to Revise Decision will be granted. An appropriate order and decision will be entered.Footnotes1. Cases of the following petitioners are consolidated herewith: Ray D. Hall and Lily M. Hall, docket No. 25811-86; and Kenneth D. Travis and Judy L. Travis, docket No. 26259-86.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621031/	Appeal of THE KINSMAN TRANSIT COMPANY.Kinsman Transit Co. v. CommissionerDocket No. 67.United States Board of Tax Appeals1 B.T.A. 552; 1925 BTA LEXIS 2913; January 31, 1925, decided Submitted November 19, 1924. 1925 BTA LEXIS 2913">2913 In determining the value as of March 1, 1913, of bulk freight vessels in use on the Great Lakes, where the method of valuation is the cost of reconstruction new less depreciation from the date the vessel was built, the rate of depreciation to be applied should be based upon the history of the particular vessel prior to the basic date; and where a formula for computing depreciation or a flat rate of depreciation is alleged to represent the amount of depreciation sustained, its application to the particular property under consideration must be proved by the evidence. Tracy H. Duncan and Wisner W. White, Esqs., for the taxpayer. S. Duffield Mitchell, Esq. (Nelson T. Hartson, Solicitor of Internal Revenue) for the Commissioner. MARQUETTE 1 B.T.A. 552">552 Before IVINS, KORNER, and MARQUETTE. FINDINGS OF FACT. The Kinsman Transit Company is an Ohio corporation and appeals from a proposed assessment of income and profits taxes for the calendar years 1917 and 1919 as set forth in the Commissioner's letter mailed June 27, 1924, and amended as to 1919 by letter mailed August 26, 1924. The taxpayer is engaged in the transportation of bulk freight upon1925 BTA LEXIS 2913">2914 the Great Lakes in what are known as bulk freight steamers. On March 1, 1913, the taxpayer was the owner of four such steamers named Henry Steinbrenner, Anna C. Minch, Philip Minch, and Matthew Andrews. The additional tax herein results from the value as of March 1, 1913, of said four vessels as fixed by the commissioner, and the allowance for depreciation and obsolescence computed thereon. In computing the March 1, 1913, value of these vessels both the taxpayer and the Commissioner used the cost of reconstruction new as of March 1, 1913, less depreciation from the time each vessel was built, to that date, and the difference as representing the March 1, 1913, value. An extensive hearing was had before the Commissioner at which the taxpayer presented its evidence and, in computing the depreciation sustained to March 1, 1913, the Commissioner upon the evidence before him, has used a flat rate of 3 per cent per year based upon a useful life of 33 1/3 years; the taxpayer contends for a formula based upon progressive depreciation, at the rate of 1 per cent for the first 5 years, 2 per cent for the second 5 years, and 3 per cent for the succeeding 10 years. None of the vessels1925 BTA LEXIS 2913">2915 is more than 20 years old and the formula has not been extended beyond that period. It is stipulated that reconstruction cost new at March 1, 1913, and date of construction of each of the vessles is as follows: Vessel.Reconstruction cost.Date built.Henry Steinbrenner$277,620November 1, 1901.Anna C. Minch261,320May 21, 1903.Philip Minch327,810May 15, 1905.Matthew Andrews373,350April 15, 1907.1 B.T.A. 552">553 No testimony has been presented to the Board tending to show the actual depreciation sustained by the above vessels between the date of construction and the basic date of March 1, 1913, or the application of the taxpayer's formula to the vessels here under consideration, and the only question before the Board is whether the method employed by the Commissioner in computing depreciation for the purpose of ascertaining value is proper. DECISION. The determination of the Commissioner is approved. OPINION. MARQUETTE: The taxpayer herein has appealed from a determination of the Commissioner proposing to assess additional taxes for the years 1917 and 1919. The additional taxes result from the action of the Commissioner in fixing1925 BTA LEXIS 2913">2916 the value as of March 1, 1913, of four bulk freight steamers operated by the taxpayer on the Great Lakes. The method of valuation adopted by the taxpayer and the Commissioner was the cost of reconstruction new as of March 1, 1913, less depreciation sustained from the date when the vessels were built. Both parties are agreed upon the reconstruction cost as of March 1, 1913, and the difference between them arises from the method used to calculate the depreciation to be deducted to March 1, 1913, in determining the value as of that date. The Commissioner, upon the evidence before him, has deducted a flat rate of 3 per cent a year based upon a useful life of 33 1/3 years; the taxpayer contends that vessels do not depreciate at a flat rate but that the depreciation is progressive over the life of the vessels and has, in its evidence, presented a formula prepared by a marine engineer of large experience, corroborated by the testimony of other experts based upon their observation over a period of years, to the effect that the actual incidence of physical depreciation in property of this character is 1 per cent per year during the first 5 years; 2 per cent per year during the second 51925 BTA LEXIS 2913">2917 years, and 3 per cent per year during the next 10 years. This formula has been applied by the taxpayer to the reconstruction cost of its vessels as of March 1, 1913, and it is claimed that such reconstruction cost less the depreciation thus computed represents the value of the vessels as of that date. We have no evidence before us pertaining to the amount of depreciation sustained by the particular vessels under consideration prior to March 1, 1913, or of the applicability of the formula thereto. The testimony adduced by the taxpayer is in the form of affidavits by experts and is general in character. The Commissioner has stipulated that the witnesses, if present, would testify to the matters set forth in their respective affidavits. The following excerpt from the affidavit of H. A. Merriman, an engineer of 25 years' experience upon the Great Lakes in building and designing ships of the kind under consideration, expresses the reasons inducing his conclusions, and in effect contains the basic reasons set forth in the other affidavits. He says: When the vessel is new she is not only sound in all her parts but those parts are properly proportioned to bear their share of the1925 BTA LEXIS 2913">2918 strains and so 1 B.T.A. 552">554 each part aids the other; but as the vessel is subjected to successive strains and repairs, one part and then another weakens, each in turn lessening the support it should give to other parts. Then, too, repairs do not give back the full strength to the repaired part in all cases and as the repairs increase this failure to give back full support to other parts is increased. Damages to the structure are frequent in the Lake trade. The repairs to these damages, while apparently adequate and substantial, are generally made by the removal of the damaged material, rerolling or reconditioning of some, and replacement of the original material. It is obvious, therefore, that the parts removed or disturbed, which have been subjected to the treatment described, will set up a depreciation that was not present in the early years of the vessel's life. In addition to the depreciation due to repairs, these vessels are subjected to very hard use in unloading and the continued pounding of the clamshell buckets in the cargo holds tends to crystallize that part of the structure. Further, the continued vibration of the entire structure, due to the propelling machinery1925 BTA LEXIS 2913">2919 and heavy seas, has a tendency to crystallize the material. An investigation of this point was made by English experts some years ago and brought to light disturbance in the materials especially around rivet holes, which required renewal of plates at many places in the vessel's structure. It will be seen, therefore, that this crystallization is an increasing factor as the vessel grows older, thereby influencing the rate of depreciation that should be used in determining the physical depreciation. No testimony was introduced by the Commissioner relating to the actual depreciation of this species of property or of the particular vessels in question, and we are left to draw our conclusions from that presented by the taxpayer. The Commissioner apparently relies upon the fact that from all the evidence adduced before him he was justified in applying a flat rate of depreciation based upon the estimated life of the property which, when deducted from the reconstruction cost new on March 1, 1913, represented the value as of that date as nearly as it could be determined. There are a number of methods of computing depreciation which lead to widely different results and each method1925 BTA LEXIS 2913">2920 has its particular advocates. Experts themselves admit that it is a guess even when based upon inspection or relevant facts, yet we are asked to adopt a formula which can be applied to bulk freighters as a theoretical yardstick in measuring the depreciation sustained by them over a period of years, without any showing of the actual depreciation sustained by the particular vessels herein. This we decline to do, and the reason therefor must be obvious. Assume two vessels in all respects alike, launched at the same time and costing the same amount. Due to accidents, use or abuse, neglect of repairs, and the numerous hazards incident to navigation, at the end of ten years one of the vessels may be ready for the scrap heap, while ordinary prudence in the use of the other and freedom from accidents may keep down depreciation to the minimum. If, however, we apply the formula suggested, both vessels would be of equal value at the end of any particular period, and the same result would ensue from the application of a flat rate of theoretical depreciation. We are not prepared to countenance such results. The value of any vessel at a particular time is a question of fact which must be1925 BTA LEXIS 2913">2921 proved by competent evidence. The reconstruction cost less actual depreciation sustained is important evidence of value and has in it important elements to prove either the market value or actual value; but depreciation is ordinarily something to be concretely determined by inspection, and in determining the rate of depreciation to be applied to property of the character herein for the purpose of ascertaining value as of a 1 B.T.A. 552">555 particular date in the past, it is highly important that the history of the vessel, the character of repairs, the actual use to which the vessel has been put, and all relevant facts tending to show the depreciation sustained be placed before us, and upon these facts, assisted by the testimony of such expert witnesses as may be produced, a fair judgment can be exercised as to the amount of depreciation sustained which will more nearly approximate the actual depreciation sustained than the application of a formula or flat rate of theoretical depreciation which only serves to produce grotesque results. The testimony of the taxpayer's witnesses, excerpts from which we have quoted, goes to show that all of the above facts are important in arriving at depreciation, 1925 BTA LEXIS 2913">2922 and all of them, working together or singly, may have a large influence upon the amount of depreciation which will occur over and beyond repairs and replacements made. Weaknesses, no doubt, are developed in some vessels which do not appear in other and crystallization may take place in one more rapidly than in another. In fact, every use to which a ship is put may have its effect upon the amount of depreciation sustained, and it is not a fair criterion to measure the depreciation of one ship by the depreciation of another which may have had a totally different history, and we do not think any formula has been, or can be, devised, which by its application will in any case approximate the fact, unless it is purely accidental. As we have heretofore said, no evidence is before us with respect to the depreciation sustained by the particular vessels in controversy, and we have no knowledge as to the character of the testimony which was presented before the Commissioner, other than the affidavits which we have quoted. These are of general application and have no reference to the depreciation sustained by the taxpayer's vessels. The effort has been to secure the adoption of a general1925 BTA LEXIS 2913">2923 formula which can be applied to all vessels of the character described herein, which, when applied to the reconstruction cost new, will give the value of every vessel as of the specified date, without evidence showing the actual depreciation. Depreciation is a matter of judgment, and must be determined from evidence rather than by mathematics or formulas. The Commissioner has exercised a judgment from the evidence before him and has determined that a flat rate represents the depreciation sustained. It may be that from all the testimony he was justified in applying a flat rate based upon the life of the property, and, for aught we know, that rate may have fairly represented the actual depreciation sustained. We are not in a position to dispute his judgment. We think that as evidence of value, where the reconstruction cost less depreciation is used, that cost, less the actual depreciation sustained, more nearly represents the actual value at a given time than a formula or flat rate based upon useful life, if arbitrarily applied. Both methods employed are open to serious objections in ascertaining value as of March 1, 1913, and the application of either method, without1925 BTA LEXIS 2913">2924 evidence to show that it fairly represents the depreciation actually sustained, may lead to unjust results to the one party or the other. It is our opinion that in determining value as of a particular date of property of the character herein, cost less theoretical depreciation, or reconstruction cost less theoretical depreciation, does not necessarily prove either the actual or market value and may not even approximate such values. 1 B.T.A. 552">*556 We are therefore constrained to reject the formula presented by the taxpayer herein for determining the depreciation its vessels had sustained to March 1, 1913, as no evidence is before us tending to show that it represents the depreciation in its vessels, and we can not say that the Commissioner's determination was wrong or that the rate of depreciation applied did not, from the evidence before him, fairly reflect the value of the taxpayer's vessels as of March 1, 1913. The determination of the Commissioner is therefore approved.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621032/	Charles W. Swingle, Jr. v. Commissioner.Swingle v. CommissionerDocket No. 72368.United States Tax CourtT.C. Memo 1959-135; 1959 Tax Ct. Memo LEXIS 106; 18 T.C.M. 594; T.C.M. (RIA) 59135; June 30, 1959Philip G. Johnson, C.P.A., Sharp Building, Lincoln, Neb., for the petitioner. Arthur B. Bleecher, Esq., for the respondent. WITHEYMemorandum Opinion WITHEY, Judge: The respondent has determined a deficiency in petitioner's income tax for 1953 in the amount of $131. The sole issue presented for our decision is the correctness of the respondent's action in determining that a portion of the capital losses of a testamentary trust may not be deducted by the income beneficiary in computing his taxable income. All of the facts have been stipulated and are found accordingly. Petitioner Charles W. Swingle, Jr., is a resident of Lincoln, Nebraska, and filed his income tax return for 1953 with the director at Omaha, Nebraska. Petitioner is a nephew1959 Tax Ct. Memo LEXIS 106">107 of Calvin L. Swingle, deceased, who was a resident of Lancaster County, Nebraska, and who died on July 5, 1952. The will of Calvin L. Swingle was admitted to probate in the County Court of Lancaster County, Nebraska, on August 11, 1952. The will of Calvin L. Swingle created two trusts, hereinafter designated Trust A and Trust B. According to the terms of Trust A, the decedent's widow, Alma Swingle, possessed the right to receive the net income of the trust for life and the power to invade the corpus of the trust with respect to certain specified property. In addition, Alma Swingle was given the power to appoint the corpus of Trust A by will. In the event that Alma Swingle should die without making a testamentary appointment of the corpus of Trust A, the property comprising the principal of Trust A was to become part of the corpus of Trust B. Under the provisions of the will of Calvin L. Swingle, his widow was to receive the income derived from Trust B for life. Upon the death of Alma Swingle, the income of Trust B was to be distributed to certain named beneficiaries, the nephews and nieces of the decedent, of whom petitioner Charles W. Swingle, Jr., was one. The remainder interests1959 Tax Ct. Memo LEXIS 106">108 in Trust B were to be distributed to the designated income beneficiaries upon their attainment of age 30. On August 7, 1953, a final distribution of the assets of the estate of Calvin L. Swingle was made pursuant to the order of the County Court of Lancaster County, Nebraska. Among the assets distributed was a 23 per cent limited partnership interest in C. W. Swingle & Company, Ltd., the business of which consisted of rendering inedibles. Pursuant to the order of the County Court of Lancaster County, Nebraska, a 30,000/65,780th part of the 23 per cent partnership interest in C. W. Swingle & Company, Ltd., was distributed to Trust A, and a 35,780/65,780th part of the partnership interest was distributed to Trust B. On August 26, 1953, Alma Swingle and the trustee of Trusts A and B executed a contract pursuant to which it was provided that the 30,000/65,780th part of the foregoing partnership interest in C. W. Swingle & Company, Ltd. (included as part of the corpus of Trust A), was to be transferred to Trust B. Although a distribution of cash in the amount of $414.36 was made by the partnership to the trusts in 1953, no distribution of profits, as such, was made by the partnership1959 Tax Ct. Memo LEXIS 106">109 to the trust during that year. On its partnership return for 1953, C. W. Swingle & Company, Ltd., reported in Schedule K the distributive share of income and credits belonging to the estate of Calvin L. Swingle as follows: a. Ordinary net income$10,028.21b. Net short-term loss(313.72)c. Net long-term loss(2,917.11)d. Contributions(148.92)On its fiduciary return for 1953, the Calvin L. Swingle Trust reported in Schedule G the distributable share of income and credits of petitioner Charles W. Swingle, Jr., a beneficiary of the trust, as follows: a. Share - ordinary income$1,916.25b. Share - short-term capital loss(62.74)c. Share - long-term capital loss(583.42)On his 1953 income tax return petitioner reported as ordinary income received from the trust the amount of $1,916.25 and deducted from income a short-term capital loss of $62.74 and a long-term capital loss of $583.42. The Commissioner determined that the short-term and long-term capital losses sustained by the Calvin L. Swingle Trust in 1953 were not deductible by petitioner. Petitioner concedes that he is taxable upon his share of the distributable income of1959 Tax Ct. Memo LEXIS 106">110 the trust for 1953 under the provisions of section 162(b) of the Internal Revenue Code of 1939. 1 He contends, however, that he is entitled to reduce his share of distributable income by his share of the capital losses realized by the trust in 1953. The respondent's Regulations 118, section 39.162-2(a)(3), define distributable income as follows: 1959 Tax Ct. Memo LEXIS 106">111 "'Income,' as thus used, must be determined in accordance with the following principles: First, such 'income' means, in general, the amount which under the applicable law of estates and trusts is considered income available for distribution to the life tenant, legatee, or beneficiary, as the case may be. Second, there must be eliminated from the income of the estate or trust, determined in accordance with the terms of the trust instrument and State law, items of income which are not includible in income of an individual for Federal income tax purposes. * " The will of Calvin L. Swingle is silent with respect to the treatment of capital gains and losses of the trusts created thereby. Reference to Nebraska law discloses no statute which controls the treatment by a trustee of the capital gains and losses sustained by a trust. However, one decision of the Supreme Court of Nebraska, State v. Bartling, 31 N.W. (2d) 422, involving the construction and constitutionality of a statute governing the treatment of gain or loss arising from the sale of bonds held in trust to provide financing for public schools, contains the following statement at page 427: "Generally when1959 Tax Ct. Memo LEXIS 106">112 bonds, securities, or other properties of a trust are sold at a profit the profit becomes a part of the principal and may not be considered as income. Restatement, Trusts, § 233(b), p. 682; 4 Bogert, Trusts and Trustees, § 823; 2 Scott, Trusts, § 233.1, p. 1258; In re Estate of Gartenlaub, 198 Cal. 204">198 Cal. 204, 244 P. 348">244 P. 348, 48 A.L.R. 677">48 A.L.R. 677; In re Thomson's Estate, 11 Pa. Co. Ct. R. 198. There are recognized exceptions to this general rule. If the trust is a manufacturing or merchandising trust involving buying and selling for profits, the profits are to be considered as income. Restatement, Trusts, § 233(c), p. 683." The petitioner recognizes that, under the law of trusts, the prevailing rule in Nebraska requires that capital losses realized by a trust be charged against trust corpus, but contends that the exception in cases where the trust is engaged in a manufacturing or merchandising business is applicable. However, it is apparent that this exception, as noted by the Supreme Court of Nebraska in State v. Bartling, supra, applies to sales by manufacturers and merchandising outlets of their regular stock in trade. The record before us does not indicate1959 Tax Ct. Memo LEXIS 106">113 that the losses here in question arose from the sale by C. W. Swingle & Company, Ltd., of its normal stock in trade. On the contrary, the schedule attached to the partnership return discloses that the losses resulted from the disposition of corporate stock and commodity futures. Consequently, the recognized exception to the general rule of trust accounting on which petitioner relies is not applicable to the facts here presented. In view of the fact that the law of trusts in the majority of states requires the allocation of capital gains to trust corpus, the amount of income distributable to an income beneficiary may not be increased by the realization of capital gain by the trust. Mary Hadley Case, 8 T.C. 343">8 T.C. 343; William R. Todd, 44 B.T.A. 776">44 B.T.A. 776. Conversely, inasmuch as capital losses sustained by a trust normally must be charged to corpus, as between a trust and its beneficiary, a capital loss realized by the trust is the loss of the trust alone and cannot be deducted by the beneficiary in computing his taxable income. Anderson v. Wilson, 289 U.S. 20">289 U.S. 20; Baltzell v. Mitchell, 3 Fed. (2d) 428; Irma L. Harris, 5 T.C. 493">5 T.C. 493;1959 Tax Ct. Memo LEXIS 106">114 T. Rosslyn Beatty, 28 B.T.A. 1286">28 B.T.A. 1286; J. Cornelius Rathborne, 37 B.T.A. 607">37 B.T.A. 607, affd. 103 Fed. (2d) 301. Accordingly, the capital losses sustained by the Calvin L. Swingle Trust in 1953 are not deductible by petitioner. Decision will be entered for the respondent. Footnotes1. SEC. 162. NET INCOME. The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that - * * (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the legatees, heirs, or beneficiaries, but the amount so allowed as a deduction shall be included in computing the net income of the legatees, heirs, or beneficiaries whether distributed to them or not. As used in this subsection, "income which is to be distributed currently" includes income for the taxable year of the estate or trust which, within the taxable year, becomes payable to the legatee, heir, or beneficiary. * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621034/	OREGON BRASS WORKS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Oregon Brass Works v. CommissionerDocket No. 10949.United States Board of Tax Appeals21 B.T.A. 257; 1930 BTA LEXIS 1887; November 10, 1930, Promulgated 1930 BTA LEXIS 1887">1887 Special assessment allowed. Robert T. Jacob, Esq., for the petitioner. R. W. Wilson, Esq., for the respondent. ARUNDELL21 B.T.A. 257">257 Proceeding for the redetermination of a deficiency of $3,660.08 in income and profits taxes for 1919. The issue is whether the petitioner is entitled to special assessment. FINDINGS OF FACT. The petitioner, an Oregon corporation engaged in the business of molding brass and bronze castings, was organized in 1906 by W. F. Prier and his brother, who were the sole members of a partnership then engaged in a like business under the name of Prier Brothers. The partners transferred the assets of the partnership to the corporation in exchange for all of its capital stock. The value of the assets so paid in for stock can not be determined. 21 B.T.A. 257">258 During the spring of 1913 all of the books of account of the petitioner were burned. Thereafter a new set of books was opened as of December 31, 1912, from such data as were available. After the books had been opened it was ascertained that they were out of balance to the extent that the liability accounts, including capital stock and surplus, exceeded the asset accounts1930 BTA LEXIS 1887">1888 by $19,175.08. There is no explanation in the books as to the basis for arriving at the figures entered in the new books. The stockholder of petitioner who had charge of opening the books died in 1916 and the whereabouts of the bookkeeper who made the entries is unknown. The books were in balance at the close of 1913. The income-tax returns of the petitioner disclose that it earned profits of $17,273.56 in 1910, $11,911.82 in 1911, and $8,052 in 1912. Petitioner's books show that the business was operated at a loss in 1913, when the volume of sales exceeded any of the three preceding years, wages were favorable and the cost of metal was about one cent less per pound than in 1912. In 1919 petitioner's sales amounted to $518,346.43, and net income, $119,921. Since its organization the petitioner has expended a substantial sum in the development of an undisclosed number of formulae for the production of metal for castings manufactured by it. The work connected with the development of such formulae consisted of determining the material, including metal, that should be used in the test, making a casting, and then subjecting the casting to a friction test. If the formula used1930 BTA LEXIS 1887">1889 did not produce the result desired, the process was repeated with a change in the formula until the proper result was reached. It was generally necessary tomake four or five tests in order to accomplish a certain result. The cost of perfecting the formulae was charged to expense. None of it has ever been capitalized. The formulae developed by the petitioner were a material factor in the production of income in 1919. It is impossible to determine the amount spent prior to 1913 in the development of the formulae. During 1913 petitioner did extensive development work in perfecting the line of urns it produced. The cost of developing the urns was charged to expense and none of it has ever been capitalized. The urns developed in 1913 were income-producing assets in 1919. They were not, however, a major factor in the production of income in that year. In 1913 and 1914 sums amounting to $7,595.46 paid out as rent on buildings and for printing were charged to "Building a/c," a capital account. None of the items has ever been transferred to an expense account. W. F. Prier, the petitioner's president and general manager, supervised petitioner's finances, endorsed its papers, 1930 BTA LEXIS 1887">1890 sold its products, 21 B.T.A. 257">259 directed the manufacture of its products, made its purchases, negotiated all of its contracts, and wrote all of the formulae for the metal used in the castings produced. He devoted from fourteen to sixteen hours per day to the performance of his duties. In 1919 he was paid as compensation for his services, the sum of $7,000. This sum is in excess of the amount of salary he received in 1918 from the petitioner. None of petitioner's income in 1919 consisted of gains, profits, commissions or other income, derived on a cost-plus basis from a Government contract or contracts. The parties entered into the following stipulation: It is hereby stipulated between counsel for petitioner and respondent that for the purpose of the determination of petitioner's tax under the provisions of sections 327 and 328 the invested capital for the taxable year 1919 is $128,759.42, the net taxable income $125,148.26. OPINION. ARUNDELL: We assume that the stipulation of the parties quoted at the conclusion of our findings of fact means that the parties are in agreement that the invested capital determinable from available data is $128,759.42, and, if the tax be1930 BTA LEXIS 1887">1891 computed under section 301 of the statute, that sum would be the amount to be used. The petitioner contends, however, and we agree with it, that the invested capital can not be determined in the manner provided by section 326 of the 1918 Act and that sections 327 and 328 must be invoked to reach petitioner's correct tax liability as provided by law. At the time of the organization of petitioner all of its capital stock was issued to the members of the partnership of Prier Brothers in exchange for the assets of the partnership. Petitioner's books of account and other records were destroyed by fire in 1913, and as there are no records showing the assets paid in for stock, it is impossible to determine the value of such property for invested capital purposes. The new books, opened as of December 31, 1912, do not disclose the basis for the opening entries, and the evidence is that they are not accurate and no information is available from which petitioner's invested capital may be determined. Petitioner's high profits were very largely due to the use of formulae which enabled it to turn out a product more accurate and perfect than its competitors. The formulae were developed prior1930 BTA LEXIS 1887">*1892 to and after 1913 by the expenditure of substantial sums, all of which were charged to expense, and, due to the destruction of records, such amounts may not now be segregated and capitalized. Petitioner is entitled to have its profits taxes determined under the provisions of section 328. Further proceedings will be had under Rule 62(c).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621055/	ROBERT CHRISTENSEN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentChristensen v. CommissionerDocket No. 10410-77.United States Tax CourtT.C. Memo 1983-43; 1983 Tax Ct. Memo LEXIS 747; 45 T.C.M. (CCH) 573; T.C.M. (RIA) 83043; January 24, 1983. Robert Christensen, pro se. Randy G. Durfee, for the respondent. DAWSONMEMORANDUM OPINION DAWSON, Judge: Respondent determined the following deficiencies in petitioner's Federal income taxes and additions to tax: Additions to TaxYearDeficiencySec. 6651(a)Sec. 6653(a)Sec. 6654 11973$1,078.24$269.56$53.91$34.3619741,301.65254.7865.0835.74748 The issues are (1) whether petitioner received unreported taxable income during the years 1973 and 1974; and (2) whether he is liable for the additions to tax for failure to file income tax returns, for negligence or intentional disregard of respondent's rules and regulations, and for failure to pay estimated tax. No facts have been stipulated and the petitioner, who declined to testify under oath, did not offer any evidence at the trial of this case. Only sketchy facts can be gleaned from the pleadings. Petitioner resided in Deer Lodge, Montana, when he filed his petition in this case. During the years in issue the petitioner operated a body shop business and for part of 1974 he was employed by Anaconda Motor Company from whom he received wages in the amount of $5,664 on which Federal income taxes of $282.50 were withheld by his employer. In the absence of records, respondent determined that the petitioner received net income from his body shop business operations of $7,053.12 in 1973 and $3,767.78 in 1974. 749 Petitioner asserts that his records were destroyed by fire and are no longer available. He offered no testimony or other evidence with respect to his income, business expenses or deductions for the years in issue. 2In his first response to respondent's request for admissions the petitioner repeatedly stated that he considered the information sought by respondent to be privileged information and he invoked his Fourth and Fifth Amendment rights. This Court, in reviewing the sufficiency of petitioner's response, said in its Order dated May 11, 1982: With respect to petitioner's apparent assertion of the Fifth Amendment privilege, respondent correctly points out that the criminal statute of limitations for prosecuting petitioner for either failure to file or tax evasion has now expired. Code section 6531; See Ryan v. Commissioner,67 T.C. 212">67 T.C. 212, 217 (1976) affd. 568 F.2d 531">568 F.2d 531 (7th Cir. 1977). Wholly aside from the750 fact that the statute of limitations precludes a criminal tax prosecution for the years here in question, it is quite apparent to the Court that petitioner is not asserting the Fifth Amendment because of any genuine fear of incrimination, but he has, from the time he filed documents purporting to be his 1973 and 1974 tax returns to the present date, simply used the Fifth Amendment and other frivolous constitutional arguments as a means to thwart respondent from determining and collecting his tax liabilities. In similar situations, we held that the Fifth Amendment does not protect petitioners from responding to respondent's discovery requests since "the privilege against self-incrimination may be invoked only when an answer to the question posed would expose the petitioner to a real danger of criminal prosecution; remote or speculative possibilities of prosecution for unspecified crimes are not sufficient to justify a refusal to respond." [Citations omitted] McCoy v. Commissioner,76 T.C. 1027">76 T.C. 1027 (1981); and Burns v. Commissioner,76 T.C. 706">76 T.C. 706, 707 (1981). See also Edwards v. Commissioner,680 F.2d 1268">680 F.2d 1268 (9th Cir. 1982); Figueiredo v. Commissioner,54 T.C. 1508">54 T.C. 1508 (1970),751 affd. by unpublished order (9th Cir. 1973). 3Petitioner has not filed Federal income tax returns for 1973 and 1974. On March 12, 1976, he filed two documents on Form 1040 which contained no information as to his income, credits or deductions. On the face of the documents and various attachments appended thereto the petitioner asserted various constitutional rights. Petitioner has the burden of proving that the deficiencies determined by respondent are incorrect. Rule 142(a), Tax Court Rules of Practice and Procedure; Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). Petitioner has introduced no evidence to refute the deficiencies. Consequently, he has failed to carry his burden of proof. The other issues to be decided are whether the petitioner is liable for additions to tax under sections 6651(a), 6653(a), and 6654. Section 6651(a) provides for an addition to tax when a return is not timely filed, unless the failure to do so is shown to be due to reasonable cause; section 6653(a) 752 provides for an addition to tax where an underpayment of tax is due to negligence or intentional disregard of rules and regulations; and section 6654 provides for an addition to tax for underpayments of estimated tax. Since the respondent determined that the petitioner is liable for such additions to tax, the petitioner must carry the burden of proving that he is not so liable. See BJR Corp. v. Commissioner,67 T.C. 111">67 T.C. 111, 131 (1976); Enoch v. Commissioner,57 T.C. 781">57 T.C. 781, 802 (1972). Petitioner introduced no evidence to justify his failure to file returns for 1973 and 1974. In order for a document to constitute a valid return it must contain sufficient information for the Commissioner to compute and assess the liability with respect to a particular tax of a taxpayer. Automobile Club of Mich. v. Commissioner,353 U.S. 180">353 U.S. 180, 188 (1957); Florsheim Bros. Drygoods Co. v. United States,280 U.S. 453">280 U.S. 453 (1930); United States v. Edelson,604 F.2d 232">604 F.2d 232 (3d Cir. 1979); United States v. Johnson,577 F.2d 1304">577 F.2d 1304, 1311 (5th Cir. 1978); United States v. Daly,481 F.2d 28">481 F.2d 28 (8th Cir. 1973);753 and Reiff v. Commissioner,77 T.C. 1169">77 T.C. 1169 (1981). The disclosure of such data must be provided in a uniform, complete, and orderly fashion. Commissioner v. Lane-Wells Co.,321 U.S. 219">321 U.S. 219, 223 (1944). Furthermore, a Form 1040 does not qualify as a return where it does not specifically state the items of gross income and the deductions and credits claimed by the taxpayer. See United States v. Moore,627 F.2d 830">627 F.2d 830 (7th Cir. 1980); Sanders v. Commissioner,21 T.C. 1012">21 T.C. 1012 (1954), affd. 225 F.2d 629">225 F.2d 629 (10th Cir. 1955); see also United States v. Johnson,supra.It is clear from this record that the Forms 1040 filed by the petitioner on March 12, 1976, fall woefully short of constituting returns. Furthermore, he has shown no "bona fide misunderstanding as to his liability for the tax, [or] as to his duty to make a return." United States v. Murdock,290 U.S. 389">290 U.S. 389, 396 (1933). His vague assertion of constitutional violations and his erroneous interpretation of existing case law simply do not convince us that his failure to file was due to reasonable cause. See Muste v. Commissioner,35 T.C. 913">35 T.C. 913 (1961);754 see also Richardson v. Commissioner,72 T.C. 818">72 T.C. 818 (1979); Hatfield v. Commissioner,68 T.C. 895">68 T.C. 895 (1977). Therefore, we sustain the additions to tax under section 6651(a). Petitioner also failed to show that his underpayments of taxes were not due to negligence or intentional disregard of rules and regulations; nor did he show that he did not underpay his estimated taxes. Consequently, we sustain the additions to tax under sections 6653(a) and 6654. Decision will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the years involved herein, unless otherwise indicated.↩2. He made the following statement at the trial: So I really do not have a large defense to this deficiency that they sent me, except that I'll be the only man that went broke in business and owe the tax that I know about. * *↩3. Petitioner's Fourth Amendment claim is without foundation and utterly devoid of merit. See Edwards v. Commissioner,680 F.2d 1268">680 F.2d 1268, 1270↩ (9th Cir. 1982).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4474716/	OPINION. ARundell, Judge: The issues in this case are whether the wife of the petitioner was a bona fide partner in the brokerage firm for the purpose of carrying on a business and sharing in its profits, or whether the partnership was a mere sham, utilized for the purpose of reducing taxpayer’s true tax liability by a pretended distribution of income; or, in the alternative, whether the wife of the petitioner was a bona fide creditor of the partnership. We have found that Edna B. Morris, wife of the petitioner, was a bona fide partner in the brokerage firm. In so finding we have been guided by the tests suggested by the Supreme Court in Commissioner v. Culbertson, 337 U. S. 733, 742, wherein it is stated: * * * Tbe question is not whether the services or capital contributed by a partner are of sufficient importance to meet some objective standard supposedly established by the Tower case, but whether, considering all the facts — the agreement, the conduct of the parties in execution of Its provisions, their statements, the testimony of disinterested persons, the relationship of the parties, their respective abilities and capital contributions, the actual control of income and the purposes for which it is used, and any other facts throwing light on their true intent — the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise. The partnership agreement provided that Edna B. Morris was to be a limited partner, and, as such, she was precluded by New York Partnership Law, art. 8, sec. 93,1 from rendering services to the brokerage firm, and consequently no attempt has been made by petitioner to show that his wife in fact rendered services other than of the most casual or trivial nature. But a partnership may yet exist where only capital and no services are contributed. Commissioner v. Culbertson, supra. It is respondent’s position, however, that Mrs. Morris’ capital contribution had its origin in gifts from her husband, the petitioner, and consequently it did not represent an independent capital contribution on her part sufficient to justify her recognition as a bona fide partner. This contention, we think, is no longer tenable since Culbertson, as the following quoted language from that opinion makes clear: The Tax Court’s isolation of “original capital” as an essential of membership in a family partnership also indicates an erroneous reading of the Tower opinion. We did not say that the donee of an intra-family gift could never become a partner through investment of the capital in the family partnership, any more than we said that all family trusts are invalid for tax purposes in Helvering v. Clifford, supra. The facts may indicate, on the contrary, that the amount thus contributed and the income therefrom should be considered the property of the donee for tax, as well as general law, purposes. The petitioner made an absolute gift to his wife of securities and cash, the total of which represented but 5 or 6 per cent of his total wealth. In making the gifts, petitioner had told his wife that she was to have absolute control of the securities and money as he wanted to interest her in their management because she would undoubtedly inherit a substantial estate from him. He retained no control and stated no limitations or controls over her ownership. The respondent has not attempted to show the contrary. Instead, counsel for respondent has said that he knows of “no question about the complete and unfettered transfer of the stocks, and the cash to her credit.” Petitioner and his wife at all times maintained separate bank accounts and had no joint bank accounts. Neither had a power of attorney in respect to any of the cash, securities, or other property of the other, nor did Mrs. Morris ever return any part of the gifts, above referred to, to petitioner, and the accounts of petitioner and his wife were kept separately on the books of the partnership. The use that Edna B. Morris made of the income derived from her capital contribution also is indicative of the genuineness of the partnership. The petitioner exercised no control over the withdrawal or use of that money by his wife. The money received by Mrs. Morris was put in her personal bank account and was expended as she saw fit. It was not used to discharge family obligations that were properly the petitioner’s, but the money was devoted to her own personal uses, for her own social activities, to purchase personal luxuries, to make gifts to her friends, to contribute to charities in which she was interested, to pay taxes, and to increase her personal securities portfolio. Petitioner continued to discharge his family obligations, to pay household expenses such as rent, wages of three family servants, a child’s clothing and expenses, and the major expenses of maintaining his wife’s wardrobe. Circumstances surrounding the partnership agreement also indicate a valid business purpose. Thus, the method of forming the partnership, viz., by means of a limited partnership, is a common method of financing stock brokerage houses in New York. By actual count, about 40 per cent of the houses on the New York Stock Exchange have limited partners. Again, while it is apparent that petitioner, along with Robert C. Winmill, was one of the firm’s two dominant partners and had thermal decision in business policy matters, the action with respect to the admission of a new partner, Edna B. Morris, had to meet with the approval of all ten partners in the firm. While all the partners, limited or general, received 6 per cent interest on the sums invested in the business, the sliding scale of profits which gave to the active partners a greater share in the profits is not without significance in showing the business basis of the agreement. Nor was petitioner’s participation in the profits of the business lessened when his wife became a partner, but, on the contrary, his share of the profits was increased from 10 per cent to 11% per cent. The Supreme Court said in the Culbertson case (p. 744) : * * * If, upon a consideration of all the facts, it is found that the partners joined together in good faith to conduct a business, having agreed that the services or capital to be contributed presently by each is of such value to the partnership that the contributor should participate in the distribution' of profits, that is sufficient. [Emphasis supplied.] We think that under the facts as detailed in our findings of fact and under the rationale of the Supreme Court’s decision in the Culbertson case, Edna B. Morris should be recognized as a partner in the partnership of Gude, Winmill & Co. It has been suggested that the conclusion we have reached here is contrary to our holding in Ralph C. Hitchcock, 12 T. C. 22, wherein we refused to recognize for income tax purposes the validity of the limited partnership involved in that case. In the Hitehcoeh case we took the view that the petitioner, as donor, never intended to absolutely and irrevocably divest himself of the dominion and control of the subject matter of his purported gifts to his children, and we pointed out that the children were not at liberty at any time to withdraw or assign their interests in the business or possessed of an unqualified right to receive their full share of each year’s earnings. In the instant case petitioner’s gift to his wife of cash and securities was complete and absolute prior to the formation of the partnership, and Mrs. Morris received each year her share of the partnership earnings and disposed of them as she saw fit. We think on the facts the cases are clearly distinguishable. Because the second issue raised by the petitioner, viz., whether or not Edna B. Morris is a bona fide creditor of the firm, is in the alternative, it is rendered moot by our finding with respect to the wife’s status as a bona fide partner. Since we have found that the petitioner’s wife was a bona fide partner in the firm during the calendar year 1944, the amounts of $8,741.48 of ordinary income and $242.65 of net short term capital gain reported by her as distributable income from that business are properly taxable to her rather than petitioner. On this issue the Commissioner is reversed. Reviewed by the Court. Decision will be entered under Bule 50. McKinney’s Consolidated Laws of New York, Ann., Book 38.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4474717/	Hill, J., dissenting: The brokerage firm of Gude, Winmill & Co. was, in my view, a partnership only of its members designated “general partners.” All of such general partners, among whom petitioner was included, contributed services in the operation of the firm’s business. Only four of them contributed capital. Such contribution constituted capital investments which were subject to the risks of the business. In the distribution of the partnership profits it was provided in the partnership contract that interest on such capital investments at the rate of 6 per cent per annum should be paid and that the remaining profits should be apportioned on the basis of stipulated percentages thereof. Such percentages were obviously computed and determined solely upon the estimated value to the firm of the services of the respective general partners. Thus, it appears that such arrangement embraces all the elements necessary to constitute a partnership in fact and in law. It is my opinion that Edna B. Morris, wife of the petitioner, and Viola T. Winmill, wife of the general partner Robert C. Winmill, who are named in the partnership agreement of Gude, Winmill & Co. as limited partners, do not, under the facts here, qualify in any sense as partners in such firm. The status of Viola T. Winmill in this connection is mentioned only because her status is the same as that of Edna B. Morris, with which we are here concerned. Neither of the so-called limited partners made a contribution to the capital of the firm. Neither of them had at any time a capital investment in the firm. Each merely loaned money to the firm. The money so loaned bore interest at the rate of 6 per cent per annum and was not subject to the risk of the business of the firm. Each of the limited partners could have legally demanded a return of her loan at the end of the partnership term, to wit, April 30, 1945. Not only do the articles of co-partnership provide for the repayment of the loans, but also provide in effect that the general partners shall hold the limited partners harmless from partnership losses. Under tha articles oí copartnership the limited partners were to perform no services for the partnership and were to have no voice in the formulation of the policies or the conduct of the business of the firm. In fact, they performed no services and took no part whatever in the conduct of the firm’s business. The rate of interest provided for the use .of the money loaned by the limited partners was by agreement of the partners fixed as a fair compensation for such use. There was paid to Edna B, Morris monthly during the tax year involved the specified rate of interest on her loan. In addition thereto there was credited to her on the books of the firm the stipulated 2 per cent participation in the profits of the firm’s business, no part of which was used in the firm’s business. It was used to pay her taxes and to purchase securities in her name and for her account. I think it clear on the above recital of facts, which is supported by the record, that Edna B. Morris did not contribute either capital or services to the partnership and that she did not join or intend to “join together in the present conduct of the enterprise” of the partnership, and that she did not act “with a business purpose” for the partnership in advancing the $80,000 loan. The only business purpose which she had in making such loan was the personal purpose of receiving profit from such advancement as a loan. It can not be seriously contended under the facts here that Edna B. Morris earned or contributed to the earning of the profits of the partnership either by service rendered or by the money loaned. I think, therefore, it must be held that the profits which she received under the 2 per cent participation arrangement are attributable solely to the earnings of her husband, the petitioner herein, and, accordingly, that he is taxable thereon. Harron and Opper, JJ., agree with this dissent.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4474718/	OPINION. Hill, Judge: In the transaction involving the exchange of petitioner’s old bonds for the securities and cash of the company under section 77 of the Bankruptcy Act, respondent contends that section 112 (b) (3) and (c) (1) of the Internal Revenue Code1 is not applicable because (1) the issuance of 116% shares of common stock by the company in 1944 for interest due petitioner as owner of old bonds from September 1, 1933, to December 31, 1938, constituted ordinary income to the extent of $3,590.06, less $2,132.55 attributable to the period prior to petitioner’s purchase of the old bonds which respondent determined constituted a return of capital to petitioner; (2) $2,250 of the cash received by petitioner in 1944 was in effect payment of interest at the rate of áy2 per cent on the bonds issued on December 29, 1944, as though such bonds actually had been issued on January 1, 1939, and hence constituted ordinary income to petitioner during the year involved; and (3) the $1,050.75 received by petitioner on the 116% shares of common stock issued to him in 1944 was for dividends in arrears and is taxable to the petitioner as ordinary income received in that year. Petitioner argues, however, that “No portion of such stock, securities and money so received may be treated as interest and taxed as ordinary income”; that “This entire exchange meets the requirements of sections 112 (b) (3) and 112 (c) (1) of the Internal Revenue Code and should be taxed solely as prescribed therein.” This is true, he says, because his claim for interest against the debtor (the company) was an integral part of the security representing the entire indebtedness and any stock or securities or property received in exchange therefor was received in exchange for a security within the meaning of the above mentioned sections. Respondent’s basic argument with respect to contention (1) above is that in the transaction involved petitioner surrendered securities (the old bonds) plus a claim for interest in the amount of $3,590.06 which was paid by the issuance to him of 116% shares of common stock of the recapitalized company as heretofore outlined. He then adds that “because the claim for interest is not a security its surrender to the corporation for the 116% common shares cannot qualify as a tax-free exchange under section 112 (b) (3). There is no doubt that those shares of stock issued for the interest in arrears comprised part of the exchange pursuant to the plan of reorganization, as required by section 112 (b) (3). It thus appears that the answer to our problem lies in the determination of whether petitioner’s claim for interest should be considered apart from the bonds, or an integral part of the bonds so that both the principal debt and interest may be termed a “security” within the meaning of that section. After an examination of many authorities on this question, we conclude that the interest may not be considered separately from the principal debt; that each coupon is a part of each bond; and that both together constitute the security. Fletcher, in his Cyclopedia of the Law of Private Corporations, section 2734, states: However, coupons are part of a bond and are affected by its infirmity as well as endowed with its strength and their character is not changed by detaching them from the bond. In section 2737 the following appears: A coupon is part of the debt covered by the mortgage which secures its bonds; and when a coupon is detached from the bond and is owned by one person while another owns the bond, the coupon is still a lien under the mortgage. Matured coupons are “a constituent part of the mortgage debt, and an assignment of them carries with it by implication an interest in the mortgage security.” A definition of securities in section 23 of the Internal Revenue Code recognizes that the coupon is considered part of the security. Section 23 (k) (3) provides as follows: (3) * * * the term “securities” means bonds, debentures, notes, or certificates, or other evidences of indebtedness, issued by any corporation * * * with interest coupons or in registered form. See also Bailey v. County of Buchanan, 115 N. Y. 297; 22 N. E. 155; Real Estate Trust Co. of Philadelphia v. Pennsylvania Sugar Refining Co., 237 Pa. 311; 85 Atl. 365; Oster v. Building Development Co., 213 Wis. 481; 252 N. W. 168, 172. It is thus apparent that there has been compliance with section 112 (b) (3). There is support for our conclusion herein in cases decided by this and other courts. In South Atlantic Steamship Line, 42 B. T. A. 705, the taxpayer in the course of the recapitalization of a corporation exchanged preferred stock upon which cumulative dividends were in arrears for new stock, bonds, and cash. The respondent contended that certain of the securities received by the taxpayer in the exchange were for dividends in arrears on the old stock and were taxable as a corporate dividend. We stated that “the right of the preferred shareholders to receive the dividend arrears was not one which could be divorced from the shares upon which it was based.” Although this case involved dividends, not interest, in arrears, we nevertheless believe the rationale controls here. See also Skenandoa Rayon Corporation, 42 B. T. A. 1287; affd., 122 Fed. (2d) 268; certiorari denied, 314 U. S. 696; Commissioner v. Food Industries, Inc., 101 Fed. (2d) 748; Humphryes Manufacturing Co., 45 B. T. A. 114; Knapp-Monarch Co., 1 T. C. 59; affd., 139 Fed. (2d) 863; 142 Fed. (2d) 456; Globe-News Publishing Co., 3 T. C. 1199; Okonite Co., 4 T. C. 618; affd., 155 Fed. (2d) 24; certiorari denied, 329 U. S. 764. Respondent argues, however, that South Atlantic Steamship Line, supra, is not authority for our conclusion in the case at bar.' He points out that we said in that case that the dividends were in arrears, but had not been declared. He reasons that, if the claim had been for dividends declared prior to the reorganization, “then such claim is separate from and independent of the stock, and must qualify or fail as a ‘security’ by reason of its own present attributes, wholly apart from its origin.” He then compares interest due on a bond to a declared dividend, concluding that neither should be considered part of the security. This argument avails respondent nothing, for, as we have pointed out before, interest due the holder of a bond is part of the principal debt which it represents. The two are not separate and may not be considered apart. We agree with respondent, however, as to contentions (2) and (3), i. e., that the cash adjustment payments do not fall within the purview of section 112 (b) (3) and (c) (1). Section 112 (b) (3) providesthat no gain or loss shall be recognized if stock or securities of a party to a reorganization are “in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation * * In the case here there was both a plan of reorganization and an exchange. But it is important to note that, although the exchange was not consummated until 1944, the effective date of the plan of reorganization was January 1,1939. Hence, we must look to that date to determine which securities were to be included in the exchange and, therefore, which securities come within the provisions of the code sections involved. Those securities were as follows: $25,000 face value of old bonds, together with interest due on such bonds in the total amount of $3,590.06, for new general mortgage. 4% per cent callable, series A, income bonds of a face value of $10,000, plus 150 shares of $100 par 5 per cent participating preferred stock, or a total par value of $15,000, plus 116% shares of common stock, the fair market value of which was stipulated at $3,590.06. The petitioner states that: * * * That date [January 1, 1939] is significant only as the starting point for the determination of the extent of the rights of all participants in the reorganization. It was not until more than four years thereafter that the Supreme Court aflirmed the decision of the District [Court] approving the plan, and it was not until its subsequent acceptance by the vote of creditors in 1943 and the entry on October 11, 1943 of an order by the District Court confirming the plan that anyone had any definitive idea of what he would get out of the reorganization. * * * That date is significant for more than being the “starting point” of the reorganization; it was the effective date of the plan. It is the rights of the participants in the reorganization as of that time that we are interested in here for the purpose of determining the applicability of the sections of the code in question. It is true that respondent, both in the notice of deficiency and the stipulation, treated the $2,371.50 cash received by petitioner with the 150 shares of preferred stock issued to him in 1944 as capital gain. This would seem to indicate that respondent agreed with petitioner that the adjustment payment should be accorded taxability within section 112 (b) (3) and (c) (1). We do not have before us the question of the correctness of such action by respondent. However, despite the fact that respondent so treated such item and thus eliminated it from our consideration here, we are convinced that under the facts and applicable law we can not do otherwise than hold that the other “adjustment payments” do not fit.within the above cited sections. All of the cases cited by petitioner, some of which were discussed and mentioned above, are distinguishable so far as issues (2) and (3) are concerned, for in none of them was there involved adjustment payments made after the effective date of the plan of recapitalization or reorganization. In view of our holding, it is not necessary to discuss the alternative issue raised by respondent. Decision will be entered vmder Rule 60. SEC. 112. RECOGNITION OF GAIN OR LOSS. ******* (b) Exchanges Solhlt in Kind.— .•*• (3) Stock fob stock on reorganization. — No gain or loss shaU be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization. »***•• (c) Gain from Exchanges Not Solely in Kind.— (1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (S), or within the provisions of subsection (1), of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph or by subsection (1) to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shaU be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property. [[Image here]]	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621056/	EASTERN STEAMSHIP LINES, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Eastern Steamship Lines v. CommissionerDocket No.24870.United States Board of Tax Appeals17 B.T.A. 787; 1929 BTA LEXIS 2245; October 7, 1929, Promulgated 2245 1. A taxpayer in 1917 issued mortgage bonds for assets in reorganization and before the end of the year it purchased such bonds for less than their face amount. Held, no income. 2. Taxpayer's property was in 1917 requisitioned by the Government, and the compensation was more than cost. Taxpayer made no application to the Commissioner and gave no bond covering a replacement fund, as required by the regulations prescribed under the statute. Held, the excess was income and no deduction was allowable. Arthur A. Ballantine Esq., and S. Milton Simpson, Esq., for the petitioner. R. W. Wilson, Esq., for the respondent. STERNHAGEN 787 Respondent determined a deficiency of $534,587.52 income and profits tax for the period of eleven months ended December 31, 1917, by (1) treating as income the difference of $1,385,725 between the face value of petitioner's bonds and the lower price at which they were purchased by petitioner in the taxable year, and (2) treating as income $610,035.07, being the excess over cost received by petitioner in the taxable year from the Government for ships requisitioned. The parties have filed a stipulation2246 of facts, which facts are hereby found in the terms stipulated, as follows: 1. Petitioner, Eastern Steamship Lines, Inc., is a corporation which was organized under the laws of the State of Maine in January, 1917, to acquire the properties and business of a corporation owning coastwise steamship properties, the business of which was then being operated by receivers. The steamships plied between Boston and New York and Boston and various points on the Atlantic seaboard. 2. Petitioner was organized pursuant to a plan of reorganization worked out by a committee for the bondholders of Eastern Steamship Corporation. This committee was organized under an agreement dated April 17, 1915. A correct copy of the report of such bondholders' committee, dated August 28, 1916, setting forth such plan of reorganization is introduced in evidence as an exhibit, to be marked Exhibit A. 788 3. The plan of reorganization set forth in Exhibit A was carried out substantially as therein proposed. Substantially all the properties of Eastern Steamship Corporation and all the cash raised by the bondholders' committee pursuant to the plan of reorganization, were acquired by petitioner. 2247 For acquisition of such properties and cash, petitioner issued all its securities, which securities were distributed among the security holders of Eastern Steamship Corporation in accordance with the plan of reorganization. The securities of petitioner so issued and distributed were: $5,700,000 face value first and Consolidated Mortgage 30-Year Non-Cumulative Income Gold Bonds; $740,000 face value Five-Year 5% Debenture Notes; $3,750,000 par value Preferred Stock, being 37,500 shares of a par value of $100 each; $1,687,500 par value Common Stock, being 67,500 shares of a par value of $25 each. 4. The $5,700,000 face value First and Consolidated Mortgage 30-year Non-Cumulative Gold Bonds were issued under an Indenture, a correct copy of which indenture is introduced in evidence as an exhibit to be marked Exhibit B. 5. On or about December 4th and 5th, 1917, petitioner had outstanding in excess of $542,900 facevalue of the above mentioned First and Consolidated Mortgage 30-Year Non-Cumulative Income Gold Bonds issued under the above mentioned indenture and in the form therein set forth. 6. On or about December 4th and 5th, 1917, petitioner purchased from the holders2248 thereof, through the sinking fund trustee, $5,542,900 face value of such income bonds for the total amount of $4,157,175 in cash. Such bonds were retired shortly after acquisition by petitioner. 7. The excess of the face amount of such income bonds over the amount of cash paid therefor was $1,385,725. Such amount of $1,385,725 is the $1,385,725 included by respondent as taxable income of petitioner and referred to in Assignment of Error marked (a) in paragraph 4 of the petition herein, and also referred to in subdivisions (c) and (d) of paragraph 5 of the petition herein. 8. On April 29, 1918, the Board of Directors of petitioner, acting under Article II of the Indenture copy of which is attached hereto as Exhibit B, found that there was no available net income for the year ended December 31, 1917, applicable to the payment of interest on the income bonds issued under said Indenture, and that no interest was due thereon. 9. No interest for the year 1917 was paid by petitioner on account of any of the above-mentioned income bonds outstanding on April 1, 1918. 10. In November and December, 1917, the President of the United States, by virtue of the power and authority2249 vested in him by the Act entitled "An Act making appropriations to supply urgent deficiencies in appropriations for the military and naval establishments, etc., approved June 15, 1917", acting through the Secretary of the Navy, requisitioned and took title to, for use of the United States, for vessels theretofore owned by the above-named petitioner. 11. Such vessels were then known as the "Massachusetts", "Bunker Hill", "Old Colony" and "Boothbay". 12. Pursuant to the notices of the taking of such vessels, appraisals were made by the United States Navy Board of Appraisal to determine the just compensation for each vessel. 13. The amount of compensation so determined for each of said vessels was as follows: Massachusetts$1,350,000Bunker Hill1,350,000Old Colony1,150,000Boothbay100,000Total3,950,000789 14. The amount of compensation so determined for such taking of the above mentioned vessels was paid by the United States to and received by the petitioner in November and December, 1917. 15. The amount of the excess of the compensation so determined and paid in the case of each such vessel over the value as shown by petitioner's2250 books of each such vessel is shown by the following table: SteamerAwardBook valueDepreciationNet differenceBunker Hill$1,350,000$1,252,044.40$33,480.91$131,436.51Massachusetts1,350,0001,251,917.9033,343.26131,425.36Old Colony1,150,0001,000,152.0028,400.52178,248.52Boothbay100,00075,865.802,342.3326,476.533,950,0003,579,980.1097,567.02467,586.9216. In December, 1917, an entry was made upon petitioner's books in respect of such steamships, "Massachusetts," "Bunker Hill," "Old Colony" and "Boothbay" - "to record on the books the difference between the amount awarded by the United States Government and the book value, less depreciation accrued to the date the vessels were commandeered, which amount is reserved as a replacement fund." A correct copy of such journal entry is introduced in evidence as an exhibit to be marked Exhibit C. 17. During the year 1918 the United States paid additional allowances of compensation aggregating $39,036 on account of supplies, ships' stores, etc., on board the above mentioned vessels when taken by the United States. A correct copy of the journal entry made by2251 petitioner with respect to the receipt of such additional allowances is introduced in evidence as an exhibit to be marked Exhibit D. 18. A correct copy of the balance sheet of petitioner as at December 31, 1917, as shown by petitioner's books and as adjusted by respondent, together with the adjustments resulting in such adjusted balance sheet, is introduced in evidence as an exhibit to be marked Exhibit E. 19. The schedule marked Exhibit F correctly sets forth the specifications referred to therein of the vessels - "Massachusetts," "Bunker Hill," Old Colony," and "Boothbay." Such schedule is introduced in evidence as an exhibit to be marked Exhibit F. 20. During the years 1919, 1920, 1921, 1922, 1923 and 1924 petitioner expended in the acquisition of vessels for use on its lines the sum of $5,270,559.66. 21. The expenditures in the acquisition of vessels aggregating $5,270,559.66 were for seven vessels, five of which were constructed for petitioner by shipbuilders under contracts and two of which were existing vessels. The names of the five vessels constructed under contract were the SS Norwalk, SS Cornish, SS Wilton, SS Boston, and SS New York. The names of the existing2252 vessels were the SS H. F. Dimock and SS H. Winter. 22. A correct statement of the dates and amounts of expenditures in acquisition of each of the vessels just referred to is set forth in Exhibit G. Such 790 schedule is introduced in evidence as an exhibit to be marked exhibit G. As shown in such schedule amounts aggregating $39,807.37 were expended on account of the SS Boston and the SS New York in 1925 and 1926. This amount is in addition to the $5,270,559,66 expended during the years 1919 and 1924, inclusive. 23. The schedule marked Exhibit H correctly sets forth the specifications referred to therein and dates of delivery to petitioner of the vessels, "Norwalk," "Cornish," "Wilton," "H. F. Dimock," "H. Winter," "Boston" and "New York." Such schedule is introduced in evidence as an exhibit to be marked Exhibit H. 24. In the audit of petitioner's return for the year 1917 it was determined by respondent that vessel depreciation in excess of that deducted on petitioner's books was properly deductible. A correct copy of the "Revised schedule on sale of vessels to U.S. Government" prepared by the agent of respondent showing the excess of the amounts received on2253 account of the steamships Massachusetts, Bunker Hill, Old Colony and Boothbay as above set forth, over the revised net book value resulting from increased allowances for depreciation, is introduced in evidence as an exhibit to be marked Exhibit I. 25. Exhibit I shows a figure of $610,035.07 as "Revised replacement reserve". This amount is the $610,035.07 added by respondent to the income shown on petitioner's return included by respondent in petitioner's taxable income, and referred to in petitioner's assignment of error, subdivision (b) of paragraph 4 of the petition herein and also referred to in sub-paragraphs (c) and (h) of paragraph 4 of such petition. 26. Petitioner's return did not include as taxable income any amount on account of the payments received for the Massachusetts, Bunker Hill, Old Colony and Boothbay. The respondent first asserted that a taxable profit was realized in this connection in his thirty-day letter, dated March 7, 1923, the original of which is introduced in evidence as an exhibit to be marked Exhibit J. The amount of taxable profit asserted by respondent in such letter on account of such vessels was $506,622.92. 27. On or about March 27, 1923, petitioner2254 filed its appeal in the Bureau from the decision of the Income Tax Unit evidenced by Exhibit J and attached thereto as Memorandum No. 1, a memorandum dealing with "Replacements", in which memorandum petitioner set forth certain facts and its position that on account of the expenditures and commitments referred to in such memorandum in the acquisition of vessel property, such sum of $506,622.92 should not be included in taxable income. 28. In such memorandum the petitioner made the following statement: "8. Leave to file bonds, etc., deemed necessary by Bureau requested."While the Company is of opinion that the facts herein outlined are sufficient to show compliance with the provisions of statute for the non-taxation of the proceeds of involuntary conversion here involved and is satisfied that such facts demonstrate that the Bureau is fully protected in any requirement in this regard, the Company hereby respectfully requests that an opportunity be afforded to file such bonds and take such other steps as may be deemed necessary by the Bureau." Prior to the filing of such memorandum the petitioner had made no application for permission to set up a replacement fund or file2255 bonds. 29. During the years 1923 and 1924 hearings were had before the Income Tax Unit, the then Solicitor of Internal Revenue and the Committee on Appeals and Review of the Bureau of Internal Revenue in regard to petitioner's claim that the proceeds of the requisitioned vessels should be excluded from taxable income, but such claims were denied. 791 30. On December 15, 1924, petitioner filed with the respondent an application the original of which is introduced in evidence as an exhibit, to be marked Exhibit K. The application evidenced by such Exhibit K was denied by respondent under date of December 12, 1925. The following facts are found from the evidence: 31. The Massachusetts, Bunker Hill, and Old Colony, were combined passenger and freight vessels especially available for use in the Boston to New York service, which required steamers of large capacity and a speed of at least twenty knots per hour. 32. The petitioner did not intend to abandon the service but always intended to replace the requisitioned vessels. Efforts to do this were constantly made by petitioner, beginning in 1919. OPINION. STERNHAGEN: 1. 2256 The first issue arises from the respondent's determination that petitioner's income should include the difference between the face value of its outstanding mortgage bonds ($5,524,900) and the lower price ($45,157,175) for which it bought them. The bonds were issued within the taxable year as part of the reorganization plan by which it acquired the properties of the predecessor corporation. Before the close of the year it discharged this capital obligation by paying less. Under circumstances less favorable to the taxpayer, the Board has in several cases decided that there is no gain to be included in income. Independent Brewing Co.,4 B.T.A. 870">4 B.T.A. 870; New Orleans, etc., Ry. Co.,6 B.T.A. 436">6 B.T.A. 436; Houston Belt, etc., Co.,6 B.T.A. 1364">6 B.T.A. 1364; National Sugar Mfg. Co.,7 B.T.A. 577">7 B.T.A. 577; Petaluma, etc., R.R. Co.,11 B.T.A. 541">11 B.T.A. 541; General Manifold, etc., Co.,12 B.T.A. 436">12 B.T.A. 436; American Seating Co.,14 B.T.A. 328">14 B.T.A. 328; Douglas County Light, etc. Co.,14 B.T.A. 1052">14 B.T.A. 1052; 2257 John F. Campbell Co.,15 B.T.A. 458">15 B.T.A. 458. Following those decisions, we hold the respondent in error on this issue. 2. The important fact in the second issue is that stipulated in paragraph 28 - that prior to March 27, 1923, the petitioner had made no application for permission to set up a replacement fund or file bonds. We have no doubt that an amount received by a taxpayer as compensation for property requisitioned is, to the extent of any excess over cost (or, in a proper case, value on March 1, 1913), with proper adjustments for depreciation, properly to be regarded as income. It is properly to be included in the statutory definition of gross income from whatever source derived, and this is none the less so if, in arriving at net, the statute provides, as in the Revenue Act of 1921, section 234(a)(14), for a deduction of the portion of gain 792 used or to be used in replacement. Pelican Bay Lumber Co. v. Commissioner, 31 Fed.(2d) 15; affirming 9 B.T.A. 1024">9 B.T.A. 1024; certiorari denied, 279 U.S. 870">279 U.S. 870. Cf. 2258 Lehigh & H. R. Ry. Co.,13 B.T.A. 1054">13 B.T.A. 1054. We find no support in United States v. Supplee Biddle Hardware Co.,265 U.S. 189">265 U.S. 189, for a contrary view. That decision was based squarely on the construction of the statute that a special treatment of the proceeds of life insurance expressly accorded to individuals was also applicable to corporations. The discussion contained in the opinion as to the nature of such proceeds did not reach a definitive conclusion and there is no reason to expand it beyond the life insurance there under consideration. Cf. Lucas v. Alexander,279 U.S. 573">279 U.S. 573. Under the Revenue Acts of 1916, 1917, and 1918, the gain in compensation for requisitioned property was regarded by the Treasury Department as income, provision being made for relieving it from tax in certain circumstances. Regulations 33 (revised), article 94; Treasury Decision 2706, 20T.D. 348; Regulations 45, articles 49 and 50. The validity of this favorable treatment prior to the Revenue Act of 1921, it is not necessary to consider here, see 2259 Pelican Bay Lumber Co. v. Commissioner, 31 Fed.(2d) 15. The Revenue Act of 1921 was the first to embody a provision in respect of involuntary sale or conversion. Section 234(a)(14) is as follows: SEC. 234. (a) That in computing the net income of a corporation subject to the tax imposed by sectin 230 there shall be allowed as deductions: * * (14) If property is compulsorily or involuntarily converted into cash or its equivalent as a result of (A) its destruction in whole or in part, (B) theft or seizure, or (C) an exercise of the power of requisition or condemnation, or the threat or imminence thereof; and if the taxpayer proceeds forthwith in good faith, under regulations prescribed by the Commissioner with the approval of the Secretary, to expend the proceeds of such conversion in the acquisition of other property of a character similar or related in service or use to the property so converted, or in the acquisition of 80 per centum or more of the stock or shares of a corporation owning such other property, or in the establishment of a replacement fund, then there shall be allowed as a deduction such portion of the gain derived as the portion of the2260 proceeds so expended bears to the entire proceeds. The provisions of this paragraph prescribing the conditions under which a deduction may be taken in respect of the proceeds or gains derived from the compulsory or involuntary conversion of property into cash or its equivalent, shall apply so far as may be practicable to the exemption or exclusion of such proceeds or gains from gross income under prior income, war-profits and excess-profits tax Acts. The last sentence, it will be noted, applies the treatment as deductions retroactively to similar situations occurring under prior acts. It is by virtue of this statutory provision alone that petitioner can make a plausible claim of right against the deficiency. Under it 793 actual immediate expenditure in replacement or the establishment of a replacement fund permitted the deduction; but only "under regulations prescribed by the Commissioner with the approval of the Secretary." Such regulations, from T.D. 2706, in 1918, through Regulations 45 (T.D. 2831, in 1919, and T.D. 3146, in 1921) into Regulations 62, under the 1921 Act, required application to and approval of the Commissioner of Internal*2261 Revenue and the giving of a bond. The statute provided no deduction otherwise; and since such requirements had been imposed by the Treasury Department in its regulations, the only reasonable construction of the conditions contained in the 1921 Act is that these requirements were expressly intended as conditions of the deduction. The petitioner did not fulfill this condition, and the Commissioner may not be required to compute the deficiency as if it did. "Men must turn square corners when they deal with the Government," Rock Island, etc., Co. v. United States,254 U.S. 141">254 U.S. 141; Botany Worsted Mills v. United States,278 U.S. 282">278 U.S. 282. The determination on this point is sustained. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621065/	TITLE & TRUST COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Title & Trust Co. v. CommissionerDocket No. 73785.United States Board of Tax Appeals33 B.T.A. 25; 1935 BTA LEXIS 819; September 10, 1935, Promulgated 819 Prior to 1931 petitioner purchased from the vendor of houses the contracts for the sale of a number of the houses and lots. In 1931 the purchasers defaulted and petitioner canceled the contracts and took over the houses and lots. The fair market value of the realty so acquired by petitioner was less than the amount of petitioner's unrecovered cost of the sale contracts, and it is held that that difference represented a deductible loss to the petitioner. J. H. Amick, Esq., for the petitioner. W. R. Lansford, Esq., for the respondent. ARUNDELL25 This case arises on respondent's determination of a deficiency in petitioner's income taxes for the calendar year 1931 in the amount of $1,178.65, and involves the sole question whether respondent erred in disallowing a deduction claimed by petitioner in the amount of $152,773.89 in respect to losses on land contracts which were purchased at a discount by petitioner from the vendor of the land and because of nonperformance were canceled in the taxable year by the petitioner, who thereupon took possession of the land. If petitioner's contention is sustained the further question of fact, the fair820 market value of the land in 1931, is raised. FINDINGS OF FACT. Petitioner is a Michigan corporation, with its principal place of business at Detroit, Michigan, where it was engaged in buying at a discount the vendor's interest in contracts for the sale of residence realty in and around the city, the petitioner receiving later payments from the purchasers. After 1913 but before 1931 petitioner purchased the vendor's interest in a large number of such land contracts. During 1931 petitioner canceled 144 of these contracts for nonperformance, the petitioner taking possession of the land and houses sold thereunder, but only the losses claimed on 45 of these contracts are here involved. These contracts to sell land were made between the Frischkorn Construction Co., as vendor, and various individuals as purchasers. They provided for the payment of the balance of the purchase price by monthly installments over a term of years, ordinarily five. Upon the payment of all sums owing on the contract the vendor bound itself to execute and deliver to the purchaser a warranty deed conveying title; in the case of purchaser's nonperformance the vendor reserved the right of reentry and the821 purchaser forfeited all payments 26 made. The petitioner acquired these contracts by purchase from the vendor, which assigned all its interest therein. Petitioner made proof of the following facts representing the individual houses, which need not be set out in detail here: The lot number, subdivision, street address, and type of house (number of rooms and whether brick or frame), year of construction of house, builder's cost, the balance owing on the contract when acquired by petitioner, the percentage of discount, the date of cancellation of the contract, the balance owing at the date of cancellation, and the unrecovered cost at that date. The houses in question were all small, of five or six rooms, of brick, brick veneer, or frame, were constructed generally of very cheap materials, and were built primarily for workmen in the automobile factories. The depression in real estate in Detroit started in 1928 and reached a very low point in August 1931, when the Ford Motor Co.'s factory closed. The fair market value in 1931 of the 45 houses and lots which were forfeited to petitioner by their purchasers in that year was $124,100. The unrecovered cost to petitioner of822 the contracts at the time of cancellation was $164,546.92. OPINION. ARUNDELL: Petitioner claimed the deduction of $152,773.89 as a loss in 1931 resulting from the cancellation of certain land contracts in that year, the loss being measured by the difference between the unrecovered cost of the contracts and the depreciated value of the houses and lots which it acquired by reason of the cancellations. Petitioner's business in the acquisition of land contrcats as a discount and the collection of the balance owing on them from the purchasers. It acquired by assignment from a construction company a large number of such contracts, 144 of which it found it necessary to cancel in 1931 because of nonperformance, but only 45 of these are here in question. Petitioner now contends that it did not step into the shoes of the original vendor of the houses and lots, the Frischkorn Construction Co., and is therefore not governed by the provisions of the Treasury regulations respecting losses allowable to a vendor who repossesses land on forfeiture or cancellation of its installment contract, but that the exchange of petitioner's interest in the land contracts on cancellation for the realty823 was in itself a completed transaction, and as such the occasion of realizing gain or loss, the loss in the present instance to be measured by the excess of the cost of the land contracts to petitioner still unrecovered at the date of cancellation over the fair market value of the land at the time of the cancellation and consequent exchange. If we sustain petitioner's method, we must 27 determine as a fact what the fair market value of the land was in 1931. As, according to the statement of petitioner's counsel, petitioner has reported its income in prior years as a proportionate amount of all collections made on the contracts, the amount of the discount allowed to petitioner on its purchase by the vendor and now earned by collection being treated as income and the remainder as a return of cost, petitioner would now determine the unrecovered cost of any cotract as the balance still outstanding as unrecovered cost under this method. In other words, instead of taking the cost of the contract to petitioner and deducting from it the total amount of collections to ascertain unrecovered cost, it is suggested that we take the cost, and deduct therefrom that percentage of the collections824 remaining after subtracting the discount. To illustrate, if the discount were 30 percent, the petitioner would have to recover 70 percent of the total contract price as its own cost. Petitioner therefore deducts 70 percent of the collections as recovered cost, to arrive at unrecovered cost at the date of the exchange. As petitioner kept its books on the cash basis and made its return on the installment basis, we can find no objection to this method, if petitioner's major contention is sound. Respondent contends that petitioner by its purchase of the land contracts merely replaced the Frischkorn Construction Co. as vendor and that, consequently, on cancellation of the contracts petitioner "repossessed" itself of the property and so, far from sustaining a loss, is liable for additional income in the amount of unreported installment collections less depreciation, under Treasury Regulations 74, article 353 (as amended by T.D. 4360). The preliminary question, then, is whether petitioner in acquiring the land contracts got something substantially the same as the vendor had originally, of which on forfeiture of the contract, it could "repossess" itself. The vendor825 owned the land in law and equity. Under the contracts of sale the Construction Co., the vendor, retains legal title until payment of the final installment of the purchase price, when it executes and delivers to the purchaser a warranty deed. The petitioner, therefore, when it bought the contracts, received the legal title, but this was a bare legal title withheld from the individual purchaser only as a means of securing performance of the contract. The equitable title had passed to the purchaser, and the vendor, as to the land, became a trustee for the purchaser. This was settled doctrine at common law. It is also the rule in Michigan, where the vendor's interest had been said to be merely "an ordinary money debt, secured by the contract." Walker v. Casgrain,101 Mich. 604">101 Mich. 604; 60 N.W. 291">60 N.W. 291. See also Bower v. Lansing,129 Mich. 117">129 Mich. 117; 88 N.W. 384">88 N.W. 384, and cases there cited. In the latter case 28 the Supreme Court of Michigan held that the vendor's interest in land held by the purchaser under a contract of purchase on the death of the vendor goes to his administrator as personalty, and is not subject to sale on execution826 against the heir. See also Commissioner v. Hart, 76 Fed.(2d) 864. Since the doctrine is general, no occasion arises, as respondent contends, to set it aside as a peculiarity of local law not binding in a Federal tax case by invoking the principel of Burk-Waggoner Oil Association v. Hopkins,269 U.S. 110">269 U.S. 110; and Burnet v. Harmel,287 U.S. 103">287 U.S. 103. We think it clear, therefore, that petitioner in acquiring equitable title to and possession of the land by cancellation of the contracts got property essentially different in nature from what it had before as a mere assignee of the vendor's bare legal title. Petitioner would not, therefore, be governed by article 353 of the Treasury Regulations. We come now to the essential question, whether petitioner's exchange of a secured chose in action for land resulted in a completed transaction by which gain or loss was realized. The original installment obligation under section 44(d) of the Revenue Act of 1928, set out in the margin, 1 had been closed as respects the vendor when the Construction Co. sold the contracts to the petitioner. Gain or loss had then been realized by the vendor. 827 The petitioner was not a seller under the installment plan, as contemplated by the statute and the regulations, but the purchaser of property of one kind which it was forced later on to exchange for property of another kind. The fact that it reported the collections on the contracts on the installment plan, treating only a propertionate part of them as income, does not alter the fundamental fact that it was not a seller of property on the installment plan "repossessing" itself at a later period of the same property sold. 828 We are of the opinion that the exchange by petitioner of its interest in the land contracts for the land itself constituted a transaction entirely separate from the vendor's original sale of the land and as such was the occasion of realizing gain or loss. In Home State Bank,15 B.T.A. 121">15 B.T.A. 121, we had occasion to consider a situation analogous to that here. In that case the petitioner sold real property in 1915 which it repossessed in 1920 because of default on the part of the purchaser in payment of promissory notes secured by mortgages 29 given to the vendor-taxpayer. The petitioner had parted with legal title, but retained mortgages as security for the payment of the balance of the sale price. We treated the original sale and the repossession as "two separate and distinct transactions" and held that a loss was actually sustained upon the repossession. Similarly, in Henry Heldt,16 B.T.A. 1035">16 B.T.A. 1035, where the vendor had sold land for cash and mortgages and later repossessed himself of the land in exchange for the mortgages, we held that gain had been realized. See also 829 Nat Webb, Jr.,22 B.T.A. 1249">22 B.T.A. 1249. In the Home State Bank case, supra, the petitioner was not reporting income on the installment basis. In Jacob M. Dickinson, Jr., et al., Executors,18 B.T.A. 790">18 B.T.A. 790, however, the petitioner sold a cotton plantation, taking a mortgage for the unpaid purchase price, and later found it necessary to foreclose the mortgage, exchanging the purchaser's notes, equal in face value to the then fair market value of the land. The petitioner reported its income on the installment basis. We held that the petitioner by its reacquisition of the land realized a profit in the amount of the proportion of notes utilized which the total profit bore to the total contract price. We there said: The reacquisition, or repurchase of the plantation on December 18, 1923, was effected by an exchange of notes having a face value of $125,000 for the plantation which then had a fair market value of $125,000. The utilization of the purchase money notes in reacquiring the plantation constitutes a realization of profit, under the installment method of reporting income. The total contract price, when the plantation was sold, was $233,025; 830 the profit was $167,637.67. The profit is 7.1398 per cent of the total contract price and under the installment method of returing income that part of each payment constitutes profit realized. It follows that 7.1398 per cent of $125,000, or $8,924.75, constitutes profit in 1923. Our judgment in the Dickinson case was predicated on the fact that the original sale by the vendor was complete because title had passed. If, as we have held in these cases, the surrender of legal title to the land by the vendor constitutes a proper criterion of separability of the original sale from the subsequent repossession and retransfer of title to the land, we think it logically follows that the substitution of a second taxpayer for the original vendor clearly results in the separation of the original sale from the act of repossession, so that the latter act results in gain or loss to the second taxpayer. We have already indicated that what the petitioner here acquired by purchase of the vendor's interest in the contracts was substantially different from that the vendor had originally held, and that consequently petitioner by repossession of the land acquired something which he had never831 before held and essentially different from the chose in action which he held against the purchaser for the purchase *30 price. We are of the opinion, therefore, that petitioner realized a loss on acquiring the land covered by the contracts and that this loss should be measured by the difference between petitioner's unrecovered cost of the contracts and the fair market value of the real estate in 1931 when acquired by it. The unrecovered cost should be determined, as already suggested, in accordance with petitioner's method of computation, in order to give due effect to income reported by it in prior years on the installment basis. The only question remaining is one of fact, namely, the fair market value of the 45 houses and lots in 1931 when acquired by the petitioner. We have determined that value to be $124,100, based on the testimony of a witness who was thoroughly familiar with each parcel of land and the condition and value of each one. Decision will be entered under Rule 50.Footnotes1. SEC. 44. (d) Gain or loss upon disposition of installment obligations.↩ - If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange - the amount realized, or (2) in case of a distribution, transmission, or disposition otherwise than by sale or exchange - the fair market value of the obligation at the time of such distribution, transmission, or disposition. The basis of the obligation shall be the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621066/	HILDA KAY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Kay v. CommissionerDocket No. 102405.United States Board of Tax Appeals45 B.T.A. 98; 1941 BTA LEXIS 1180; September 12, 1941, Promulgated 1180 X, recently a widower, offered to give petitioner, his niece, 300 shares of A.T. & T. Co. stock if she would come to his home to live with him and his family in Illinois. Petitioner accordingly gave up a position in New York paying a salary of $5,400 a year and went to her uncle's home in Illinois. The arrangement was not satisfactory and while petitioner was away on a short trip she was told by her uncle not to return. Her uncle having failed to turn over the stock to her, petitioner brought suit against him for breach of contract. In settlement of this suit petitioner received in the taxable year certain money and securities. Held, under the facts, these receipts constituted taxable income and not a gift. Mark Eisner, Esq., for the petitioner. F. S. Gettle, Esq., for the respondent. KERN 98 Respondent determined a deficiency in petitioner's income tax liability for the year 1935 in the amount of $4,168.85, and also a penalty of $1,042.21 for the same year by reason of petitioner's failure to file a return. Petitioner contests this determination. 99 The questions presented are (1) Whether the amount of $28,281.25 (consisting1181 of $2,000 cash and the fair market value of 250 shares of American Telephone & Telegraph Co. stock), received by petitioner during the taxable year is taxable income, and (2) if any part of the $28,281.25 constitutes taxable income, whether the 25 percent penalty provided by section 291 of the Revenue Act of 1934 should be added to the tax by reason of petitioner's failure to file a return for 1935. FINDINGS OF FACT. The parties have stipulated all the facts in this proceeding and, in so far as deemed material, they are set forth below. The petitioner, Hilda Kay, is an individual residing in Miami, Florida. Petitioner was always known as Hilda Kleinschmidt until 1918, when she changed her name to Hilda Kay and held herself out thereafter under that name to her friends and acquaintances, with their acquiescence and recognition. The petitioner did not attempt to obtain a court order authorizing the change of name. Shortly after his wife's death in 1932, Edward E. Kleinschmidt, petitioner's uncle, suggested that she come to Highland Park, Illinois, and live there as a member of his household and family. Kleinschmidt wrote numerous letters to her in January 1933 relative1182 to this matter. Material portions of those letters are as follows: As of January 9, 1933: As I said when you were here I will give you 300 shares of A.T. & T. stock if you will come to live with us permanently. If for any reason it does not work out and you decide to go on your own again in the next few years it will be entirely up to you as to whether or not you wish to return the shares, in other words, there will be no strings to the transaction whatsoever; your own conscience will be the only control. I want to give you this stock so you will have sufficient income to be independent and one of our little family and so that you will not have the feeling that you are being paid to take care of us. As of January 13, 1933: If I marry you shall not feel obligated to return the shares. If you marry and you think you ought to return the shares it will be all right providing I accept them otherwise it will be entirely up to you. I know about the gift tax and it would be worth while to do some thinking as to how it could be avoided. If you can figure out some way let me know. As of January 19, 1933: So far as I can see we need nothing in writing. I want to give you1183 the shares so that you will have sufficient income to be independent (you know that these in normal times are worth at least $60,000) and that covers everything. When I have given you the shares my obligations are completed. You are coming to live with us and I hope you will stay a very long time and I know we will be very happy together. All of the children will have a substantial income of their own and they will pay for their personal expenses out of their own income. Of course, as long as they live with me they will do so 100 as my guests but as long as they have independent incomes and are of age I do not feel obligated to provide a home for them. When you come out I want to consider you in the same light as regards these things as I do my children. When you come out you will do so as part of our family and I want to think of it in no other way. I am providing an income for my children so that they will be financially independent and so that they will get to know what money means. I did the same with Virginia and it worked out very well. In February 1933 petitioner gave up the employment that she then had in New York City and moved with all her belonging to1184 her uncle's home in Highland Park. At that time petitioner was 35 years of age and had been employed since 1924 by the Metropolitan Life Insurance Co. as assistant secretary to Frederick Ecker, the president of the company, at a salary of $5,400 a year and with good opportunities for advancement, since her immediate superior was near retirement age and was then receiving about $9,000 a year. The first American Telephone & Telegraph Co. dividend date after petitioner arrived at Highland Park was April 15, 1933. Shortly after that date, Kleinschmidt gave petitioner a check in an amount exactly equal to the amount of dividends due April 15, 1933, on 300 shares of American Telephone & Telegraph Co. stock. An amount equal to the dividends paid thereafter by the American Telephone & Telegraph Co. was paid to petitioner by check of Kleinschmidt shortly after receipt of such dividends by him. Except as hereinafter set forth, Kleinschmidt did not cause to be transferred to the name of petitioner the 300 shares of stock, although, on several different occasions during the petitioner's stay in her uncle's home she requested that such transfer be made. Under date of April 2, 1934, petitioner1185 received from Kleinschmidt a letter while she was in New York City. This letter read as follows: DEAR HILDA: It must be apparent to you that your stay in Deere Park is not working out successfully. When we last discussed the subject I suggested that we try it out for a while longer to see if the situation would work itself out. It has not worked out so far as I can see. I fact we seem to be happier by ourselves as the last week has demonstrated. I thought I would write to you while you are in New York so that you can make arrangements while you are there to return which you will no doubt want to do. As regards the financial situation I will give you an amount that will take care of your expences [sic] until you can find a position again. Sincerely UNCLE EDWARD. In April 1934 petitioner, through her attorneys, caused a summons to be served upon Kleinschmidt, in New York City. Thereafter, Kleinschmidt appeared by attorneys, and a complaint was served and filed alleging that petitioner had entered into an agreement with Kleinschmidt whereby she agreed to assist him in the maintenance of his 101 home and in he bringing up of his minor child and Kleinschmidt1186 agreed immediately to give to her, without condition, the 300 shares of common stock in the American Telephone & Telegraph Co. and keep her in his home on the same basis as a member of his immediate family. The complaint alleged that these were mutual considerations and that the agreement constituted a contract, whch was breached by Kleinschmidt both by his improper treatment of petitioner and thereafter discharging her without right or cause, by reason of which petitioner was deprived of the benefit of the contract and of the means of earning her living, to her damage in the in the sum of $90,000. Judgment in that amount, with interest from January 19, 1933, was demanded. Kleinschmidt's answer was a blanket denial of all allegations except that he admitted that he did not deliver 300 shares of common stock of the American Telephone & Telegraph Co.Prior to any trial of that suit and before noticed for trial, the suit was settled by payment and delivery by Kleinschmidt to petitioner of 250 shares of stock of American Telephone & Telegraph Co. and $2,000 in cash. The fair market value of these 250 shares at the time of settlement and the stock transferred of record to petitioner1187 was $28,281.25. Petitioner did not file a donee return nor did she file an income tax return for the year 1935. In that year petitioner did not keep books of account and for tax purposes was on the cash receipts and disbursements basis. From the foregoing evidentiary facts we find as an ultimate fact that Kleinschmidt's promise to transfer stock to petitioner became a valid contractual obligation upon him when petitioner assumed her position in his household, and that the stock and money received by petitioner in the taxable year was in satisfaction of this obligation and not a gift. OPINION. KERN: The first issue to be considered is whether the $28,281.25 received by petitioner during the taxable year is taxable income. Respondent asserts that a contract existed between Kleinschmidt and petitioner, and that any amounts received by reason thereof, whether in performance of the contract, by judgment of court, or by way of settlement, constitute income within the meaning of section 22(a) of the Revenue Act of 1934. Petitioner, on the other hand, argues that a contract never existed between herself and Kleinschmidt; that Kleinschmidt's offer was clearly to make a gift, 1188 and therefore, any stock or money received by her pursuant to his gratuitous promise was nontaxable. Consequently, our initial inquiry must be whether or not the negotiations between petitioner and Kleinschmidt constituted a contract. 102 It is frequently a matter of the greatest difficulty to clearly ascertain the dividing point between promises creating legal obligations and mere gratuitous agreements. As the courts have often said, each case depends so much on its own peculiar facts and circumstances that it is of little aid in determining later cases with differing facts. The promise or agreement, the relation of the parties, benefits to the promisor, detriment to the promisee, the circumstances surrounding the promise, and the intent of the parties as it may be deduced from all the facts in evidence, play important parts in the inquiry. If it can be ascertained that the sole purpose was to confer a benefit on the promisee merely from affection or generosity, the agreement is clearly gratuitous. But if the purpose is to obtain a quid pro quo, the promise is not gratuitous and becomes in time a legal obligation. 1189 ; ; ; . Upon an examination of the facts in our instant case, we note that Kleinschmidt did not attempt to induce petitioner to come to Highland Park through any pity for her, nor can we conclude that it was merely affection or generosity which motivated his offer. His wife had just died and he needed someone to fill her place in the running of his household. If she came to Highland Park and assumed this role, it would clearly be beneficial to Kleinschmidt. The fact that she was gainfully employed in New York, receiving $5,400 a year, and had good chances for advancement meant that she would have to forego this lucrative career if she accepted Kleinschmidt's offer. This she ultimately determined to do. The intent of the parties is perhaps a trifle difficult to ascertain. Frequently Kleinschmidt spoke of the stock as a gift to petitioner and he even asked petitioner's assistance in devising a plan to avoid payment of a gift tax. In his letter of January 9, 1933, he said that "there will be no strings1190 to the transaction whatsoever"; and in his letter of January 19, 1933, he said: "So far as I can see we need nothing in writing. I want to give you the shares so that you will have sufficient income to be independent * * ." But in the January 9 letter he said: "I want to give you this stock * * so that you will not have the feeling that you are being paid to take care of us." We interpret this to mean: "Actually you are being paid to take care of us but I don't want you to be constantly reminded of this fact by receiving monthly amounts from me, or the like." In the April 2, 1934, letter, writter when Kleinschmidt had determined that the set-up was not working well, he did not mention the stock at all, although he had never turned it over to petitioner. He merely said: "As regards the financial situation I will give you an amount that will take care of your expences [sic] until you can 103 find a position again." It would seem that Kleinschmidt felt that petitioner's services did not merit the stock, even though he had told her in an earlier letter that, if for any reason the arrangement did not work out and petitioner decided to go on her own again after a few1191 years, it would be entirely up to her as to whether the shares should be returned to him. When petitioner verified her complaint in May 1934, she swore that her relationship with Kleinschmidt had been a contractual one and that, pursuant to the agreement between herself and her uncle, he was obligated to turn over the 300 shares of stock to her. Kleinschmidt formally denied that any contractual agreement had ever been entered into, but subsequently, and apparently under advice of counsel, he agreed to and did settle the dispute by payment of 250 shares of stock and $2,000 in cash to petitioner. While petitioner's position at that time does not estop her now from asserting otherwise, it is strongly indicative of her conception of the purpose, intent, and effect of Kleinschmidt's promise. Upon all the facts in the case we are impelled to call the relationship between petitioner and Kleinschmidt a contractual one. Benefit to the promisor was anticipated and detriment to the promisee was inevitable. Under these circumstances it is a fair conclusion that a unilateral contract existed. Williston on Contracts, Rev. Ed. vol. 1, p. 380; 1192 ; . Petitioner had a legal claim against her uncle for services rendered pursuant to this agreement. The fact that the amount petitioner eventually received resulted from a settlement of her suit can not alter the fact that, basically, the payment was a mere substitute for compensation under the agreement. . In the Hort case, the Supreme Court said: That the amount petitioner received resulted from negotiations ending in cancellation of the lease rather than from a suit to enforce it cannot alter the fact that basically the payment was merely a substitute for the rent reserved in the lease. Applying this theory in the present case, we see that, regardless of whether petitioner had prosecuted her suit to recovery or accepted, as she did, stock and money in settlement, the payment was merely a substitute for the payment provided in the agreement. This being the case, the total amount received is ordinary gross income, and taxable as such. We can see no merit in petitioner's contention that there was a symbolic delivery1193 of the stock to her in 1933 by virtue of Kleinschmidt's payment to her of an amount equal to the amount of the dividends due thereon April 15, 1933. In the first place, this contention is based on the premise that Kleinschmidt had an intention to *104 make a gift of the stock, with which, as we have shown above, we can not agree. In the second place, even if he had an intention to make a gift, there is nothing in the stipulated facts to show that there was an intention to make a present gift rather than a gift in futuro.The remaining issue concerns the 25 percent penalty provided by section 291 of the Revenue Act of 1934 for failure to file a return. Having determined that the deficiency exists, the penalty is mandatory. ; affd., ; certiorari denied, . Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621067/	P. J. HIATT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ANNA BELLE HIATT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Hiatt v. CommissionerDocket Nos. 82568, 82569.United States Board of Tax Appeals35 B.T.A. 292; 1937 BTA LEXIS 899; January 19, 1937, Promulgated 899 In 1932 the petitioners were the owners of lands in a reclamation district of California mortgaged to an amount in excess of their then fair market value. The reclamation district had levied an assessment against the lands in the amount of $81,846.51, which was a prior lien on the lands. The assessment was not a personal obligation of the petitioners. To protect its mortgage the mortgagee advanced $15,258.63 in the purchase of bonds of a par value of $80,933.99, plus accrued interest of $1,160.06, which were applied in satisfaction of the assessment referred to plus accrued interest. The mortgagee charged the $15,258.63 against the petitioners. The respondent has held that the petitioners derived income from the transaction to the amount of the difference between the assessment plus accrued interest and the cost of the bonds, or $66,835.42, and has added one-half of that amount to the net incoem reported by each petitioner for 1932. Held, that the amount thus added to the reported net income of each did not constitute taxable income of each in 1932. Arthur C. Huston, Jr., Esq., Stephen W. Downey, Esq., and Harry B. Seymour, Esq., for the petitioners. 900 Owen W. Swecker, Esq., for the respondent. SMITH 293 These proceedings, consolidated for hearing, involve income tax deficiencies for 1932 as follows: PetitionerDocket No.DeficiencyP. J. Hiatt82568$4,907.58Anna Belle Hiatt825694,785.05The question presented by these proceedings is, Did the petitioners realize a taxable gain of $66,835.42 when reclamation district bonds having a face value of $82,093.99 (including accrued interest) were purchased for their account by a mortgagee at a cost of $15,258.63, which bonds were used to satisfy an assessment for special benefits of the reclamation district in the amount of $81,846.51 (plus accrued interest), which assessment was a lien upon petitioners' lands but not a personal obligation of the petitioners? FINDINGS OF FACT. In 1932 the petitioners were husband and wife, domiciled in the State of California. In 1913 the Legislature of the State of California created Reclamation District 1500 (Stats. 1913, ch. 100), as agent of the state to carry out certain works of reclamation on lands located within its boundaries. Prior to 1919 and at all times subsequently the901 petitioners owned approximately 1,800 acres of farm lands located within the district. In 1919, in accordance with state law, the reclamation district levied an assessment upon the lands located within its boundaries in the principal amount of $5,000,000. This assessment was duly apportioned 294 and spread upon the lands in the district in accordance with benefits. For the purposes of the assessment the petitioners' lands were appraised at $324,396. The portion of the assessment spread upon the lands owned by the petitioners amounted to $81,846.51 in principal amount and became a lien upon the lands in August 1919. Thereafter the district caused bonds to be issued against the assessment and sold, and the proceeds thereof were used by the district for the purposes for which the assessment was levied, namely, construction of works of reclamation, incidental expenses, and charges for maintenance and operation. In addition to the lien of the reclamation assessment the petitioners' lands were subject to a deed of trust (mortgage) in favor of the California Trust & Savings Bank (a Sacramento bank), securing an indebtedness which on September 1, 1932, amounted to approximately902 $221,500. The fair market value of the lands, freed from all assessments, on that date was not in excess of $145,000. Under the statutes of the State of California the assessment standing against any lands in the reclamation district could be satisfied by the delivery to the county treasurer of reclamation district bonds of a par vlaue, plus accrued interest, equal to the amount of the assessment standing against the lands. No interest had been paid upon the bonds for a long period of years and they were selling on the market at approximately 18 percent of the face value thereof. On September 26, 1932, the California Trust & Savings Bank, for the purpose of protecting its mortgage from the menace of the underlying and admittedly superior statutory assessment lien, advanced under its trust deed for the Hiatts' account $15,258.63 for the purpose of purchasing bonds to satisfy the assessment lien standing against petitioners' lands. This amount was used to acquire bonds of the reclamation district having a total par value of $80,933.99 and bearing accrued interest of $1,160.06. The bonds thus acquired were surrendered to the county treasurer as fiscal agent of the reclamation903 district and accepted at their par value in payment of the entire assessment of $81,846.51, which was thus canceled a nd discharged. The reclamation bonds above referred to were not purchased by the petitioners. Neither did they ever come into the possession of the petitioners. The bank, at the solicitation of Edward Schranz, Jr., the president of the board of directors of Reclamation District No. 1500, authorized Schranz to purchase the bonds and apply them in satisfaction of the assessment. The advance was made by the bank with the full approval of the petitioners, and the bank charged the petitioners with the $15,258.63 which it had advanced in their behalf in the purchase of the bonds. 295 There was practically no market for lands in Reclamation District No. 1500 in 1932. Sales that have been made since 1932, freed from all assessments, have practically all been at prices less than the total amounts that had been assessed upon them for works of reclamation and improvements. The petitioners' lands in 1936 had a value of about $176,800. The value in 1932 was about 20 percent less than that amount. The California Trust & Savings Bank went into receivership subsequent904 to 1932. The petitioners' total indebtedness to the bank on January 1, 1936, was $223,355.29 plus unpaid interest of $40,661.74. The bank's claim against the petitioners was compromised in 1936 for an amount of approximately $166,600. The petitioners filed separate income tax returns for 1932. In neither return was any amount reported as taxable gain from the transaction by which the California Trust & Savings Bank advanced $15,258.63 in the acquisition of reclamation bonds which were applied in satisfaction of the assessment standing against the lands of $81,846.51 plus interest. In the determination of the deficiency the respondent has determined that the petitioners, together, owed an assessment plus accrued interest of $82,094.05, which was satisfied by an investment of cash in the amount of $15,258.63, thereby resulting in a profit of $66,835.42, one-half of which, or $33,417.71 has been added to the net income reported by each petitioner. He has also added to the net income reported by P. J. Hiatt $2,604.87 representing one-half of the difference between an assessment of $6,399.13, standing against lands in the reclamation district and $1,189.39, the cost of bonds to905 cancel that assessment which the respondent in his deficiency notice states were "truned in for application at par value against assessments against land owned by you and N. L. Miller." No proof has been offered by the petitioners relative to the item of $2,604.87 added to the net income reported by P. J. Hiatt. OPINION. SMITH: The question presented by these proceedings is whether the petitioners realized taxable income by having assessments against their lands in the amount, including interest, of $82,094.05 satisfied by a charge against them on the books of the mortgagee of the lands of $15,258.63, the latter amount representing the cost to the mortgagee of purchasing bonds to satisfy the assessment. In his deficiency notices the respondent states: "These transactions are held to be equivalent to sales and the difference between the purchase price of the bonds and the amount of credit received against the assessments represents property subject to tax just the same as if the bonds had been purchased and sold outright, even though the 296 credit may have applied against an item that had been capitalized." The authorities relied upon by the respondent in his determination906 are ; ; ; certiorari denied, . The facts in the above cited cases were entirely different from those which obtain in teh proceedings at bar. In , the Kirby Lumber Co. was held liable to income tax upon profit realized by it in the redemption of some of its bonds at a price less than the issuing price. The facts clearly showed that the company had a cash profit from the redemption of the bonds at prices less than the issuing price. In , the facts were that the American Chicle Co. had purchased the assets of another corporation and as a part of the purchase price had assumed the payment of the bonds at par. The American Chicle Co. redeemed some of these bonds at less than par. The case involved, as the Court pointed out, a "narrow point." Upon the facts907 before it the Court held the company liable to income tax in respect of the difference between the par value of the bonds and the redemption price. Substantially the same facts obtained in , and . In all of these cases a reduction in the amount of a personal obligation of a taxpayer was involved. No such situation is presented by these proceedings. In , it was held that the doctrine of , and , has no application in any case where, as here, the indebtedness reduced is not the personal obligation of the taxpayer although it may be a lien upon its lands. The facts in the Fulton case were that the taxpayer purchased certain real property upon which there stood a prior mortgage which was not assumed by the taxpayer. Thereafter the taxpayer was able to secure the release of the mortgage lien by the payment of less than its full face amount. 908 Later the taxpayer sold the property and in its income tax return for that year set forth its adjusted cost basis as being the purchase price of the land, including the full face amount which it compromised for a smaller sum. It based its position upon the doctrine of The Board held, however, that the adjusted cost basis could only include the amount actually paid to settle the mortgage rather than its face amount. It said that the Kirby Lumber Co. and the American Chicle Co. cases had no application to the case because 297 the mortgage lien discharged by the taxpayer was not its own personal obligation even though it was a lien on its lands. In , the facts were that the taxpayer acquired assets subject to an outstanding mortgage securing bonds issued by the seller. The American Seating Co. did not assume liability on the bonds. Subsequently, the buyer purchased the bonds then outstanding in the hands of the public for less than par and the mortgage was satisfied. We held that the payment represented part of the cost of the assets and did not result909 in taxable income in the year in which it was made. Cf. ; and . In , the facts were that the taxpayer owned practically all of the stock of a California corporation. By an agreement between the taxpayer and a third party such third party canceled the amount of the corporation's indebtedness. It was claimed by the Government that such cancellation of indebtedness amounted to a taxable gain by the taxpayer in view of the fact that he was practically the sole stockholder of the corporation. The Board held, however, that Lawrence realized no income in the transaction, but at most realized an increase in the value of his stock as a capital investment. Likewise, in , the Board held that , has no application in a case where the taxpayer secures a reduction in the cost of a capital investment but there is no reduction for personal obligation in connection therewith. 910 Special assessment benefits such as those levied upon the lands of the petitioners, when paid, are not legal deductions from gross income. Under the income tax law they are treated as additional cost of the land benefited. ; affd., . Where, as here, the land owner does not pay the assessment in full the only additional cost to the land owner is the amount that he pays on the assessment. If he obtains a reduction of the assessment, such reduction merely serves to reduce the amount of the additional cost of the land. It does not result in taxable income. The cost of the petitioners' lands in 1932 was not enhanced by $82,094.05 by the satisfaction of the special assessment upon it, but only by the amount of $15,258.63, which was the amount of cash advanced for their benefit by the California Trust & Savings Bank in satisfaction of the assessment. The respondent in his deficiency notices also relies upon the decision of the Board in . It was there held that since in 1928 the petitioner transferred to its principal creditor certain911 real estate in consideration 298 of the cancellation of its indebtedness, which indebtedness was in excess of the petitioner's equity in the property, the transfer constituted a sale upon which the petitioner realized taxable profit. The Board's decision in that case was reversed by the . The court stated: * * In effect the transaction was similar to what occurs in an insolvency or bankruptcy proceeding when, upon a debtor surrendering, for the benefit of his creditors, property insufficient in value to pay his debts, he is discharged from liability for his debts. Thsi does not result in the debtor acquiring something of exchangeable value in addition to what he had before. There is a reduction or extinguishment of liabilities without any increase of assets. There is an absence of such a gain or profit as is required to come within the accepted definition of income. * * * It is true that the total debt against the petitioners' lands in 1932 was reduced to the extent of $66,835.42 by the purchase of the bonds and their application against the assessment. But the remaining indebtedness was*912 far in excess of the market value of the lands then, or at any subsequent date. No gain, profit, or income can be spelled out of such a transaction. At most it served only to increase the mortgagee's equity in the lands. Even after the transaction the petitioners' equity in the lands was valueless. The petitioners have offered no evidence with respect to the transaction by which the respondent added to the gross income of P. J. Hiatt $2,604.87, as shown in our findings of fact, although the transaction appears from the deficiency notice to have been of the same nature as that considered herein. For lack of proof upon the point, the action of the respondent in adding $2,604.87 to the reported net income is sustained. Reviewed by the Board. Judgment will be entered under Rule 50.MURDOCK, LEECH, and TURNER concur only in the result.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621069/	W. P. Sewell v. Commissioner. R. B. Sewell v. Commissioner. Estate of R. A. Sewell, Josephine M. Sewell, Executrix v. Commissioner.Sewell v. CommissionerDocket Nos. 112298, 112299, 112339.United States Tax Court1944 Tax Ct. Memo LEXIS 380; 3 T.C.M. (CCH) 106; T.C.M. (RIA) 44040; February 7, 1944380 Wilton H. Wallace, Esq., and E. F. Colladay, Esq., for the petitioners. J. Marvin Kelley, Esq., for the respondent. DISNEYMemorandum Findings of Fact and Opinion DISNEY, Judge: These proceedings, consolidated for opinion, are for the redetermination of the following income tax deficiencies and penalties. Docket No.YearDeficiencyPenalty1122981934$ 3,940.06$ 1,425.9819354,492.521,823.23193619,920.999,960.4919376,645.983,322.991122991935$ 2,419.07$ 1,209.5419366,497.123,248.5619374,087.872,043.941123391934$ 6,181.82$ 3,205.51193511,823.585,911.79193636,359.2418,179.6219371,370.85685.43The issues are as follows: First, whether dividends on certain stock of Sewell Manufacturing Co. are taxable to petitioners W. P. Sewell and R. B. Sewell, and to the decedent R. A. Sewell, or to their respective wives, alleged to be owners of the stock by reason of gifts from their husbands; Second, whether dividends paid in 1937 on certain stock of Hubbard Pants Co. are taxable to the petitioner, R. B. Sewell, or to his wife, Mary W. Sewell, alleged to be the owner of the stock by reason of a gift from 381 her husband; Third, whether amounts credited as interest by Sewell Manufacturing Co. to the wife of W. P. Sewell and to the wife of R. A. Sewell are taxable to the wives or to their respective husbands; Fourth, whether profits on sales of certain Sewell Manufacturing Co. stock standing in the name of the wife of R. A. Sewell are taxable to her or to her husband; Fifth, whether profits on sales, under certain so-called pledge contracts, of stock standing in the name of R. A. Sewell and stock standing in the name of his wife are taxable in 1936 or 1937; Sixth, whether the profits for 1936 and 1937 of a certain hat manufacturing business are taxable in their entirety to R. A. Sewell, or whether the business was a partnership and its profits taxable to the alleged partners in proportion to their respective shares. Seventh, whether W. P. Sewell is entitled to deduct in 1934 the amount of certain farm expenses incurred and paid by him in 1933. Eighth, whether the entire amounts deducted by R. B. Sewell for traveling and other expenses incident to his business as a salesman, or only portions thereof, are allowable; Ninth, whether W. P. Sewell and R. B. Sewell are liable for the fraud382 penalties determined against each of them. Other issues raised by the pleadings have been abandoned or conceded. Findings of fact and opinion as to the issues remaining in controversy will be set forth separately. Findings of Fact Applicable to the First Issue (Whether Dividends Taxable to All Petitioners) The petitioners are residents of Atlanta, Georgia. R. A. Sewell the petitioner's decedent in Docket No. 112339, was a brother of W. P. Sewell and R. B. Sewell, the petitioners in Docket Nos. 112298 and 112299, respectively. In 1919 or 1920 the three Sewell brothers became associated in business as manufacturers of mens' and boys' clothing. For a time the business was operated as a partnership, but in 1931 it was incorporated under the laws of the State of Georgia as Sewell Manufacturing Co., hereinafter sometimes called the company. Since the time of incorporation the three brothers and their respective families have been the principal stockholders. At the close of the year 1933, 5,000 shares of stock of the part value of $20 each were outstanding. Of that number, 1901-3/20 were owned by W. P. Sewell, 675 by R. B. Sewell, 2023-17/20 by R. A. Sewell, and the remaining 400383 by A. R. Lovvorn, secretary of the corporation. With the exception of three certificates issued to W. P. Sewell for 100 shares each, none of the stock certificates had then ever been, nor were they ever subsequently detached from their stubs in the stock certificate book. The book itself was in the custody of A. R. Lovvorn, and was at all times kept in the vault at the company's offices. On January 2, 1934, the three brothers discussed among themselves the advisability of making transfers of some of their stock to their wives. R. B. Sewell decided to think the matter over, but W. P. and R. A. Sewell decided then to make such transfers. At their direction the accountant for the company prepared a certificate for 950 shares in the name of Ava F. Sewell, the wife of W. P. Sewell, and five certificates for a total of 1,000 shares in the name of Josephine M. Sewell, the wife of R. A. Sewell. All were signed by the proper officers and the corporate seal was affixed on that day. Certificates for 1,000 shares in the name of R. A. Sewell and 1,000 shares in the name of W. P. Sewell were canceled. A new certificate for 50 shares was issued to W. P. Sewell. Neither Josephine M. Sewell nor Ava384 F. Sewell was present at the time of the issuance of the certificates. Neither has ever had actual possession of them. Each was advised by her husband that a gift of the stock had been made. The certificates remained at all times attached to their stubs in the stock book at the company's office. In December 1934, R. B. Sewell endorsed certificates in his name totaling 500 shares of Sewell Manufacturing Co. stock, and directed the accountant of the corporation to transfer 500 shares to his wife, Mary W. Sewell, on January 1, 1935. The transfer was not actually effected until June 1935. R. B. Sewell at that time directed that a certificate for 500 shares be issued to his wife to be dated as of January 1, 1935, and that his certificates totaling that number be canceled. Those directions were carried out. Mary W. Sewell was not present when her certificate was issued. She had been told by her husband in December 1934 that he was going to make the gift on January 1, 1935, but she did not see her certificate until sometime in the summer of 1935. The certificate was never actually delivered to her, but was permitted to remain in the stock book of the corporation. On July 31, 1936, the 385 accountant for the company, at the direction of R. A. Sewell, procured the issuance of a certificate for an additional 300 shares to Josephine M. Sewell, and at the same time canceled two certificates totaling 300 shares then standing in the name of R. A. Sewell. As in the cases of the other earlier transfers, Josephine M. Sewell was not present when the certificate was issued, and never had actual physical possession of it. It remained in the stock book of the company. W. P. Sewell filed a gift tax return for 1934 and R. A. Sewell filed gift tax returns for 1934 and 1936 on which each reported making gifts of the stock issued in the names of their respective wives in those years. After examination, the Commissioner of Internal Revenue assessed additional tax against each as the result of adjustments increasing the value of the stock over the amounts reported on the returns. In each case, after negotiations between the accountant retained by the Sewells and representatives of the Commissioner, valuations were agreed upon and the tax liability of the donors was determined accordingly. During the course of these negotiations, the Commissioner did not question the making of the gifts, 386 nor their validity. In the case of R. A. Sewell, the amount of tax liability for 1936 was not finally settled until March 22, 1939. A timely gift tax return reporting the transfer in 1935 of 500 shares of stock to the wife of R. B. Sewell was not filed. Upon learning that no return had been filed, R. B. Sewell directed the accountant to prepare and file one immediately. Such return was filed on September 15, 1940. None of the wives of the three Sewell brothers took any part in the management or business of the company. None of them ever had notice of or attended any stockholders' meetings. Each of them came to the office occasionally, from time to time, and each had access to the vault, which was left open during business hours. Josephine M. Sewell, at the time of or subsequent to the issuance of the certificates to her endorsed them in blank. Some of the endorsements were not made until about the times her shares were sold. At sometime during the summer of 1935, Mary W. Sewell endorsed in blank the certificate for 500 shares issued in her name. She did so in order that her husband might pledge it as collateral for a loan should he wish to borrow money on it. The certificate for 387 950 shares issued in the name of Ava F. Sewell was not endorsed. During the taxable years cash dividends declared by the company on the stock standing in the names of Josephine M. Sewell, Ava F. Sewell and Mary W. Sewell, and reflected by credits to their respective accounts on the books of the company, were as follows: JosephineAva F.Mary W.M. SewellSewellSewell1934$14,000.00$13,300None193517,238.8020,900$11,000193615,767.8035,40018,4641937None17,8408,928Totals$47,006.60$87,440$38,392 Dividends payable on and before March 31, 1934, on the stock standing in the names of Josephine M. Sewell and Ava F. Sewell amounted to $4,000 and $3,800, respectively. In each instance those amounts had been credited originally to the accounts of R. A. Sewell and W. P. Sewell, respectively. Transfers of the credits were effected by debits to the account of R. A. Sewell in the total amount of $4,000 and corresponding credits to the account of Josephine M. Sewell, on November 3, 1934, and by similar adjusting entries made in the accounts of W. P. Sewell and Ava F. Sewell on December 26, 1934. Dividends payable prior to June 26, 1935, on the388 500 shares of stock transferred to the name of Mary W. Sewell, amounted to $8,500. Credits therefor, totaling that amount, had been entered in the account of R. B. Sewell at the times of declaration and payment of the dividends. On June 26, 1935, at the direction of R. B. Sewell or that of A. R. Lovvorn, the company bookkeeper transferred that amount to the account of Mary W. Sewell. With the foregoing exceptions, all dividend credits to the accounts of the respective wives were entered therein on the date of declaration and payment. In addition to credits representing dividends, there were also credited to the accounts of Josephine M. Sewell, Ava F. Sewell and Mary W. Sewell during the taxable years the following amounts: JosephineAva F.Mary W.M. SewellSewellSewell1934$15,000.00$ 500.00None193562,084.728,038.37None193698,684.00NoneNone1937None3,000.00NoneTotals$175,768.72$11,538.37None In the case of Josephine M. Sewell the additional amounts were made up almost entirely of the proceeds of sales of stock or the proceeds of loans 1 on stock standing in her name. In the case of Ava F. Sewell, the additional amounts were389 principally made up of transfers to her personal account from an account of notes payable to her by the company, and of a transfer from the account of A. R. Lovvorn, representing a payment on a loan which she had made to him. On June 27, 1937, the balance standing to her credit in the notes payable account, in the amount of $7,444.53, was transferred to the account of W. P. Sewell. During the taxable years amounts standing to the credit of Josephine M. Sewell, Ava F. Sewell and Mary W. Sewell were transferred, from time to time, to the accounts of their respective husbands. In every case the amount transferred represented the then entire credit balance in the account from which it was transferred. These transfers were as follows: FromJosephineAva F.Mary WaccountM. SewellSewellSewellR. A.W. P.R. B.to accountSewellSewellSewellDec. 31, 1934$13,800.00May 20, 1935$ 38,177.77Oct. 21, 193568,988.1718,957.60$10,000.00Dec. 30, 1935697.701,188.151,000.00Oct. 31, 193685,751.8026,600.00Dec. 18, 193628,700.00Dec. 31, 19368,800.001,210.00Dec. 31, 19376,112.756,793.59Totals$222,255.44$75,458.50$19,003.59390 The only debits to the account of Josephine M. Sewell other than those made to effect transfers to the credit of R. A. Sewell, amounted to about $520, which represented principally payments made by the company for her to the Collector of Internal Revenue and to the Georgia State Tax Commissioner. Debits to the account of Ava F. Sewell, other than those made to effect transfers to the credit of R. A. Sewell, amounted to about $23,600. Of that amount, about $7,500 represented payments made by the company for her to the Collector of Internal Revenue and to the Georgia State Tax Commissioner; about $5,100 represented the price of additional stock purchased with funds from her account and issued in her name; $6,000 represented a loan made to A. R. Lovvorn; and about $5,000 represented amounts transferred to her credit as notes payable. Debits to the account of Mary W. Sewell, other than those made to effect transfers to the credit of R. B. Sewell, amounted to about $19,400. Of that amount, about $2,700 represented payments made by the company for her to the Collector of Internal Revenue and the Georgia State Tax Commissioner; the balance of about $16,700 represented amounts paid for stock, 391 or loaned on pledge of stock, 2 standing in the name of Josephine M. Sewell. The transfers of the credits to the accounts of the husbands were made by the bookkeeper of the company at the direction of A. R. Lovvorn, the secretary. In some instances the husbands requested Lovvorn to have them made, but in others, particularly those at the end of each year, they were made at Lovvorn's direction without specific authorization from any one. Each wife knew that her husband made use of some of the dividends standing to her credit. Each had agreed with her husband that he could make use of them at any time he needed money. W. P. Sewell executed promissory notes payable to his wife, Ava F. Sewell, for each of the three transfers made to his account on and prior to December 30, 1935. The notes were not delivered to Ava F. Sewell, but were placed by the company bookkeeper in a drawer in the vault used jointly by her and her husband for keeping deeds, notes and other papers. Notes covering the transfers to W. P. Sewell made during 1936 and 1937 were not executed during those years. In April 1939, their absence392 was called to the attention of the bookkeeper by the internal revenue agent examining the transactions. The bookkeeper then prepared notes for $5,000, $8,800, 3 and $6,112.75, and dated them October 31, 1936, December 31, 1936, and December 31, 1937, respectively. They were signed by W. P. Sewell a day or two subsequent to their preparation. No payments were made on any of the notes until December 1941. At that time W. P. Sewell deeded to his wife four parcels of real estate, of the aggregate value of $10,250 according to an appraisal made by the Atlanta Real Estate Board. At the same time, he endorsed and delivered to her two promissory notes of which he was the holder, in the respective amounts of $2,890 and $2,595. The appraised value of the real estate plus the amount of the first note, amounting in all to $13,140, was credited as a payment of principal on the note for $13,800 representing the credit transfer of December 31, 1934. The note for $2,595 was credited as a payment of principal on the note for $18,957.60 representing the credit transfer of October 21, 1935. No other payments, of principal or interest, have ever been made. On or about the date of the conveyance of the393 real estate to her, Ava F. Sewell made deeds for the same properties to the children of herself and W. P. Sewell. R. B. Sewell executed promissory notes payable to his wife, Mary W. Sewell, for each of the transfers made to his account on October 21, 1935, December 30, 1935, and December 31, 1937. A note for $1,210 representing the transfer of December 31, 1936, was prepared by the company bookkeeper, but it was never signed. The notes were not delivered to her, but were placed by the bookkeeper in the company vault with other papers of her own and her husband. The notes have been exhibited to her on various occasions. On December 31, 1941, and December 31, 1942, transfers from the account of R. B. Sewell to her credit amounted in the aggregate to $10,298.40. Of that amount $10,000 was credited as in full payment of the principal of the note of October 21, 1935, and $298.40 as partial payment of the note of December 31, 1935. On December 24, 1940, $6,793.59 was transferred from the account of R. B. Sewell to the credit of Mary W. Sewell. She then endorsed the note of December 31, 1937, as paid. No payments of interest have394 been made on any of the notes. R. A. Sewell did not execute promissory notes for any of the amounts transferred to his account from that of his wife. He used the funds so transferred, together with other money, in the organization of a hat manufacturing business and for the construction and equipment of its building and plant. During the taxable years the accounts of W. P. Sewell and Ava F. Sewell were consolidated for the purpose of computing interest. If together they reflected a credit balance on which interest was owing from the company, the amount owing was credited to the account of W. P. Sewell; if they reflected a debit balance on which the company was entitled to interest, the amount owing was charged to the account of W. P. Sewell. His account was also charged with amounts credited to his personal bank account from time to time and charged by the bank against funds which the company had on deposit. Ava F. Sewell had authority to draw checks against his bank account without limit. In February 1940 and thereafter the company charged her personal account with the amounts charged against it on account of checks drawn by her. Similarly, since 1940 or 1941, the company has debited395 the account of Mary W. Sewell with the amounts charged against it by the bank for her account. W. P. Sewell and R. B. Sewell had occasion at various times to prepare and file financial statements with banks and credit institutions. W. P. Sewell filed such a statement with the Bank of Fulton County, East Point, Georgia, showing his financial condition as of January 1, 1935, on which he stated the value of "stocks and bonds other than U.S." owned by him to be $250,000. On January 1, 1935, the aggregate book value of the 1,900 shares of stock in Sewell Manufacturing Co. standing half in his name and half in the name of Ava F. Sewell was approximately $250,000. A statement filed by him with another financial institution showing his financial condition as of October 26, 1935, listed 1,900 shares of Sewell Manufacturing Co. stock as owned by him. On another statement dated January 22, 1937, showing his financial condition as of January 1, 1937, under "Assets" he wrote "Stock owned by wife but controlled by me $139,106," immediately under which he inserted the following: "Note I have given for tax purposes to Mrs." The latter words were stricken out by W. P. Sewell with pen and ink. On 396 a statement of condition as of January 1, 1938, he stated the value of Sewell Manufacturing Co. stock owned by him to be $400,000. None of the foregoing statements disclose any liability of W. P. Sewell to Ava F. Sewell. R. B. Sewell filed a statement of his financial condition as of April 1, 1935, with the First National Bank of Atlanta, Georgia, on which he included in his own assets the 500 shares of Sewell Manufacturing Co. stock which he had previously instructed the accountant for the company to transfer to the name of his wife. In a statement dated February 10, 1936, he expressly stated that the value of 500 shares of Sewell Manufacturing Co. stock owned by his wife was not included among his assets shown thereon. A similar notation was made on a statement dated January 19, 1937, but the following additional note was also written thereon: "558 shares of Sewell Mfg. Co. - owned by my wife and controlled by me - are not included." None of the foregoing statements filed by R. B. Sewell disclose any indebtedness to Mary W. Sewell. Two statements filed by R. A. Sewell with an Atlanta bank, purporting to show the financial condition of "R. A. Sewell operating as Sewell Hat Manufacturing397 Co."; on May 31, 1936, do not disclose any proprietary interest in Josephine M. Sewell nor any indebtedness to her. The same is true of another statement filed with a different bank at the same time. None of the stock transfers in question were intended by the Sewell brothers to vest dominion and control over the shares of stock transferred in their respective wives. It was their intention to retain, and they did retain, that control and dominion in themselves. Each of the wives knew such intention existed, and each impliedly agreed that her husband retain control over the stock in her name. Completed gifts of the stock certificates so transferred were not made. Josephine M. Sewell, Ava F. Sewell and Mary W. Sewell each reported as her own income the amounts credited to her account as dividends during the taxable years. The respondent determined that the dividends were taxable to R. A. Sewell, W. P. Sewell and R. B. Sewell, respectively, and adjusted net income reported by each accordingly. The amounts of the adjustments for the years 1935 and 1936 in the cases of R. A. Sewell and W. P. Sewell varied slightly from the amounts reported by their wives, but the petitioners do not assign398 error with respect to the differences. Opinion Whether the dividends here in question are taxable to the three Sewell brothers or any of them, or to their respective wives, depends upon whether valid and effectual gifts of the stock were made to the wives. The respondent in substance takes the view that there were lacking in each case three of the elements of a bona fide gift inter vivos, namely, "a clear and unmistakable intention on the part of the donor to absolutely and irrevocably divest himself of the title, dominion, and control of the subject matter of the gift, in praesenti; the irrevocable transfer of the present legal title and of the dominion and control of the entire gift to the donee, so that the donor can exercise no further act of dominion or control over it; and a delivery by the donor to the donee of the subject of the gift or of the most effectual means of commanding the dominion of it." Those are among the elements which, in Adolph Weil, 31 B.T.A. 899">31 B.T.A. 899, 906 affd., 82 Fed. (2d) 561 (C.C.A., 5th Cir.) quoted by the respondent as above, were stated to be essential to the consummation of a valid399 gift. Each of them has frequently been recognized as essential, and the absence of one or more of them has been held determinative of the nonexistence of alleged gifts. See, e.g., Allen-West Commission Co. v. Grumbles, 129 Fed. 287; Jackson v. Commissioner, 64 Fed. (2d) 359, 360; Oscar G. Joseph, 32 B.T.A. 1192">32 B.T.A. 1192; Lunsford Richardson, 39 B.T.A. 927">39 B.T.A. 927, 932; Empire Trust Co. et al., Executors, 41 B.T.A. 839">41 B.T.A. 839, affd., 119 Fed. (2d) 421. If any of them was lacking in the instant cases our decisions must be for the respondent. We consider first whether the alleged donors may be said to have intended to divest themselves and did divest themselves completely and finally of title, dominion and control of the stock in question. The subjective state of mind of each of them must be found not only from their testimony of what they intended, but also from an examination of all the circumstances surrounding each transaction. As was said in Chicago Title & Trust Co., Executor, 32 B.T.A. 249">32 B.T.A. 249, 253,400 "Surrounding circumstances, including subsequent acts of the taxpayer, often establish intent more clearly than the words of the participants." Cf. Theodore C. Jackson et al., Administrators, 32 B.T.A. 470">32 B.T.A. 470, 477, and cases there cited; and Arthur M. Godwin, 34 B.T.A. 485">34 B.T.A. 485, 492. In the instant proceedings, we think the actions of the parties subsequent to the transfers in question were such as to negative the existence of donative intent in each case. We will discuss briefly some of the several factors which lead us to that conclusion. Both Josephine M. Sewell and Mary W. Sewell endorsed in blank the certificates issued to them, the latter shortly after the time of issuance. Josephine testified that some of the certificates issued in her name were not endorsed until about the time the shares they represented were sold. That testimony fails to place satisfactorily the actual time of the endorsements, since sales of stock standing in her name occurred in each of the years 1934, 1935, 1936, and, according to her contention, 1937. The periodic transfers of the entire credit balances from the accounts of the wives furnishes401 further evidence of dominion exercised by their husbands over the stock in question. In the case of R. A. Sewell the aggregate of the amounts transferred during the taxable years, $222,255.44, was but about $520 less than the sum of all the amounts credited. The credits to his wife's account were all traceable to the stock standing in her name, either from dividends, sales or loans. In the case of W. P. Sewell the total amounts transferred, $75,458.50, were about $23,600 less than the sum of all the amounts credited to his wife. Of the $23,600, about $5,000 was transferred to her notes account, the entire credit balance of which was in turn transferred to her husband's account. The remaining amounts were used in payment for stock transferred to her name from the name of Josephine M. Sewell, in payment of federal and state taxes, and for a loan to A. R. Lovvorn. With respect to the transfer of $26,600 on October 31, 1936, it is contended that only $5,000 was a loan and that the remaining $21,600 was in payment for 150 shares of stock. An examination of the accounts of W. P. and Ava F. Sewell, and of the stock certificate in question, leads us to conclude that the transfer was originally402 recorded without explanation, and that subsequently there was written in "21,600 - 150 shares 5,000, loan," in the account of Ava F. Sewell, and "21,600 stock 5,000 LOAN," in the account of W. P. Sewell. A certificate for 150 shares of stock issued under date of October 31, 1936, quite evidently bore the name W. P. Sewell, as originally drawn, but has since been altered by the insertion of "Mrs." immediately before and partially above his name. In the case of R. B. Sewell the total amounts transferred, $19,003.59, were equal to approximately one-half of the sum of all the amounts credited to his wife, all of which represented dividends on the stock standing in her name. The remaining amounts were used for the purchase of additional stock in her name from Josephine M. Sewell, or for loans to Josephine M. Sewell and for the payment of state and federal taxes. It does not appear that the wives had specific knowledge either of the foregoing transfers or of the other entries made in their accounts from time to time, much less that they had any voice in the transactions which the entries purport to reflect. One instance, we think, typifies the extent to which they were permitted to remain403 in ignorance. A debit to the account of Mary W. Sewell under date of October 31, 1936, in the amount of $8,352 is explained on the books as a loan to Josephine M. Sewell. At the hearing the bookkeeper testified that the loan had actually been made by R. B. Sewell and should have been charged to his account rather than his wife's, although on that date R. B. Sewell's account reflected a debit balance of some $2,200; but that correcting entries had not been made because the error was not discovered until after these proceedings had been instituted. When questioned about the matter, Mary W. Sewell admitted that she had not been told of the error, and had no knowledge of it until hearing the bookkeeper's testimony. It is difficult to imagine that any one with the substantial interest which it is contended she had, would not be informed fully and promptly of an item involving that amount of money. It is our opinion that the husbands at all times intended to retain and did retain complete control over the accounts of the wives, dictating the entries to be made and the transactions they represented as best suited their own conveniences. This conclusion finds support not only in the evidence404 as to what was actually done, but in the testimony of the interested parties themselves. W. P. Sewell testified that he used the dividends credited to his wife as he saw fit in the business. His wife testified that he had always handled her affairs, thate he had authority to do so, and that he did as he saw fit with her stock. R. B. Sewell testified that his wife had agreed that he might use any money standing to the credit of her account. His wife testified that her dividends were at her husband's disposal, and that it was understood that he might use the money any time he needed it and she didn't. Josephine M. Sewell testified that the evidence given by Ava F. Sewell and Mary W. Sewell with regard to the dividends on their stock applied as well to those on the stock in her name. Prior to the hearing she told an agent of the Bureau of Internal Revenue that her husband had her permission to use the dividends for the company's benefit. Other circumstances lend support to the conclusion that complete and final gifts of the stock were not intended and were not made. The making of financial statements by W. P. Sewell and R. B. Sewell, in which they held themselves out as owning or controlling405 the stock issued to their wives, and in which they failed to disclose any liability for the amounts they now claim to have borrowed from them, is one. The fact that the statements filed byR. A. Sewell disclosed no interest in the hat manufacturing business in his wife or any liability to her, is another. That no notes were given for some of the alleged loans, that others were not made until these transactions were under investigation by the Bureau of Internal Revenue, and that no payments were made on any of the notes for several years after their execution, and then at a time when the nature of the transactions was in question, are others. Some of the circumstances we have noted as discrediting the petitioners' contention are unexplained. Most of the others are claimed to have resulted from errors and oversights on the part of the company accountant, the bookkeeper or the Sewell brothers themselves. Undoubtedly some actual errors may have been made. On the whole evidence, however, we can not say that the petitioners have established the existence of donative intent which must necessarily have been present in order for them to prevail on this issue. The assessment of gift taxes and406 the subsequent additional assessments were based upon representations, implicit in the filing of returns by the alleged donors, that gifts had been made. For gift tax purposes there never was any reason to question the bona fides of the gifts. Nothing in the nature of an estoppel against the position now asserted by the respondent can be said to have arisen from his prior actions predicated upon representations made by the petitioners themselves; and estoppel is not pleaded. It has frequently been held that a manual delivery of stock certificates is not always necessary to consummate a valid gift of the stock, and under certain circumstances transfer on the books of the corporation in itself has been regarded as a sufficient delivery. Marshall v. Commissioner, 57 Fed. (2d) 633; see also Owen v. Commissioner, 53 Fed. (2d) 329, 332, and Kathryn Lammerding, 40 B.T.A. 589">40 B.T.A. 589, 596; Essie Irene Gaffney, Executrix, 36 B.T.A. 610">36 B.T.A. 610, 614. In view of the conclusions we have already expressed, however, it becomes unnecessary for us to decide whether the manner of delivery407 to the alleged donees would have been sufficient had the other circumstances been different. On the first issue we sustain the respondent. Findings of Fact as to the Second Issue (Whether 1937 Dividends Taxable to R. B. Sewell) On June 28, 1935, a certificate for 100 shares of $50 par value capital stock of Hubbard Pants Co., a Georgia corporation, was issued in the name of the petitioner, R. B. Sewell. The certificate itself was permitted to remain in the stock certificate book of the issuing corporation until August 28, 1936, when it was detached and delivered to the petitioner. On January 1, 1937, he endorsed it in favor of his wife, Mary W. Sewell, and at that time told her he was giving her 100 shares of stock of Hubbard Pants Co. The certificate was never delivered to her, but was kept in the vault of Sewell Manufacturing Co. No report of a transfer of ownership was reported to the corporation. On December 22, 1937, Hubbard Pants Co. declared a 40 per cent dividend to be paid in cash or in stock, at the option of the stockholder. R. B. Sewell was not present at the meeting but learned of the declaration shortly thereafter. On December 27, 1937, he notified the secretary-treasurer408 of the corporation that he had given his stock to Mary W. Sewell about the first of the year, and requested that the dividend be paid in stock and that the certificate therefor be issued in her name. Four or five weeks later the original certificate was delivered to the corporation and its transfer was effected by the issuance of a new certificate for 100 shares in the name of Mary W. Sewell. At the same time another certificate for 40 shares was issued in her name in payment of the dividend. Both certificates were dated December 27, 1937, the date when the secretary-treasurer had been informed of the gift. Both were permitted to remain in the stock book of the corporation until July 12, 1938, when they were detached and delivered to Mary W. Sewell. On March 8, 1938, R. B. Sewell filed a gift tax return for 1937 on which he reported making a gift on January 5, 1937, of 50 shares of common stock in Hubbard Pants Co. The accountant who prepared the return inadvertently stated that the number of shares had been 50 instead of 100. Mary W. Sewell reported $2,000. the par value of 40 shares of Hubbard Pants Co. stock as taxable income from dividends on her 1937 income tax return. The respondent409 determined that that amount was taxable to R. B. Sewell and adjusted his reported net income accordingly. R. B. Sewell did not make a completed gift of his 100 shares of Hubbard Pants Co. stock to Mary W. Sewell in 1937. Opinion Whether the dividend here in question is taxable to the petitioner or to his wife depends upon whether he or she was the owner of the stock on which it was declared on December 22, 1937. That question in turn depends upon whether an effectual gift had previously been made to her. The evidence establishes that the petitioner endorsed the certificate in her favor and had told her that he had made her a gift of the shares. The petitioner contends that the original certificate was also delivered to her, and he so testified. However, his wife stated positively that it was the new certificate which was handed to her in July 1938, and that she had not had possession of the original. We conclude that no actual delivery occurred, and that W. P. Sewell retained possession until the certificate was surrendered and the new one issued. Nor was there any constructive delivery in 1937. The mere endorsement of the certificate in favor of the wife, without delivery to her, 410 or to some one for her, or without a transfer on the books of the corporation, can not be said to have satisfied this essential element of a completed gift, even though the alleged donee was advised by the petitioner that a gift had been made. Marshall v. Commissioner, 57 Fed. (2d) 633; Sizer v. United States, 65 Ct. Cl. 450">65 Ct. Cl. 450. It does appear that the petitioner intended at sometime to make a gift to his wife, but there was no time during the taxable year when she may be said to have had dominion over it. R. B. Sewell did not vote the stock, but could have done so had he wished, having both the possession and record title. It was at his direction and not his wife's that the dividend was paid in stock rather than in cash. We conclude and hold that a valid gift had not been made on or prior to the declaration of the dividend in question. On this issue the respondent's determination is sustained. Findings of Fact as to the Third Issue (Taxation of Credits to Wives of W. P. Sewell and R. A. Sewell) We incorporate herein by reference the findings of fact as to the first issue, in so far as they relate to the proceedings411 of W. P. Sewell and the Estate of R. A. Sewell, and find the following additional facts: During the taxable years the following amounts were entered as interest to the credit of Ava F. Sewell and Josephine M. Sewell on the books of Sewell Manufacturing Co.Josephine M.DateAva F. SewellSewellDec. 31, 1934$480.00May 1, 1935$ 69.00May 20, 1935201.60May 31, 1935$641.87Dec. 7, 1935287.77Totals (1935)$558.37$641.87Oct. 19, 1936$168.71June 29, 1937$236.20June 29, 193740.00Total (1937)$276.20The credit of $69 on May 1, 1935, to the account of Ava F. Sewell, and that of $641.87 on May 31, 1935, to the account of Josephine M. Sewell represent interest on the average credit balance in their respective accounts for the period January 1, to May 1, 1935. With the exception of the $287.77 credited to Ava F. Sewell on December 7, 1935, the remainder of the foregoing credits represented interest computed on amounts loaned by Ava F. Sewell from funds of her own to Sewell Manufacturing Co. The credit of December 7, 1935, represents interest on a loan made by her to A. R. Lovvorn, the amounts of the credit having been charged against412 his account. The only amounts standing to the credit of Ava F. Sewell and Josephine M. Sewell during the period January 1, 1935, to May 1, 1935, resulted entirely from dividends paid by the company. Josephine M. Sewell reported the credit of $641.87 as her income on her return for 1935. Ava F. Sewell reported all the amounts credited to her as interest during the taxable years as her income. The respondent determined in each instance that the interest credits were taxable to W. P. Sewell and R. A. Sewell, respectively, and adjusted their reported net income accordingly. Opinion With regard to the credits made in May 1935, representing interest on the average credit balances in the accounts of Ava F. Sewell and Josephine M. Sewell, our decision is governed by our opinion on the first issue. We held there that the dividends on the stock standing in the names of the wives, although credited to their accounts, were taxable to their husbands. It follows that the interest accruing thereon and also credited to their accounts is taxable to the husbands. The respondent properly so determined. The remainder of the credits in question are all in the account of Ava F. Sewell and represent413 interest on loans made by her to the company and to A. R. Lovvorn. The evidence establishes that the loans to the company were made from funds of her own, and an examination of her account leads us to conclude that the same is true with regard to the loan to Lovvorn. It follows that as to these latter amounts the respondent's determination was in error. Findings of Fact as to the Fourth and Fifth Issues (Taxation of Profits on Stock Sales as to R. A. Sewell, or Wife) We incorporate herein by reference the findings of fact as to the first issue in so far as they relate to the proceeding of the Estate of R. A. Sewell, and find the following additional facts: On December 29, 1934, 123-17/20 shares of Sewell Manufacturing Co. stock, standing in the name of Josephine M. Sewell, were sold to C. E. Graybill for $14,930.12. A taxable profit was realized on the sale, but was not reported either on Josephine M. Sewell's return or that of her husband. On different dates during 1935 an aggregate of 527-3/10 shares of Sewell Manufacturing Co. stock standing in the name of Josephine M. Sewell was sold to various persons for prices totaling $61,442.85. Taxable gain from these sales in the414 amount of $23,672.66 was reported as her income on her 1935 return. On October 31, 1936 an aggregate of 243 shares of stock standing in her name was sold to various persons for prices totaling $34,992. Taxable gain from these sales in the amount of $9,943.56 was reported as her income on her 1936 return. On October 31, 1936 Josephine M. Sewell entered into a written contract with A. R. Lovvorn under the terms of which she assigned to him 35 shares of Sewell stock as security for a loan of $5,040. The contract provided that the assignee receive all dividends on the pledged stock in lieu of interest, and that the pledgor (Josephine M. Sewell) within three years either repay the loan in cash, or surrender the stock held as collateral "it being understood and agreed that said value of said * * shares shall not be less than * * " the amount of the loan. On the same date she entered into a contract having the same terms with W. P. Sewell, assigning to him 150 shares of Sewell stock as security for a loan of $21,600, and another similar contract with R. B. Sewell assigning 58 shares of Sewell stock as security for a loan of $8,352. On December 18, 1936 she made a similar contract with415 A. R. Lovvorn assigning 30 shares of Sewell stock to secure a loan of $5,250, and another with R. B. Sewell assigning 44 shares to secure a loan of $7,700. Also on that date she and R. A. Sewell, her husband, entered into a similar contract with W. P. Sewell, under which they assigned 110 shares of Sewell stock to secure a loan of $19,250. Of that number, 90 shares were in her name and 20 in the name of R. A. Sewell. R. A. Sewell, alone, entered into a similar contract with W. P. Sewell on the same day assigning 400 shares of stock to secure a loan of $59,400. The amounts received by R. A. Sewell and Josephine M. Sewell from the sales and under the pledge contracts were paid by credits to their respective accounts and charges against the accounts of the vendees and pledgees on the company books. The aggregate number of shares sold outright on October 31, 1936 was equal to the aggregate number covered by the three pledge contracts executed on that day. The total of the prices received from the sales was equal to the total of the amounts advanced under the contracts. In the latter part of 1937 the pledgors exercised the options, granted by each of the contracts, to surrender the stock416 covered thereby. Between the time the contracts were made and the options exercised the stock had increased in value approximately $18 a share. During 1937 Sewell Manufacturing Co. paid dividends aggregating 80 per cent of outstanding capital stock. On her income tax return for 1937, Josephine M. Sewell reported a taxable gain of $18,688.04 from sale or exchange of the 407 shares of stock in her name covered by the 1936 pledge contracts. On his income tax return for 1937, R. A. Sewell reported a taxable gain of $18,154.40 from sale or exchange of the 420 shares of stock in his name covered by the 1936 pledge contracts. The 1,301-3/20 shares of stock in the name of Josephine M. Sewell thus disposed of by outright sale and under the pledge contracts were the 1,000 shares and 300 shares transferred to her by R. A. Sewell in 1934 and 1936 as described in our findings of fact as to the first issue, and an additional 1-3/20 shares transferred to her by him on December 18, 1936. The respondent determined that the gains realized on the sales of all of those shares are taxable to R. A. Sewell, and that the gains on the shares covered by the 1936 pledge contracts are taxable in 1936 rather417 than in 1937. Net income reported by R. A. Sewell was accordingly adjusted by addition of the following amounts: 1934$ 5,859.34193523,912.671936Stock in name ofJ.M.S.$28,231.601936Stock in name ofR.A.S.18,154.40$46,386.00Other adjustments in capital gains reported on his 1935 and 1936 returns are not in issue. Opinion The questions here are whether the gains realized on the sales of Sewell Manufacturing Co. stock registered in the name of Josephine M. Sewell are taxable to her or to R. A. Sewell, and whether the gains realized on the stock covered by the 1936 pledge contracts are taxable in 1936 or in 1937. No question having been raised as to minor adjustments made by respondent in the amounts of some of the gains, we assume that their correctness is conceded. The first of the two questions here presented is governed by our holding on the first issue that R. A. Sewell remained the owner for tax purposes of the 1,300 shares of stock which he caused to be transferred to his wife's name. The petitioner has not shown the circumstances surrounding the transfer of the additional 1-3/20 shares on December 18, 1936, and upon brief does 418 not contend that they should be treated differently from the others. We hold that the gains realized on the sales of the 1301-3/20 shares of stock in the name of Josephine M. Sewell are taxable to R. A. Sewell. As to the second question, the respondent contends that the pledge contracts of 1936 are to be treated as contracts of sale with the right to repurchase reserved to the sellers, and therefore that the gains are taxable in 1936 rather than 1937. So to treat the transactions would require evidence that the real intention of the parties was other than what each of the executed contracts on its face represents it to be. The respondent argues that such evidence may be found in the surrounding circumstances, pointing out that nowhere in the contracts do the pledgors promise to repay to the pledgees the amounts of the loans; that the pledgors parted with title, possession and the benefits of ownership; that one of the pledgees held himself out as owner of the stock allegedly pledged to him; that the pledgees received by way of the dividends far more than a fair rate of interest on their money, and that between the time the contracts were executed and the stock was surrendered it had419 enhanced in value about $18 a share. The contracts by their terms gave the pledgors the option of repaying the loans and taking up their shares or of surrendering the stock to the pledgees if it be worth the amount of the loan at the time of surrender. An obligation to pay the indebtednesses in the one manner or the other was clearly imposed. It is true that possession and the right to receive dividends passed to the pledgees and we may assume, arguendo, that they received title as well. Those factors are of little significance, however, since whatever passed is expressly provided to have passed as security for money loaned, and the receipt of dividends by the pledgees was to compensate them for the use of their money. The fact that the dividends were high worked to their advantage, but as the petitioner points out, even though they had been high in preceding years, there might very possibly have been none during the period in question, and in that event the pledgees would have loaned their money interest-free. The representation by one of the pledgees that he owned the stock assigned to him is of but slight force as against the pledgors. The respondent points to the further420 fact that at the time the pledgors elected to surrender the stock in 1937 its value had substantially increased. But in our opinion that single circumstance will not warrant the conclusion that the transactions in question were sales rather than loans. The pledge contracts are in evidence. That evidence meets the presumption favoring the correctness of the respondent's determination, and establishes a prima facie case for the petitioner. The pledgors' decision to surrender rather than redeem may have been motivated by one or more of a variety of reasons, and we are not prepared to speculate as to what they might have been. The fact is that Sewell and his wife held contract rights to redeem if they wished, and had they done so there would be little reason on these facts to question the form of the transactions. That they did not does not require the inference that their true intention was to sell and that of the pledgees was to purchase the stock in 1936. Until the options were exercised there were not completed sales. It follows that the gains are taxable in 1937 rather than in 1936. On this question the respondent's determination is reversed. Findings of Fact as to the Sixth Issue421 (Taxation of Profits of 1936-37 of Hat Business to R. A. Sewell, or to Pariners) We incorporate herein by reference the findings of fact as to the first issue, in so far as they relate to the proceeding of the estate of R. A. Sewell, and find the following additional facts: The amounts transferred from the account of Josephine M. Sewell to the credit of R. A. Sewell on the books of Sewell Manufacturing Co. were withdrawn and invested by him in the construction and equipment of a manufacturing plant known as Sewell Hat Manufacturing Co. By the close of the year 1935, he had withdrawn and so expended the $107,803.64 transferred from his wife's account during that year, and the additional amount of $54,220.41. By the close of 1936 the $114,451.80 so transferred to him during that year and the additional amount of $84,726.66 had been similarly withdrawn and invested. In the fall of 1935 R. A. Sewell became seriously ill and unable to operate his hat business. His brother, W. P. Sewell, agreed to buy it, and on October 14, 1935 a deed was executed and delivered to him. At that time W. P. Sewell agreed to reconvey the factory to R. A. Sewell for the same price then paid, if R. A. 422 Sewell should ever wish it. Having recovered from his illness during the early part of the following year, R. A. Sewell did request a reconveyance, and on February 27, 1936 W. P. Sewell accordingly executed a deed in his favor. For the year 1935 the hat business sustained an operating loss of about $18,000, the entire amount of which was claimed as a deduction by R. A. Sewell on his individual return for 1935. At different times during 1936, R. A. Sewell told his accountants and two other business associates that the hat business was being operated as a partnership, the members of which were himself and his wife and their four children. However, in financial statements filed by him for credit purposes he represented that on May 31, 1936 he was the sole owner. The capital account in the hat business ledger was opened August 31, 1935 under the caption "Investment - Capital - R. A. Sewell." On about March 15, 1937 the bookkeeper, acting on instructions from R. A. Sewell, added the words "and family" to the caption. At about the same time, also upon instructions from R. A. Sewell, the bookkeeper inserted a sheet in the ledger headed "(Memo) Division of Investment Account for year 1936423 R. A. Sewell and Family." That sheet reflects a credit balance in capital account of $380,098.66 as of December 31, 1936, and a breakdown of that amount as follows: R. A. Sewell$159,025.27Josephine M. Sewell159,025.27R. A. Sewell, Jr.15,818.39Joseph Sewell15,417.24Hugo Sewell15,435.26Helen Virginia Sewell15,377.23 The figures for the above break-down were given to the bookkeeper by the accountant retained to examine the books of the hat business for preparation of a 1936 income tax return. Under date of March 19, 1937 the same accountant prepared a gift tax return for Josephine M. Sewell on which were reported gifts on January 1, 1936 of separate $15,000 interests in Sewell Hat Manufacturing Co., to each of her four children, R. A. Sewell, Jr., Joseph, Hugo and Helen Sewell. A partnership return for Sewell Hat Manufacturing Co., prepared by the same accountant and executed on March 19, 1937, reported net income of $10,311.05 distributable as follows: R. A. Sewell40%$4,124.43Mrs. R. A. Sewell40%4,124.42R. A. Sewell, Jr.5%515.55Joseph Sewell5%515.55Hugo Sewell5%515.55Helen Virginia Sewell5%515.55 Josephine M. Sewell's 424 individual return for 1936, also executed on March 19, 1937, was prepared by the same accountant. Nothing was reported thereon as her distributive share of profits of the hat company. At about the time the foregoing income and gift tax returns were under preparation the accountant instructed one of his employees to prepare a trust agreement covering gifts from Josephine M. Sewell to her four children. The employee undertook the work at that time. When he had completed a proposed instrument, his employer or R. A. Sewell suggested the insertion of some additional provisions. The final draft incorporating the suggestions was completed on May 27, 1937 but bore date of June 1, 1936. It was between Josephine M. Sewell, party of the first part, and herself and R. A. Sewell, as trustees for their four children, party of the second part, and provided in part as follows: "WHEREAS, the party of the first part has this day purchased and paid for a three-fifths (3/5) undivided interest in a certain business, known as the SEWELL HAT MANUFACTURING COMPANY, located at Red Oak, Fulton County, Georgia, and whereas the undersigned desires to convey in trust for each of her following minor children, 425 to wit: Robert A. Sewell, Jr., Joseph Sewell, Hugo Sewell and Helen Sewell, an undivided one-twentieth (1/20) interest in and to all of the assets of said business, and all profits therein accruing from and after this date, upon the terms, conditions and powers hereinafter set forth, and "WHEREAS, the undersigned desires that her husband, Robert A. Sewell, who is the owner of two-fifths (2/5) undivided interest in the business, continue the active management and control of said business, both for himself and for the benefit of said minor children, and for the benefit of the party of the first part. "NOW THEREFORE, the party of the first part, in consideration of love and affection, does hereby transfer and convey unto herself and Robert A. Sewell, as Trustees for said named minor children, a one-fifth (1/5) interest, i.e., a one-twentieth (1/20) interest for each minor child, in and to said partnership, upon the following terms, conditions and powers, hereinafter set forth, that is to say: "1. The party of the first part does constitute, select, and appoint herself and husband, Robert A. Sewell, as Trustee for each of said described children during their minority, the said Trustees426 to hold legal title to said respective partnership interests and assets, for the use and benefit of said minor children, and the said business shall continue from and after this date as a partnership consisting of the party of the first part owning an undivided two-fifths (2/5) interest, her said husband, Robert A. Sewell, owning an undivided two-fifths (2/5) interest, and the aforesaid Trustees holding the legal title for each of said minor children, to an undivided one-twentieth (1/20) interest for the use and benefit of said children." Josephine M. Sewell subsequently signed the instrument. It was later lost and has never been recovered. On October 16, 1940, she executed a carbon copy of the original. During the time that the trust agreement was under preparation, the employee who drafted it was engaged also in the preparation of a limited partnership agreement between R. A. Sewell, individually, as general partner, and Josephine M. Sewell, individually, and R. A. Sewell and Josephine M. Sewell as trustees for their four children, as limited partners. The final draft was completed at about the same time as the trust agreement and was executed under date of July 1, 1937. It provided427 that R. A. Sewell and Josephine M. Sewell should each contribute to the capital of the limited partnership their separate undivided two-fifths interest in Sewell Hat Manufacturing Co., and that as trustees for their children they should contribute four undivided one-twentieths interests; that profits and losses be divided in proportion to the capital contributions; that R. A. Sewell have active charge of the conduct of the business, and be paid a salary therefor not to exceed forty per cent of net income of the business; and that in the event of the death of R. A. Sewell, the partnership should terminate. There had been no written partnership agreement affecting the hat business prior to the execution of the trust agreement and the limited partnership agreement in 1937. Under date of September 30, 1937 the capital investment accounts of R. A. Sewell and Josephine M. Sewell were debited $20,000 each, and credits of $10,000 each were entered in the accounts of each of the four children. At that time, it was agreed that the distributive share of profits of each child should be 8 1/3 per cent. A partnership return for Sewell Hat Manufacturing Co. for 1937 reported net income of $42,889.95, 428 before payment of salaries of $8,400 to R. A. Sewell and $3,000 to Josephine M. Sewell, leaving a balance of $31,489.95, distributable as follows: R. A. Sewell$10,496.55Jos. M. Sewell10,495.55R. A. Sewell, Jr.2,624.22Joseph Sewell2,624.21Hugo Sewell2,624.21Helen V. Sewell2,624.21 Josephine M. Sewell reported the amount of $13,496.55 as income from the hat business on her individual return for 1937. The amounts reported as the distributive shares of profits of Josephine M. Sewell and of the four children, less withdrawals, were transferred in each of the taxable years and in subsequent years to the credit of their respective capital accounts. In 1937 withdrawals in the amount of $18,763.46 were charged to Josephine M. Sewell, and of $47.50 to each of the four children. R. A. Sewell died on January 16, 1940. Thereafter the hat business was operated by his widow and the children. In 1942 it was incorporated and has been oprated as a corporation since that time. The respondent determined that taxable income from the hat business was $11,670.43 in 1936 and $43,323.93 in 1937, and that the entire income for each year is taxable to R. A. Sewell. Opinion The 429 issue here is whether the hat business was owned and operated solely by R. A. Sewell during 1936 and 1937, or whether it was a partnership of which he and his wife and their four children were members. The petitioner concedes that R. A. Sewell was sole proprietor during 1935, but contends that a partnership was formed by an oral agreement as of January 1, 1936, between husband and wife individually and as trustees for the benefit of the four children, and that the interests of the latter were increased by gifts of additional capital interests in 1937 by both Mr. and Mrs. Sewell. The respondent's position, as we understand it, is that initially Mrs. Sewell had no interest in the business; that so far as appears she never purchased such an interest; and therefore she had nothing to transfer to the trusts which she created for the children, and nothing to retain for herself. A considerable portion of the evidence submitted on this issue has to do with the date on which the trusts for the children were created. Josephine M. Sewell and the accountant in whose office the trust instrument was prepared both testified that the actual execution occurred in 1936. A copy of a preliminary draft, 430 an unexecuted copy of the final draft and the copy of the final draft which was executed on January 16, 1940 were all introduced in evidence. The preliminary copy bears date of January 1, 1936; both copies of the final draft are dated June 1, 1936. The employee who prepared the instrument testified that his work was not completed until May 27, 1937, and that prior to that time the instrument had not been executed. He testified from permanent records which he had made contemporaneously with the preparation of the instruments on which were recorded the amounts of time spent and the nature of the work done by him in each week for his employer. He testified further that he remembered completing the trust instrument after having moved into a particular office building, and that the move was not made until March of 1937. The conflict in the evidence on this issue must be resolved in the respondent's favor, and we have accordingly found as facts that the instrument was prepared in 1937, and that it was executed by Mrs. Sewell at some time subsequent to its preparation. In disposing of the First Issue presented in these proceedings we held that the Sewell Manufacturing Co. stock registered431 in the name of Josephine M. Sewell was to be considered for tax purposes as the property of her husband, the decedent. The moneys traceable to that stock which he invested in the hat business were likewise his own. Such investment, by itself, created no interest therein in his wife. If she and the children were the owners of capital interests in the taxable years, those interests must have been acquired, whether by gift or purchase, from the decedent. The interests of the children are alleged to have sprung from that of Josephine M. Sewell. The trust instrument executed by her recites that she purchased and paid for a three-fifths undivided interest in the business. Even if that instrument had been executed in 1936 we would be unable to say that it effected the transfer of interests in the partnership. Admittedly R. A. Sewell was a sole proprietor prior to 1936, and nothing in the record will justify a finding that he parted with any interest during 1936. The entries in the capital investment account reflecting the division of capital, the preparation of the gift tax return for Josephine M. Sewell, and of the trust indenture and the limited partnership agreement all occurred in 1937. 432 The work in connection with all of those matters was done under the direction or suggestion of the accountant retained to prepare an income tax return, and was begun at or about the time the return was under preparation. In our opinion the idea of the creation of a partnership was then hit upon for the first time, as an afterthought, for the purpose of minimizing the tax on the substantial profits which had been earned in 1936. We conclude that R. A. Sewell made no transfer of any interest in the hat business during 1936. It follows that its profits are taxable to him alone. With respect to 1937 we have the following additional facts: That in that year book entries were made transferring from the decedent's capital account to the credit of his wife and four children amounts approximating two-fifths and one-twentieth interests, respectively, and that the trust instrument and limited partnership agreement were executed. The record does not indicate the extent to which Mrs. Sewell participated in the management of the business, with the exception of the testimony of one employee that during 1933 she came to the office at regular intervals and discussed business matters with her husband, 433 but that she took no particular part in the actual running of the business. There is no explanation of the disposition made of the amounts charged to Mrs. Sewell and the children on account of withdrawals. In our opinion the additional facts are not sufficient to justify a holding in favor of the petitioner. It is true that a valid partnership between husband and wife or among husband, wife and children can exist for tax purposes, and we have held that the fact that the capital contributions made by the wife or the children were acquired by gift from the husband or parent is not determinative against the existence of such a partnership. See e.g. Jasper Sipes, 31 B.T.A. 709">31 B.T.A. 709; Walter W. Moyer, 35 B.T.A. 1155">35 B.T.A. 1155; Justin Potter, 47 B.T.A. 607">47 B.T.A. 607. The petitioner's position here, however, is not that the decedent made a gift of a capital interest in the hat business to his wife, but rather that she purchased such an interest with funds of her own. That position we have already held untenable. The execution of the partnership and trust agreements and the entries dividing capital account add nothing to434 the evidence on this issue. The trust instrument recites a purchase by Mrs. Sewell of her interest and the partnership agreement provides for the transfer of portions of an existing capital interest. Neither purports to evidence a transfer to her by gift. Whether under different circumstances the performance of such acts, without more, would be held to establish prima facie gifts of a capital interest to Mrs. Sewell and by her in turn to the children need not be considered. We hold that the 1937 profits are taxable in their entirety to the decedent. Upon brief the respondent asserts that "There is too much uncertainty about petitioner's evidence for the Court to hold that a partnership existed prior to July 1, 1937. It is highly doubtful whether a partnership actually existed after that time except for the purpose of avoiding taxes." The brief also contains a request that we find as a fact that "the Sewell Hat Manufacturing was a sole proprietorship operated by R. A. Sewell, individually, from February 27, 1936, to July 1, 1937, when the limited partnership went into effect." The petitioner interprets that statement and request as a practical admission that a limited partnership 435 was in existence after the execution of the agreement of July 1, 1937. We can not agree. Although the purport of the statements is not entirely clear, we think it apparent from reading the brief as a whole that the respondent does not concede that a limited partnership came into existence in 1937. It requests that we find as a fact that "Mrs. Josephine M. Sewell had no interest in the Sewell Hat Manufacturing Company at any time and, therefore, conveyed no interest to her four children under the alleged trust instrument dated June 1, 1936." The last point argued is that there is no error in the determination that "for the years 1936 and 1937 the entire net income" of the hat business was taxable to R. A. Sewell. We conclude that the statements in question were made in support of an alternative contention and not as a concession of error in the determination of the deficiencies. Findings of Fact as to the Seventh Issue (W. P. Sewell Farm Expense) In September, 1933, W. P. Sewell acquired a farm in south Georgia. He raised no crop in 1933, but after acquiring the farm and before the end of that year, he spent $9,062.79 for seed and fertilizer, which were used in the production436 of the 1934 crop. The 1934 crop consisted of cotton and peanuts, which were planted early in 1934. In order to get a full crop of peanuts and cotton in south Georgia, it is necessary for a farmer to break and begin to prepare his land before the first of the year. The petitioner did not deduct the $9,062.79 on his 1933 return, but did claim that amount in 1934 as part of the expense of raising the 1934 crop. The 1934 crop was not sold in that year, but the petitioner reported $15,370.69 as its value, as income from farm operations. Expenses of $28,429.22 were claimed resulting in a reported loss in the amount of $13,058.53. The respondent determined that under section 23 (e) of the Revenue Act of 1934 the 1933 expenses are not allowable as a deduction in computing the loss from farm operations for 1934. Opinion The petitioner seeks to justify the deduction in 1934 of the expenses here in question under one of the provisions of (A)-11 section 19.23 (a)-11 of Treasury Regulations 103. The corresponding provision of Regulations 86, applicable to the year 1934, is substantially the same as that to which petitioner refers, and is printed in the margin. We find no support for the petitioner437 in that provision. There is no proof that the Commissioner consented to the determination of expenses on the crop basis. Moreover the petitioner could not have brought himself within the provision, since his own testimony was to the effect that his crops were planted early in 1934 and harvested in the latter part of the same year. The petitioner argues that the seed and fertilizer purchased in 1933 were used in the production of the 1934 crops, and that since he reported as income for 1934 the estimated value of the peanuts and cotton on hand at the close of that year, allowance must be made for expenses incurred in producing that income. The same argument could be made with equal force had the 1933 purchases been stored until 1935 or a later year and then used for the production of a crop. It can not serve to defeat the long recognized requirement that income taxes be assessed on the basis of annual returns showing the net result of a taxpayer's transactions during a fixed period, either the calendar year or at his option a particular fiscal year. Burnet v. Sanford & Brooks Co., 282 U.S. 359">282 U.S. 359. The petitioner has not shown that he was not on a cash 438 basis in 1933, therefore the expenses incurred in 1933 are not shown properly deductible in 1934. On this issue we sustain the respondent. Findings of Fact as to the Eighth Issue (R. B. Sewell Traveling Expenses) R. B. Sewell was engaged as a salesman for the Sewell Manufacturing Co., and during each of the years 1935, 1936 and 1937 spent approximately 300 days on business away from home. His sales territory embraced all of Alabama and portions of Florida, Tennessee and Kentucky. His sales in each year amounted to about a half-million dollars. All traveling expenses incurred by the petitioner, including expenses for meals and lodging, and for business telephone calls and telegrams, were paid by him personally. He received no reimbursement from the company for any of these expenditures. The petitioner kept no accurate records of expenses incurred by him while on his business trips. We find that he expended an average of $5.00 a day for actual lodging for 300 days in each year, and not less than the following additional amounts for business telephone calls and telegrams: 1935$626.521936624.541937683.00 Deductions claimed on the returns, including the above 439 listed amounts for telephone and telegraph, and additional undisclosed amounts for lodging, meals and travel were as follows: 1935$ 8,716.14193614,093.44193716,934.39 The respondent permitted the deduction of $1500 a year for hotel accommodations, but disallowed the amounts claimed for telephone and telegraph, reducing the total deduction allowable in each year to the following amounts: 1935$ 8,056.06193612,546.80193714,674.48Opinion The proof submitted on this issue consists of the petitioner's testimony of the estimated cost of hotel rooms and of telephone calls and telegrams, and of one exhibit, consisting of receipted bills for accommodations and services furnished him on different days in 1936 by a hotel in Birmingham, Alabama. He testified that he had other receipted bills and canceled checks for expenses paid by him, but that those introduced in evidence were typical. On direct examination he testified that the cost of hotel accommodations averaged $10 a day and that telephone and telegraph expenses averaged $4.00 a day. On cross examination he testified that his lodgings cost him $3.50 to $15.00 a day. The record does not disclose the items440 making up the deductions claimed on the returns with the exception of the telephone and telegraph expense, nor can the particular items as to which the respondent made adjustments be ascertained. The petitioner has the burden of proving error in the respondent's disallowance of portions of the claimed deductions. N. H. Van Sicklen, Jr., 33 B.T.A. 544">33 B.T.A. 544. It has been recognized that absolute certainty in such matters as are here involved is impossible and unnecessary, Cohan v. Commissioner, 39 Fed. (2d) 540, but the impossibility of exactitude does not excuse the petitioner from furnishing as definite proof as is reasonably possible. See Rugel v. Commissioner, 127 Fed. (2d) 393, 395. Here he did not offer the canceled checks and receipted bills which he admittedly possessed, with the exception of the one exhibit showing amounts paid for accommodations at one hotel on some thirty different days during 1936. That evidence, either alone or in conjunction with the petitioner's estimates of his hotel expenses, will not justify a holding that the respondent's allowance of $1500 in each year was 441 inadequate. We think the respondent erred in disallowing the amounts claimed as telephone and telegraph expenses. The petitioner's sales territory covered a wide area, in which he sold large volumes of merchandise. It would be unlikely that in servicing such an area and transacting such a business he would not find it necessary to make extensive use of telephone and telegraph. His own estimate that the cost therefor averaged $4.00 a day does not seem to us unreasonable. However, the reasonableness of that estimate need not be decided. It is our opinion that the amounts expended were not less than those claimed on the returns. The respondent's action disallowing them is reversed. Ultimate Finding of Fact as to the Ninth Issue (Fraud Penalties) No part of any of the deficiencies determined against W. P. Sewell and R. B. Sewell is due to fraud with intent to evade tax. Opinion In Docket No. 112298 (W. P. Sewell), the respondent's answer affirmatively alleged that the petitioner, with willful intent to evade income taxes, filed false and fraudulent returns for each of the years 1934, 1935, 1936 and 1937, in failing to report in his income the dividends paid in those years on 442 the Sewell Manufacturing Co. stock registered in the name of his wife, and in failing to include the interest credited to his wife on the books of that company. In Docket No. 112299 (R. B. Sewell) the answer alleges that the petitioner filed false and fraudulent returns with intent to evade income taxes for each of the years 1935, 1936 and 1937, in failing to report as income the dividends paid in those years on the Sewell Manufacturing Co. stock registered in the name of his wife, and in failing to report certain interest income in 1937. The allegations of fraud were denied by reply filed in each case. The answer in Docket No. 112339 (Estate of R. A. Sewell) contains no affirmative allegations in support of the fraud penalties there determined. At the hearing, respondent's counsel expressly stated that those penalties would not be asserted. In our decision of the Second Issue we held that interest credited to the wife of W. P. Sewell was not taxable to him with the exception of the $69 credit of May 1, 1935 which we held to be interest on dividends credited to her account but taxable to the petitioner. Upon brief the respondent concedes that most of the interest income which he determined443 R. B. Sewell had omitted from his 1937 return was not in fact taxable income, and no evidence has been introduced with regard to the small balance as to which error is not confessed. For purposes of the present issue therefore, we need decide only whether the petitioners failed to report the dividends credited to their wives, and the one item of interest credited to the wife of one of them fraudulently with intent to evade tax. We hold that they did not. The respondent recognizes that he has the burden of establishing the fraud which he has charged. Satisfaction of that burden requires more than a mere preponderance of evidence. See Frank A. Maddas, 40 B.T.A. 572">40 B.T.A. 572, 578, and cases there cited, aff'd 114 Fed. (2d) 548. It has been said that the evidence of fraud must be "clear and convincing," Griffiths v. Commissioner, 50 Fed. (2d) 782, 786; Oscar G. Joseph, 32 B.T.A. 1192">32 B.T.A. 1192, 1205; A. W. Mellon, 36 B.T.A. 977">36 B.T.A. 977, 1054, and that it must establish more than suspicion or more than a mere probability of dereliction, J. William Schultze, 18 B.T.A. 444">18 B.T.A. 444, 447,444 that it must reveal a "specific purpose to evade a tax believed to be owing," Mitchell v. Commissioner, 118 Fed. (2d) 308. In our opinion the evidence of fraud in the instant proceedings does not meet those tests. It is one thing to hold that the petitioners did not make completed gifts of the stock transferred to their wives, but quite another to say that their failure to report the dividends thereon was motivated by fraud and unlawful intent. See Oscar G. Joseph, supra.It is possible that they had the opinion that what they did was legally sufficient to relieve them of liability for tax. If in fact they did, no fraudulent intent existed. Cf. Court Holding Co., 2 T.C. 531">2 T.C. 531, 541. We disagree with their contention that the transfers had that effect but cannot say that they were shams designed to evade tax. A careful review of all the evidence does not clearly and convincingly establish fraudulent intent, and the doubts which it leaves must be resolved against the respondent. We hold that the petitioners are not liable for the penalties asserted. Decisions will be entered under Rule 50.445 Footnotes1. The nature of some of these transactions, as sales or loans, is in controversy in connection with the fifth issue.↩2. These are some of the transactions referred to in footnote 1, supra.↩3. This note was actually made payable to W. P. Sewell.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621071/	John R. and Constance H. Hamilton v. Commissioner.Hamilton v. CommissionerDocket No. 2881-69 SC.United States Tax CourtT.C. Memo 1970-34; 1970 Tax Ct. Memo LEXIS 328; 29 T.C.M. (CCH) 97; T.C.M. (RIA) 70034; February 5, 1970, Filed John R. Hamilton, pro se, 164 Victory Blvd., Staten Island, N.Y. Patrick E. Whelan, for the respondent. DAWSONMemorandum Findings of Fact and Opinion DAWSON, Judge: Respondent determined a deficiency of $448.51 in petitioners' Federal income tax for the year 1967. Petitioner made certain concessions at the trial. The only issue for decision is whether petitioners are entitled to deduct as a loss the amount of property damage caused by former tenants to commercial property owned by petitioners. Findings of Fact Some of the facts have been stipulated and are so found. John R. Hamilton and Constance H. Hamilton (herein called petitioners) are husband and wife who, at the time their petition was filed herein, resided on Staten Island, New York. They filed a joint Federal income tax return for the year 1967329 with the district director of internal revenue, Manhattan, New York. In February 1966, petitioners inherited a building at 164 Victory Boulevard, Staten Island, New York. Petitioners occupy one of two apartments in the building, while renting the other apartment and a tavern which occupies the first floor and basement. In February 1967, the tavern tenants, Bowen and Hall, defaulted on their lease and abandoned the premises. Petitioners took possession of the premises June 6, 1967. By the terms of the lease, Bowen and Hall were obligated to keep the tavern premises in good repair at their own expense and to surrender them at the end of the term in good order and broom clean. In the event of breach they were liable for damages and attorney's fees. When petitioners took possession, the premises were not in good order. Plate glass windows were broken, the front and rear doors were broken, plaster was torn from the walls, the basement grating was missing, the tile flooring was worn through, and the premises required painting, removal of debris, and extermination. Under the terms of the lease, the tenants were responsible for the windows, the doors, the grating, damage to plaster,330 and removal of debris. Petitioners would be responsible for paint, flooring, cleaning and extermination to prepare for new tenants. The cost of these latter items is deductible only as an expense or as depreciation. An estimate prepared for the petitioners places the cost of repairing the windows, the doors, the plaster, and the grate at $1,335. Removal of debris would not exceed $40. Since petitioners did not have money enough to make the necessary repairs themselves, they later rented the property as they found it to the carpenter who had supplied the estimate. He made the repairs, including painting, cleaning, flooring and extermination, and now operates the tavern. Petitioners claimed a net loss of $3,622.70 on their Federal income tax return. Although the entire amount appears to involve the rental portions of the property, only $2,600 as an uninsured loss is now claimed. The $3,622.70 includes the $1,375 which Bowen and Hall were responsible for, estimates for cleaning, painting, flooring, extermination, some duplication of estimates for doors and windows, and certain unsubstantiated items. Estimates of repair to the rented apartment were $244, but $344 was claimed by petitioners331 even though it appears that they took expenses for the same repairs. 98 Sometime in late 1967 petitioners instituted a suit against the former tenants, but now (1970) do not expect to be able to collect after judgment. Hall has died, Bowen has nine children, and both had already defaulted on the lease. Petitioners do not intend to press the claim now unless the tenants press a counterclaim. Petitioners have failed to prove that they sustained any loss from the rental property in 1967 in excess of the amount allowed by respondent. Opinion Petitioners contend that under the terms of the lease with Bowen and Hall they are entitled to a deduction of $2,600 as damages for uninsured losses. Respondent's position is that the petitioners have reasonable hopes of recovering from their former tenants, and that no loss deduction should be allowed before the outcome of the litigation is known. Alternatively, respondent argues that there has been no identifiable event which justifies giving recognition to the loss in 1967. We agree with respondent. Petitioners may not deduct a loss if "there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery. 332 " Section 1.165-1(d)(2), Income Tax Regs., Louis Gale, 41 T.C. 269">41 T.C. 269 (1963); and Scofield's Estate v. Commissioner 266 F. 2d 154, 159-160 (C.A. 6, 1959). The fact that petitioners instituted suit against the former tenants in 1967 is some evidence of a reasonable hope of recovery. Certainly the death of one of the defendants is no proof that petitioners' prospects of recovery have drastically changed. The fact that petitioners waited from February 1967 until June 1967 to reenter the premises is further evidence of an expectation that the tenants had the means to pay both the damages and the rent for the February-June period. If there was no prospect of collecting further rent, petitioners should have exercised their right under the lease to treat it as terminated and to reenter upon 10-days notice. The burden was on petitioners to show that their prospect for recovery was no longer reasonable as of the end of 1967. This they have failed to do. Nor could it be determined with reasonable certainty at the end of 1967 whether or not reimbursement would be received. Moreover, petitioners will not have "sustained" a loss absent "closed and completed transactions. 333 " Section 1.165-1(d)(1), Income Tax Regs. Normally closed transactions require a sale, exchange, involuntary conversion, abandonment, retirement, theft, casualty, or similar disposition of property in order to qualify for a loss. Petitioners do not seem to fit any of these categories. In addition, the damage has been repaired by the new tenant. Since respondent does not contend that the repairs represent rent, petitioners are no worse off than if they had charged more rent and made the repairs themselves, deducting the repair expenses. Petitioners have paid out nothing. It is true that their rental income has been reduced, but section 165 does not cover loss of income, which in an economic sense is "deducted" by never appearing as taxable income. Thus we believe the capital loss claimed remains speculative, perhaps no more than a reduction of a future anticipated gain. In view of the circumstances present herein, we hold that petitioners have failed to prove they sustained a loss of $2,600 on such rental property. See J.G. Boswell Co., 34 T.C. 539">34 T.C. 539 (1960), affd. 302 F. 2d 683 (C.A. 9, 1962); Mrs. J. C. Pugh, Sr., Executrix, 17 B.T.A. 429">17 B.T.A. 429, affd. 334 49 F. 2d 76 (C.A. 2, 1931), certiorari denied 284 U.S. 642">284 U.S. 642. Accordingly, Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621073/	STEPHEN C. PECORARO AND JUDY D. PECORARO, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentPecoraro v. CommissionerDocket No. 25155-88United States Tax CourtT.C. Memo 1990-52; 1990 Tax Ct. Memo LEXIS 48; 58 T.C.M. (CCH) 1323; T.C.M. (RIA) 90052; January 30, 199048 Ps filed a petition with this Court 440 days after the notice of deficiency was mailed. R moved to dismiss the petition in this proceeding for lack of jurisdiction. Ps' former counsel submitted a U.S. Postal Service Form 3811 return receipt card as proof of timely filing. The submitted return receipt card was from another case in which Ps' former counsel was the attorney of record. The handwritten delivery date on the submitted return receipt card had been altered. Held, Ps failed to prove that they timely filed a petition in this case. Accordingly, R's motion to dismiss for lack of jurisdiction is granted. Robert W. Nuzum, for the petitioners. Dale P. Kensinger, Terry W. Vincent and Chris J. Ray, for the respondent. NIMSMEMORANDUM FINDINGS OF FACT AND OPINION NIMS, Chief Judge: Respondent determined the following deficiency in and additions to petitioners' 1983 Federal income tax: Additions to Tax - SectionsYearDeficiency6621(c)6653(a)(1)6653(a)(2)66611983$ 173,556.45to be$ 8,677.8250% of$ 43,389.11determinedinterest dueon $ 173,556.45(Unless otherwise indicated, all section references are to sections2 of the Internal Revenue Code in effect for 1983. All Rule references are to the Tax Court Rules of Practice and Procedure.) This case is before the Court on respondent's motion to dismiss the petition in this proceeding for lack of jurisdiction. FINDINGS OF FACT50 On July 14, 1987, respondent mailed a statutory notice of deficiency dated July 14, 1987, for the taxable year 1983 to petitioners at their last known address (R.D. 1, Box 191H Kearney, Missouri 64060). Petitioners retained attorney Michael P. O'Keefe (O'Keefe) to represent them and file a petition on their behalf. On July 22, 1988, a petition was filed with the Court in another case, Robert L. McKinney and Lavona M. McKinney v. Commissioner, docket No. 19129-88. O'Keefe was the attorney of record in the McKinney case. O'Keefe prepared and filed the petition in McKinney. The envelope in which the petition in the McKinney case was mailed to the Court has a certified mail sticker attached to its face. Article number P-491 765 186 is printed on the certified mail sticker in print type OCR 85. "CERTIFIED MAIL/RETURN RECEIPT REQUESTED" is written on the envelope. On September 22, 1988, O'Keefe mailed a petition to the Court on petitioners' behalf, which was received by the Court on September 26, 1988. O'Keefe attached a cover letter to the petition which stated in part as follows: Attached to this letter are office copies of a cover letter and Petition (with51 attachments) dated September 23, 1987. Those documents were prepared with regard to the same tax assessment disagreement for which the above notice of September 21, 1988 Petition has been prepared. The September 23, 1987 Petition was sent to the U.S. Tax Court by certified mail seventy-one (71) days after the July 14, 1987 Notice of Deficiency. Also attached to this letter is a copy of the certified mail/return receipt, No. P491-765-186, dated September 28, 1987 and signed by J. E. Noland. However, for reasons yet unknown, the September 23, 1987 Petition was not filed with the U.S. Tax Court, and, despite a diligent search of the Court's records and files, that Petition has not been found. A thorough search of the Court's records revealed that no petition dated September 23, 1987, for petitioners' taxable year 1983 had been received. On October 6, 1988, the Court ordered O'Keefe to submit the original return receipt card, Postal Service Form 3811, corresponding to the earlier petition that he claimed had been mailed on September 23, 1987. On October 17, 1988, O'Keefe submitted to the Court a Form 3811 bearing handwritten article number P 491 765 186 (the Form 3811). This is52 the same article number that was printed on the certified mail sticker attached to the envelope in which the McKinney petition had been mailed to the Court. O'Keefe attached a cover letter to the submitted Form 3811 which stated in part as follows: Please find enclosed herewith the original of return receipt card, Postal Service Form 3811, which was manually signed and dated apparently on September 28, 1987, by an employee of the U.S. Tax Court. On November 22, 1988, respondent filed a motion to dismiss the petition in this proceeding for lack of jurisdiction because it was not filed within 90 days after the notice of deficiency was mailed to petitioners, as provided in sections 6213(a) and 7502. On December 16, 1988, O'Keefe filed a notice of objection to respondent's motion on petitioners' behalf. The notice of objection states in pertinent part as follows: 1. That this Court ordered on October 6, 1988 that the Petitioners send to the Court on or before October 24, 1988 the original return receipt card from the Postal Service. 2. That by Petitioners' October 17, 1988 letter, copy of which is attached hereto, such order was fully complied with. On April 19, 1989, a53 hearing on respondent's motion was held at Washington, D.C. At this hearing, O'Keefe stated that he could not locate the certified mail receipt for the petition that he alleged was mailed on September 23, 1987. He further stated that he was unable to locate the certified mail receipt or the Form 3811 return receipt card used in mailing the McKinney petition. Thereafter, the Court declared its intention to submit the Form 3811 to the Forensic Laboratory of the Internal Revenue Service Criminal Investigation Division for examination. On May 10, 1989, the Court submitted the Form 3811 to the Forensic Laboratory. Larry A. Olson, an examiner of questioned documents at the Forensic Laboratory (the forensics expert), examined the Form 3811 by non-destructive, physical means using microscopy, ultraviolet light and infrared light (via an infrared image converter). On July 26, 1989, the Court held a second hearing on respondent's motion to dismiss at Washington, D.C. At the hearing, O'Keefe appeared and submitted a letter addressed to him from petitioners which states in part as follows: Judy and I do not wish you to represent us any further in our present tax problem with the54 IRS. Specifically, we do not wish you to represent us in Washington on July 26 in the tax court. By Court Order, O'Keefe was withdrawn as petitioners' counsel pursuant to Rule 24(c). O'Keefe was replaced by attorney Robert W. Nuzum, who appeared at the hearing and filed an entry of appearance on petitioners' behalf. At the hearing, the forensics expert submitted a videotape documenting his examination of the Form 3811. He testified that the handwritten delivery date on the Form 3811 had been altered by overwriting and that the original delivery date was either "7/22/86" or "7/22/88." Margaret Falwell, a senior classification support specialist at the United States Postal Service (the postal expert), testified that article number P-491 765 186 had been printed on only one certified receipt prior to April 2, 1989, in print type OCR 85. On September 8, 1989, respondent filed a memorandum brief in support of his motion. Petitioners did not file a memorandum. OPINION Section 6213(a) provides that a petition must be filed with the Tax Court within 90 days from the date on which the statutory notice of deficiency is mailed. Unless a petition is filed within such 90-day period, 55 this Court does not acquire jurisdiction of the case. ; . Filing is generally completed when a petition is received by the Court. . An exception to this rule occurs in the case of a petition timely sent by United States certified mail, although received by this Court after the due date for filing. Section 7502(c)(2); section 301.7502-1(c)(2), Proced. & Admin. Regs. O'Keefe claims that he prepared a petition and a clerical person in his office mailed it to the Court on September 23, 1987, by United States certified mail. Section 301.7502-1(d)(1), Proced. & Admin. Regs, provides that if a petition is not delivered to the Court, proof that a postmarked certified sender's receipt was properly issued and that the envelope was properly addressed to the Tax Court constitutes prima facie evidence of delivery. See . O'Keefe failed to produce a certified mail receipt as required by the regulation. Therefore, 56 petitioners do not come within the safe harbor for certified mailing. See . Because petitioners do not satisfy any of the exceptions provided in section 7502, they must establish that their alleged September 23, 1987, petition was actually and timely received by the Court. See . Petitioners contend that a petition was delivered to the Court on September 28, 1987. In support of this contention, O'Keefe submitted the Form 3811 which he alleges bears a delivery date of "9/28/87" and, thus, proves that petitioners' petition was filed within the 90-day period. The Court has no record of receiving such a petition. O'Keefe implies that the Court received and misplaced the petition. We find his argument to be specious. The handwritten delivery date on the Form 3811 was altered by overwriting prior to the submission of the Form 3811 to the Court. The forensics expert testified that the delivery date on the Form 3811 submitted by O'Keefe had been altered by overwriting, and the actual delivery date was either "7/22/86" or "7/22/88." This latter date57 is the exact date upon which the petition in the McKinney case was received and filed with the Court. The Form 3811 submitted by O'Keefe bears the same article number as the certified sticker on the envelope in which the McKinney petition was mailed to the Court. The postal expert testified that this article number was not used again by the United States Postal Service on a certified receipt in print type OCR 85 until April 2, 1989, or well after the mailings in dispute. We find that the delivery date on the Form 3811 was altered. O'Keefe submitted the Form 3811 that was used in the McKinney case. Under section 7503, the 90-day period expired on Tuesday, October 13, 1987, because Monday, October 12, 1987, was a legal holiday in the District of Columbia. The only petition filed in this case was the petition filed on September 26, 1988, which date is 440 days after the notice of deficiency was mailed to petitioners. Accordingly, respondent's motion to dismiss for lack of jurisdiction must be granted. The facts of this case are extremely disturbing. The ability of the Tax Court to function effectively and properly adjudicate the controversies brought before it is58 in large part dependent on the honesty and integrity of the attorneys and other representatives who appear before us. As officers of this Court, attorneys owe a duty to assist the Court in the administration of justice, not to perpetrate a fraud upon it. We recognize that petitioners are in no way personally culpable and are being denied access to this Court because of their former attorney's failure to timely file their petition. While sympathizing with petitioners' plight, we cannot provide them with relief. See . An appropriate order will be issued.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621074/	SERGE C. and JEAN V. NAGGAR, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentNaggar v. CommissionerDocket No. 1548-81.United States Tax CourtT.C. Memo 1983-559; 1983 Tax Ct. Memo LEXIS 230; 46 T.C.M. (CCH) 1362; T.C.M. (RIA) 83559; September 12, 1983. Serge C. Naggar and Jean V. Nagger, pro se. Patricia A. Donahue, for the respondent. FEATHERSTONMEMORANDUM FINDINGS OF FACT AND OPINION FEATHERSTON, Judge: This case was assigned to Special Trial Judge Fred R. Tansill, pursuant to General Order No. 6, 69 T.C. XV (1978). The Court approves and adopts his opinion, which is set out hereinbelow. OPINION OF THE SPECIAL TRIAL JUDGE TANSILL, Special Trial Judge: Respondent determined a deficiency of $1,333.24 in petitioners' 1977 income taxes. The issue for decision is whether petitioners are entitled to a deduction for office-in-home expenses under section 280A. 1231 FINDINGS OF FACT Some of the facts were stipulated. The stipulation of facts, together with the exhibits identified therein, is incorporated herein by reference. Petitioners lived in New York City, New York, at the time the petition was filed in this case. Mr. Naggar has, since 1968 and throughout 1977, the taxable year involved, operated as a sole proprietor a management consulting business under the name of "Naggar Consulting." In that business he furnishes to client-businesses, on a contract basis, reports including recommendations on how to make their businesses function more efficiently. Mrs. Naggar was a member of a partnership with another person which operated a literary agency known as "Manuscripts Unlimited." The partnership represented authors in dealing with book publishers (domestic and foreign), magazine publishers, and moving picture producers in efforts to have the authors' manuscripts published and to sell dramatic and performance rights to the producers. Both of these businesses were operated out of an apartment on East 72nd Street in New York City, which was also where the petitioners and their three children (aged 14, 12, and 9) resided. The apartment232 had three bedrooms, a living room, a kitchen, a dining room, a foyer, a terrace opening off the bedroom occupied by petitioners, two baths, and six closets. There were items of office equipment such as desks, files, typewriters and their stands, located in petitioners' bedroom, the bedroom occupied by their two sons, living room, the dining alcove, and the foyer. Supplies for the businesses were stored in four of the six closets as well as behind drapes in petitioners' bedroom. The apartment was basically a place of business from 8:30 a.m. to 6:00 p.m., Monday through Friday, while during the other hours and on weekends it was the family home. The total rent for the apartment in 1977 was $6,591.24. Each of the petitioners included a Schedule C with the joint return which they filed for that year, and each claimed a deduction on Schedule C for rent in the amount of $2,197 (one-third of the total rent for the apartment). Respondent disallowed both of these claimed deductions. OPINION Section 280(a) generally disallows a deduction with respect to the use of a dwelling unit used by the taxpayer as a residence. Subsection (c) of 280A makes exception, however, for certain233 business use, and provides in relevant part as follows: (1) Certain business use. -- Subsection (a) shall not apply to any item to the extent such item is allocable to a portion of the dwelliong unit which is exclusively used on a regular basis -- (A) [as] the principal place of business for any trade or business of the taxpayer, (B) as a place of business which is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of his trade or business, or * * [Emphasis added.] The evidence satisfies us that the apartment was used regularly as the principal place of business of each of the petitioners. However, the evidence fails to show that any portion of the apartment was used exclusively for the business purposes of either of the petitioners. It is fair to say that petitioners' business activities permeated the entire apartment, with the exception of their daughter's bedroom, the kitchen, the bathrooms, and two of the six closets. Yet those "business areas" became family dwelling quarters when the business day ended at or about 6:00 p.m. The result must be that the "Business areas" were not used exclusively for business234 purposes; they served a mixture of business and personal family needs. 2 The business and personal use of the subject areas was so intermingled that we cannot find that a specific portion of the apartment was used exclusively for business purposes. 3235 Respondent's determination must be sustained. 4Decision will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. Regarding the exclusivity requirement of sec. 280A (c)(1), the Senate Finance Committee stated the following: Exclusive use of a portion of a taxpayer's dwelling unit means that the taxpayer must use a specific part of a dwelling unit solely for the purposes of carrying on his trade or business. The use of a portion of a dwelling unit for both personal purposes and for the carrying on of a trade or business does not meet the exclusive use test. Thus, for example, a taxpayer who uses a den in his dwelling unit to write legal briefs, prepare tax returns, or engage in similar activities as well for personal purposes, will be denied a deduction for the expenses paid or incurred in connection with the use of the residence which are allocable to these activities. * * * [S. Rept. No. 94-938 (1976), 1976-3 C.B. (Vol. 3) 49, 186.] This statement is clear evidence of congressional intent to prohibit a deduction in situations such as the instant one in which we have found that petitioners used certain portions of their residence for both business and personal activities. ↩3. Petitioners' reliance on and is misplaced. In those cases, the Court held that a room or a specific portion of a room in the taxpayer's residence was used exclusively for business purposes and was never used at any time of the day for personal purposes. Here, the intermingled business and personal use of petitioners' residence, albeit at alternate times of the day, make a finding of exclusive business use impossible.↩4. , affd. without published opinion ; ; .↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621075/	RICHARD M. WATSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWatson v. CommissionerDocket No. 5607-76.United States Tax CourtT.C. Memo 1977-217; 1977 Tax Ct. Memo LEXIS 226; 36 T.C.M. (CCH) 910; T.C.M. (RIA) 770217; July 13, 1977, Filed 226 Richard M. Watson, pro se. Alice Gresham and Charles N. Woodward, for the respondent. SCOTT MEMORANDUM OPINIONSCOTT, Judge: Respondent determined a deficiency in petitioner's income tax for the calendar year 1974 in the amount of $1,574.89. The issue for decision as presented to the Court when the case was called for trial at Houston, Texas on May 9, 1977, was whether petitioner's "demand" for a trial by jury in this Court should be granted. The only allegation contained in the petition in this case is as follows: I disagree with the entire $1574.89 because: #1.) I had (during other encounters with agents of the IRS) and still have in my possession complete substantiation of all deductions. #2.) I don't practice prevarication when I file my tax returns with any tax agency. #3.) The legal right of a taxpayer to decrease the amount of what other-wise would be his taxes, or all-together (sic) avoid them, by means which the law permits, cannot be doubted. When trial of the case was to commence, petitioner refused to offer evidence in substantiation of the only allegation in his petition and stated that he insisted on standing on227 the ground he assigned of a right to trial by jury. After having been admonished by the Court that the case would be determined against him if he did not offer evidence to substantiate the deductions claimed by him which had been disallowed by respondent, petitioner persisted in his position. At the request of the Court, the parties stipulated that at the time of the filing of the petition in this case petitioner's residence was in Houston, Texas and that he filed a Federal income tax return for the calendar year 1974 claiming the following deductions: Moving Expense$1,850Employee Business Expense2,420Casualty Loss2,760Child Care Expense2,006 Respondent at the trial conceded that he had improperly disallowed petitioner's claimed deduction for a casualty loss. Petitioner offered no evidence to show that any deduction taken on his return not conceded by respondent to be properly allowable was in fact proper. We therefore, except to the extent of the casualty loss deduction which respondent conceded, sustain respondent's determination of petitioner's tax liability for the year here in issue. We have previously considered the question of whether a taxpayer's228 constitutional rights are violated by placing on him the burden to show error in respondent's determination of deficiency and have held that a taxpayer's constitutional rights are not violated by requiring him to show such error. Hartman v. Commissioner,65 T.C. 542">65 T.C. 542, 547 (1975). We have also, on a number of occasions, considered whether a petitioner is entitled to a jury trial in the United States Tax Court and have held that he is not. Swanson v. Commissioner,65 T.C. 1180">65 T.C. 1180 (1976); Cupp v. Commissioner,65 T.C. 68">65 T.C. 68, 86 (1975), affd. F.2d (3d Cir. 1977). In the Swanson case, we specifically pointed out that a taxpayer has no right either under the Seventh Amendment to the Constitution or under statutory law to a jury trial in the Tax Court. In that case we discussed previous cases holding that a taxpayer is not entitled to a jury trial in the Tax Court and further concluded that those cases are still effective under the new Rules of Practice adopted by this Court as of January 1, 1974. On the basis of our holding and the underlying reasons set forth in the opinion in the Swanson case, we hold that petitioner229 has no right to a jury trial in this Court in the instant case. Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621076/	Robert Herndon v. Commissioner.Herndon v. CommissionerDocket No. 4071-65.United States Tax CourtT.C. Memo 1968-135; 1968 Tax Ct. Memo LEXIS 163; 27 T.C.M. (CCH) 662; T.C.M. (RIA) 68135; June 27, 1968, Filed 163 W. Ralph Musgrove, for the petitioner Joseph F. Dillon, for the respondent. 663 MULRONEY Memorandum Findings of Fact and Opinion MULRONEY, Judge: Respondent determined deficiencies in the income taxes of petitioner as follows: YearDeficiency1959$ 8,668.8619606,537.0119612,980.52196220,878.42The issue remaining after certain concessions is whether the gains petitioner realized on the sale of certain properties in 1959, 1960, and 1962 are taxable as ordinary income or capital gains. The record in this case consists of a Stipulation of Facts and the testimony at trial of petitioner and three witnesses. The stipulated facts are so found. Findings of Fact Petitioner resided in Dearborn, Michigan, at the time his petition was filed. His income tax returns for the years in question were filed with the district director of internal revenue at Detroit, Michigan. Petitioner is a real estate dealer. He has been engaged in real estate activities since 1909. During the years 1959 through 1962, he was licensed by the State of Michigan as an associate real estate broker and he maintained a real estate office in the Detroit area. 164 He has been so licensed and has maintained a real estate office in or around Detroit since 1924. During the years here in issue petitioner made sales of businesstype realty which he reported as business sales as well as the sales in issue which he reported as capital transactions. Petitioner is the president and principal stockholder of the Robert Herndon Realty Company which was and is engaged in the business of selling real estate on a commission basis. Also petitioner is engaged in the general insurance business and he owns and operates office buildings and golf courses, and he has gains from investments in stocks and real estate. In 1959, petitioner was 71 years of age. His first wife, Della G. Herndon, had died on December 6, 1957. During the years 1959 through 1962, petitioner's principal business activity was the management of two golf courses. He also managed the Robert Herndon Realty Company during this period but he did not handle the realty agency selling activities of the company. He devoted approximately 200 to 250 hours per year from 1959 through 1962 to the realty company and received no salary for this work. The sales giving rise to this case involved property165 in three different locations. First are the "Pebblebrook Estates Subdivision" lots, of which 3 1/2 were sold in 1959 and another in 1960. The two other groups of lots were located in "Herndon's Dearford-Telegraph Subdivision". They were lots 21 through 28, sold in 1960 and lots 61, 62, 65, 66, and 67, sold in 1962. Pebblebrook Estates Subdivision On December 26, 1925, petitioner's former wife, Della, executed a contract to purchase 39.75 acres of farm land in the western part of Oakland County, Michigan. On October 10, 1932, the property was conveyed to petitioner and his wife. There was a barn and other farm buildings on the farm and one house on the property which petitioner and his wife occupied as a summer home and another house that was occupied by the farm tenant. The tenant farmed the land on shares with soybeans as the main crop. Petitioner realized an income of $700 or $800 a year from the farming operation. Immediately after acquiring the property in 1932, petitioner planted trees and berry bushes, stocked a stream on the property with brook trout and placed pheasants and grouse in the fields. Petitioner and his former wife farmed the land and made it their summer166 residence until 1949. They planned to build a new home and they hired an architect to prepare the plans. During 1949, Della suffered a coronary thrombosis which required her hospitalization. This and the population movement to the suburbs, coupled with the acquisition of nearby properties by a large department store to build a shopping center, resulted in petitioner's decision not to build the new home but instead liquidate the property. Petitioner had a subdivision plat of the property prepared in 1954. It was approved by the Oakland County authorities on June 15, 1954, and recorded on June 17, 1954. Petitioner incurred the following expenses in connection with the platting, subdividing, and dedication of the property: engineering fees of $4,800, $4,110 for a gravelsurfaced road, and $1,102.50 for a fence. There were 30 lots in the subdivision. The lots were large and homes worth more than $30,000 were built on these lots. Access to the individual lots was by the gravelsurfaced road. There were no sidewalks or paved streets in the subdivision. 664 On April 20, 1955, petitioner had certain restrictions placed on this property. These restrictions provided that no building167 could be constructed or altered on any lot until the construction or alteration plans were approved by petitioner. Also, before any structure could be put on the property the plans for the same were to be approved in writing by petitioner. In addition, the location and size of mailboxes to be built on the individuals lots were covered by the restrictions. Petitioner had negotiated for the subdivision of Pebblebrook Estates, set the sales policy in connection with the sale of the lots in the subdivision, arranged for the installation of the access road, and set the sales prices of the individual lots. Immediately after the property was subdivided, petitioner listed the lots for sale with the Robert Herndon Realty Company which placed signs in at least four different locations in the subdivision advertising the lots for sale. During the years 1955 through 1965, the following lots in Pebblebrook Estates Subdivision were sold at the prices indicated: Date of SaleLot NumberSellingPrice5/16/5526$ 6,5006/21/55295,4006/25/55306,0009/29/55277,0003/16/56255,0006/28/5711 & part of 1211,5008/29/581410,7504/20/59South 1/2 of 105,25010/8/591512,59010/20/591612,59010/20/591212,5901/11/601312,5907/22/631612,5904/30/65247,875168 The following schedule reflects the lot number, date of sale, gross sales price, basis, sales expense, and gain for each of the Pebblebrook Estates lots sold in 1959 and 1960: PropertyDate SoldGross Sales PriceBasisSales ExpenseGain19591/2 of Lot 104/20/59$ 5,250$ 774.46$1,050$ 3,422.54Lot 12 110/20/5912,590774.4630011,512.54Lot 1510/ 8/5912,5901,554.922,5188,517.08Lot 1610/20/5912,5901,554.922,5188,517.081960Lot 131/11/6012,5901,554.922,7188,317.08169 Herndon's Dearford-Telegraph Subdivision In December of 1923 petitioner negotiated for the purchase of a 20-acre parcel of land in western Wayne County, Michigan. Title was taken in the name of petitioner's wife, Della. Petitioner caused the land to be platted into what is called "Herndon's Dearford-Telegraph Sub." This plat was approved by the Wayne County Board of Auditors May 8, 1924 and filed for record in the Register of Deed's Office May 10, 1924. It divides the tract into four unnumbered blocks containing lots numbered 1 to 159. The platted area was bounded on the north by Ellis Avenue; on the east by Telegraph Road; on the south by Bonaparte Avenue and on the west by Fenton Avenue. Three north and south streets, named Grove Avenue, Glenwood Avenue and Woodbine Avenue, divide the tract into blocks of equal size. In each block there is an alley 20 feet wide extending from Ellis Avenue, south to another east-west alley located 110 feet north of Bonaparte Avenue. All of the lots facing Telegraph Road and Bonaparte Avenue are approximately 20 feet wide and 110 feet long. The rest of the lots range from 39 feet to 41 feet wide and 110 to 127 feet long. Nearly all of the lots170 in this subdivision were sold during the period from 1924 through 1927 with the exception of lots 24, 25, 26, 27 and 28. Most were sold under land contracts and many of the purchasers defaulted on their contracts and some were sold to the State of Michigan for unpaid taxes. Lot 24 is located at the corner of Telegraph Road and Bonaparte Avenue. It fronts on Bonaparte Avenue and it is 18.5 feet wide and 110 feet long, extending back 665 to the east-west alley. Lots 25, 26, 27, and 28 are to the west of lot 24. They are each 20 feet wide and they, too, extend from Bonaparte Avenue to the east-west alley, or 110 feet. Across the alley and to the rear of the above described lots is lot 23, and next to it is lot 22, and next to it is lot 21. These lots front on Telegraph Road and there is a north-south alley to the rear of these lots. These lots are also 20 feet wide and 110 feet long. Some of these lots were leased during short periods of time to landscape men who displayed flowers and Christmas trees on the property. The three lots fronting on Telegraph Road were sold in 1925 to three purchasers and in 1954 petitioner bought them back from the purchasers. (1) Sale of Lots 21171 through 28 On April 9, 1956, petitioner entered into a lease-option agreement with Thomas Gutowski covering lots 21 through 28. The lease called for a period of 5 years at $100 per month, commencing on July 1, 1956. The lease also contained a renewal option for an additional five-year period at $150 per month. The option to purchase provided as follows: 6. The landlord gives to the tenant the right to purchase the demised premises at any time after January 1, 1957, and during and up to June 30, 1961 at a price of Twenty-five Thousand Dollars ($25,000.00), one quarter (1/4) of this amount down and the balance in four (4) equal annual payments including interest at the rate of six (6) percent per annum, and if the tenant exercises his right for an additional five (5) year lease, as herein provided, then the landlord gives the tenant the option to purchase said property at any time during the term of this additional five (5) years at a price of Thirty Thousand Dollars ($30,000.00), one quarter (1/4) of this amount down and the balance in four (4) equal annual payments including interest at the rate of six (6) percent per annum. In 1960, Gutowski exercised his option to purchase172 the property. A land contract for the purchase of lots 21 through 28 was executed on June 10, 1960. The price was $30,000, of which $3,000 was paid down and the balance of $27,000 was to be paid in monthly installments of $250 with interest at 6 percent. Petitioner's basis in these lots was $9,400 and the expenses of sale amounted to $375. (2) Sale of Lots 61 through 67 Lots 61 to 67, inclusive, are 7 lots facing south on Bonaparte Avenue with lot 61 being at the corner of Bonaparte Avenue on the south and Woodbine Avenue on the west. They are 20 feet wide and extend back to the east-west alley, or 110 feet. These lots were sold to various purchasers in the twenties. Lots 61, 62, 65, 66, and 67 were reacquired by petitioner at tax sales between 1940 and 1945. On July 9, 1962, petitioner granted an option to Standard Federal Savings & Loan Association to acquire lots 61, 62, 65, 66, and 67 of the subdivision. The savings and loan association exercised this option and acquired title by deeds dated October 19, 1962. The selling price was $20,000. Petitioner's basis for the lots was $2,116.75. Petitioner reported the sales of the Pebblebrook Estates lots and lots 21 through173 28 and lots 61, 62, 65, 66 and 67 in Herndon's Dearford-Telegraph Sub. as installment sales on his tax returns and the gains on these sales as long-term capital gains on Schedule D. Respondent determined that petitioner realized ordinary income in the years 1959 through 1962 from the sales of the Pebblebrook Estates Subdivision and Herndon's Dearford-Telegraph Subdivision lots rather than long-term capital gains as reported by petitioner. Opinion The sole issue is whether the gains realized by petitioner from the sale of certain lots in 1959, 1960, and 1962 should be taxed as ordinary income, as respondent has determined, or as long-term capital gains, as petitioner contends. Section 1221(1) of the Internal Revenue Code of 19542 excludes from the definition of a capital asset "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." Thus, the resolution of the issue depends on whether the lots petitioner sold were held by him "primarily for sale to customers in the ordinary course of his trade or business." The question is one of fact and numerous cases have emphasized that there is no hard and fast174 test to be applied in this situation but that each case must turn on its own particular facts. Nelson A. Farry, 13 T.C. 8">13 T.C. 8 (1949); D. L. Phillips. 24 T.C. 435">24 T.C. 435 (1955); Randolph D. Rouse, 39 T.C. 70">39 T.C. 70 (1962). 666 The courts have evolved certain criteria or factors to be considered in determining whether the property was held primarily for sale to customers in the ordinary course of business. Some of them are: The purpose for which the property was acquired and held, the extent of the improvements to the property, the nature and extent of the taxpayer's business, his activity in connection with the sales, the character and degree of supervision and control exercised by the taxpayer over his representatives employed to carry on his activities, whether the property was held primarily for an investment, the frequency and continuity of transactions which are claimed to result in a trade or business, and whether the taxpayer devoted substantial time to the alleged "additional business" so that it amounts to an occupational undertaking. No single175 factor is decisive; rather it is the totality of the factual pattern which must control the result. Mauldin v. Commissioner, 195 F. 2d 714 (C.A. 10, 1952). affirming 16 T.C. 698">16 T.C. 698 (1951). In Malat v. Riddell, 383 U.S. 569">383 U.S. 569 (1966), the Supreme Court of the United States has commented on the purpose of the statute and construed the word "primarily" as used in section 1221(1) as meaning "of first importance" or "principally". In the cited case the court stated: The purpose of the statutory provision with which we deal is to differentiate between the "profits and losses arising from the everyday operation of a business" on the one hand * * [citations omitted] and "the realization of appreciation in value accrued over a substantial period of time" on the other * * . A literal reading of the statute is consistent with this legislative purpose. We hold that, as used in § 1221(1), "primarily" means "of first importance" or "principally." We have held that a person can be both an investor and a dealer with respect to his real estate holdings. Nelson A. Farry, supra; Walter R. Crabtree, 20 T.C. 841">20 T.C. 841 (1953); @ D. L. Phillips, supra;176 Randolph D. Rouse, supra; Real Estate Corporation, Inc., 35 T.C. 610">35 T.C. 610; and Eline Realty Co., 35 T.C. 1">35 T.C. 1. The farm property that later became Pebblebrook Estates Subdivision was acquired in 1932 for the purpose of making a home for petitioner and his wife and using it as a farm. Petitioner in fact lived on the property during the summers and farmed it under share-crop arrangements with resident tenant farmers. Respondent concedes on brief: "It may be said that in this case there is sufficient evidence in the record to find that the petitioner originally purchased this property with the intent of making it into a farm as well as his residence." Respondent goes on to argue that the purpose for which the property was acquired was not the principal purpose for which the property was being held at the time of sale. We think the purpose that was present at the time of acquisition continued until the decision to liquidate the property was made after the illness of petitioner's wife. The subdividing was liquidation activity and the rather infrequent sales of lots do not indicate a business with respect to this property. Over a period of nearly 10 years, 177 from May 1955 through April 1965, petitioner sold only 13 lots and portions of two others in the subdivision. This was not of a frequency or continuity to indicate a business. That petitioner held a real estate broker's license and may have been a real estate dealer with respect to other properties, is a factor to consider but it is not decisive. The activity of petitioner with respect to construction of a gravel road and fence would not tend to indicate a purpose to sell to customers in the ordinary course of business. There were no sidewalks, sewer lines or other utilities installed by or on behalf of petitioner. Petitioner exercised little or no direct control over his representatives in selling this property; he devoted only 200 hours per year to his employment at the Robert Herndon Realty Company. The property was held for over 29 years from the date Della Herndon contracted to purchase the property to the date the first lot was sold and it appreciated in value from a cost in 1932 of $6,213.68 to sales prices in 1959 and 1960 totalling $55,610. These considerations persuade us that petitioner did not hold the Pebblebrook Estates properties primarily for sale to customers in the178 ordinary course of a trade or business. We hold for petitioner with respect to the sale of the lots in the Pebblebrook Estates Subdivision. Petitioner testified that when he platted Herndon-Telegraph Subdivision in 1924 it was his intention to sell all of the 159 lots in the subdivision to customers in the ordinary course of his real estate business with the exception of lots 24, 25, 26, and 27. He said: "I expected to keep those and to 667 have them for income producing properties. It is a valuable corner. I considered it a valuable corner then, or would become, and it has since become a valuable corner." It was petitioner's testimony that most all of the other lots were sold by 1927 and most of them were sold on contracts, resulting in many defaults and sales to the State for unpaid taxes. Petitioner reacquired many of the lots that had originally been sold in the 1925-1927 period either by buying from the original purchasers or from the State when the State had acquired title for nonpayment of taxes. Lots 21, 22, and 23 were three lots petitioner reacquired in 1954 purchases from the original buyers in the 1925-1927 period. It was petitioner's testimony that he reacquired179 the above three lots in order to "round out" the corner property he was holding. Petitioner did not state what he meant by "round out". Lots 24, 25, 26, 27, and 28 from a parcel that is nearly square with frontage on Bonaparte Street to the south of almost 100 feet and a frontage on Telegraph Road of 110 feet. Lots 23, 22, and 21 form a parcel about 110 feet by 60 feet lying north of the corner square with an alley between it and the corner square. It does not readily appear that the last three lots, being divided from the other lots by a 20 foot public alley, would be rounding out the corner property in the sense that they formed a more complete corner parcel. At any rate, we are of the opinion petitioner failed to establish that any of the lots 21 through 28 were not held for sale to customers in the ordinary course of petitioner's real estate business. No serious argument can be made that the lots were held for rental income. They were vacant lots which the record shows were rented occasionally for short periods of time. There is no record they were ever rented prior to 1942 and it fairly appears that the rent received in any one year was less than the taxes. For instance, it180 is stipulated that taxes in the amount of $2,755.35 were paid in 1960 on lots 21 through 28 and this was a year in which the lots were rented to Gutowski for $100 a month. It is true that a dealer in real estate can be a dealer with respect to some of his properties and an investor as to others. We have earlier cited a number of authorities for that proposition but in most of the cited cases the investment property was income-producing. When we have held non-income-producing property was held by a real estate dealer as investment property there has usually been present some other fact that indicated the property was not part of the dealer's stock of unimproved realty. In Eline Realty Co., supra, it was an odd-shaped lot thought to be useless when the subdivision was made but which became valuable when adjacent land was subdivided by another owner. In Charles E. Mieg, 32 T.C. 1314">32 T.C. 1314, there was a subdivision of the front side of the mountain where the taxpayer sold lots in the course of his real estate business. The land on the back side of the mountain could not be economically subdivided and we held when parcels of this land were sold it was not to customers181 in the ordinary course of the taxpayer's business. In Curtis Co., 23 T.C. 740">23 T.C. 740 (1955), reversed on another issue, 232 F. 2d 167, we held property acquired by a real estate dealer for the construction of a shopping center which would be held for rental was acquired for investment purposes and after the shopping center was blocked by zoning restrictions the two sales of the unimproved property were entitled to capital gains treatment. All that we have here is the testimony of petitioner who was an active real estate dealer that at the time of acquiring these lots it was his intent to hold them for rental income-producing purposes and for investment. We have already shown the contention that the property was held for rental is without any support for the unimproved lots could only command an occasional nominal rental. In fact, petitioner's attorney makes no argument that the investment was in rental property. The investment theory is that petitioner intended to hold the lots for a long period of time for a speculated rise in value; that petitioner did hold the lots for approximately 36 years; and they did rise considerably in value. Actually it was petitioner's182 stated intention to sell all of the lots in his subdivision. His plan of sale was to sell some as quickly as possible and delay the sale of others for a later sale after a hoped for rise in value. This is the plan petitioner carried out but it cannot be said the planned sales of lots that were carried out quickly were to customers in the ordinary course of petitioner's real estate business and the planned sales of other lots in the same subdivision that were carried out later were not to 668 customers in the ordinary course of petitioner's real estate business. This case is much like Margolis v. Commissioner, 337 F. 2d 1001 (1964), affirming in part and reversing in part a Memorandum Opinion of this Court. There the taxpayer was a real estate dealer who contended he held some lots for a long period of time speculating on an increase in value, and when he sold them he was entitled to capital gains treatment. In affirming our holding that the gains on such sales were ordinary income, the court stated: We agree with the Tax Court. Where one is engaged in the business of buying and selling real estate on as broad a basis as was taxpayer, the fact that property was183 acquired with the intention of holding it for a substantial period of time before sale, is not sufficient to constitute it an investment. n5 If the purpose of the acquisition and holding and the only manner in which benefit was to be realized from the property acquired was ultimate sale at a profit, its acquisition and holding by a dealer such as taxpayer must be considered to have been for sale to customers in the ordinary course of business. [Footnote n5 omitted]. It is true that lots 24 through 28 were held for a long period of time before they were sold. But petitioner testified that after 1928 or 1929 no unsold lots in the subdivision were selling. It is also true that when they were sold, with lots 21, 22, and 23, the selling price was a big gain over cost but we must assume petitioner paid taxes on these vacant lots for over 30 years. When a person is engaged in the business of selling non-income-producing real estate the fact that he plans to delay the sale of some parcels for a long period of time does not mean that when the sale occurs it is anything but a sale to customers in the course of the business the real estate man is conducting. White v. Commissioner, 172 F. 2d 629184 (C.A. 5). After considering all of the evidence with respect to these lots 21 through 28, it is our conclusion that they were held primarily for sale to customers in the ordinary course of petitioner's real estate business and not for investment. Between 1940 and 1945 petitioner reacquired lots 61, 62, 65, 66, and 67 in Herndon's-Telegraph Sub. These lots had been sold by petitioner in furtherance of his real estate business in the 1925-1927 period and sold again to the State for nonpayment of taxes. Being a prior owner, petitioner had first chance under Michigan law to buy them back from the State and petitioner did buy them back. Petitioner testified that when he bought these lots he "planned to keep them until the time that we could have sold them at a profit." He also testified that while waiting for this profitable sale the lots were rented occasionally but the rent was only "nominal". This testimony of petitioner that he intended to hold the lots until such time as he could realize a profit on the sale of the lots and the fact that the lots were held for around 20 years before they were sold to the savings and loan association in 1962 constitute the only evidence which petitioner*185 argues supports his right to capital gains treatment as to said sale. There is less evidence here to support the investment theory than was present with respect to the sale of lots 21 through 28. All that we said in concluding the sale of the previously mentioned lots is equally applicable here. It is our conclusion these lots were held primarily for sale to customers in the ordinary course of petitioner's real estate business and not for investment. Various concessions were made by both parties. Decision will be entered under Rule 50. Footnotes1. The sale of lot 12 resulted in petitioner's receiving $300 in 1959. He then received another $700 in 1960 on the same contract. In 1960, however, petitioner and the purchaser agreed to terminate the contract. The parties are agreed that the $300 received in 1959 is offset by the $300 commission paid by petitioner, so that no taxable income was realized in 1959 in connection with that sale. The parties further agreed that the $700 is includable in petitioner's 1960 gross income. The question of whether this $700 is capital gain or ordinary income is dependent upon our resolution of the principal issue with respect to the sales of lots in Pebblebrook Estates Subdivision.↩2. Unless otherwise noted, all Code references herein are to the Internal Revenue Code of 1954.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621078/	ST. AUGUSTINE TRAWLERS, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; VELTON J: O'NEAL and PEARL W. O'NEAL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSt. Augustine Trawlers v. CommissionerDocket Nos. 46843-86, 48350-86.United States Tax CourtT.C. Memo 1992-148; 1992 Tax Ct. Memo LEXIS 166; 63 T.C.M. (CCH) 2362; T.C.M. (RIA) 92148; March 16, 1992, Filed 166 Decisions will be entered under Rule 155. James D. O'Donnell and Keith H. Johnson, for petitioners. Avery B. Cousins III, for respondent. PARKERPARKERMEMORANDUM FINDINGS OF FACT AND OPINION PARKER, Judge: In these consolidated cases, respondent determined deficiencies in Federal income tax and additions to tax for both the corporate taxpayer and the individual taxpayers as follows: St. Augustine Trawlers, Inc. (Docket No. 46843-86)Addition to TaxFiscal Year EndingDeficiencySec. 6653(b)6/30/75$ 18,224 --6/30/767,822--6/30/7791,360--6/30/78155,829--6/30/79455,148$ 222,5746/30/80801,864400,932On November 30, 1988, respondent filed an Amendment to Answer in which she asserted the following increases in petitioner's taxable income: "cash payments of $ 400,000.00 from Archie Woody Moore, $ 400,000.00 from Ken Kiken, $ 100,000.00 from Gene Culmer, $ 90,000.00 from Jack Hemingway, $ 200,000.00 from William Wells, an unknown amount from James Murray, and additional unreported income from scrap metal and vending machine sales." The resulting increased deficiencies and additions asserted by respondent were: 167 Addition to TaxFiscal Year EndingDeficiencySec. 6653(b)6/30/79$ 491,148 $ 245,5746/30/801,077,864538,932Velton J. and Pearl W. O'Neal (Docket No. 48350-86)Addition to TaxTaxable Year EndingDeficiencySec. 6653(b)12/31/74$ 4,785 $ 12/31/7523,208--12/31/7674,254--12/31/7760,992--12/31/7817,472--12/31/79432,160216,08012/31/80536,160268,08012/31/811,478--On November 30, 1988, respondent filed an Amendment to Answer in which she asserted increases in petitioners' taxable income for all or part of the following: "cash payments of $ 400,000.00 from Archie Woody Moore, $ 400,000.00 from Ken Kiken, $ 100,000.00 from Gene Culmer, $ 90,000.00 from Jack Hemingway, $ 200,000.00 from William Wells, an unknown amount from James Murray, and additional unreported income from scrap metal in the amount of $ 21,000.00." The resulting increased deficiencies and additions asserted by respondent were: Addition to TaxTaxable Year EndingDeficiencySec. 6653(b)12/31/79$ 579,510$ 289,75512/31/80893,510446,755After concessions, 1 the following issues remain 168 for decision: 1. Whether the corporate taxpayer, St. Augustine Trawlers, Inc., failed to report income for its taxable years ending June 30, 1979, and June 30, 1980; 2. If the corporate taxpayer failed to report income, whether any portion of the understatement of income and resulting underpayment of tax each year was due to fraud on its part; 3. Whether the individual taxpayers, Velton J. and Pearl W. O'Neal, failed to report income they received in 1979 and 1980; and 4. If so, whether the understatement of income and resulting underpayment of tax each year was due to fraud on the part of petitioner Velton J. O'Neal. 2169 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts, the first supplemental stipulation of facts, the second supplemental stipulation of facts, and the exhibits attached thereto are incorporated herein by this reference. The principal place of business of the corporate taxpayer, St. Augustine Trawlers, Inc. (hereinafter Trawlers), at the time it filed its petition was St. Augustine, Florida. Trawlers was in the business of building, maintaining, and repairing shrimp boats and trawlers. After 1978, Trawlers also built dry docks and barges. Corporate StructureTrawlers was incorporated in Florida on September 3, 1971. At the time of incorporation, petitioner Velton J. O'Neal (hereinafter O'Neal) was president, Frank D. Upchurch, Jr., was vice president, and Jerry D. Thompson 3 was secretary/treasurer. From December 29, 1971, to June 30, 1976, O'Neal was president, Jerry D. Thompson was secretary, and Joseph T. Thompson170 4 was treasurer. On June 30, 1976, Joseph T. Thompson also became vice president. During the June 28, 1979, board of directors meeting, O'Neal was elected president and Jerry D. Thompson was elected secretary, treasurer, and executive vice president. At the organizational meeting on September 6, 1971, Trawlers had issued 563 shares of stock to O'Neal and 375 shares to Joseph T. Thompson. Shortly thereafter, Jerry D. Thompson became a shareholder, with the result that O'Neal and Joseph T. Thompson each owned 37.5 percent of the Trawlers stock and Jerry D. Thompson owned 25 percent. In 1976, O'Neal acquired Joseph T. Thompson's interest and sold an additional 8.33 percent interest to Jerry D. Thompson (hereinafter Thompson). Thompson gave O'Neal a promissory note, 171 but made payments only for the first and second years. From 1976 until the sale of Trawlers on January 6, 1981, O'Neal owned 66.67 percent and Thompson owned 33.33 percent of the stock. Sale and Subsequent Reacquisition of TrawlersIn December of 1980, O'Neal and Thompson negotiated with David L. Smeaton for the sale of Trawlers stock. The negotiated terms were $ 5 million, plus an additional $ 2 million to O'Neal and an additional $ 1 million to Thompson. On January 6, 1981, O'Neal and Thompson sold their stock in Trawlers to Smeaton. The sales agreement reflected a sales price of only $ 5 million, but O'Neal and Thompson also received notes for the additional amounts. The additional amounts were to be paid to a bank in the Cayman Islands. O'Neal told Thompson that they would not have to pay taxes on the $ 3 million portion of the purchase price that was paid in the Cayman Islands. Between January 6, 1981, and May 6, 1981, when he reacquired the corporation, O'Neal held the stock pursuant to a pledge agreement. Immediately after the sale in January 1981, Fernando A. Hernandez was appointed president of Trawlers and Robert E. Luedke was appointed vice president, chief172 executive officer, and secretary. O'Neal and Thompson were retained to assist in the transition of ownership. In February of 1981, however, Smeaton and Luedke discharged Thompson, first giving him a 30-day suspension letter and then terminating his employment during that 30-day period. At that time, Bruce Hoover, an independent certified public accountant and consultant to Smeaton, became suspicious when he discovered large credit memos that were being used to offset Trawlers' accounts receivable. He asked the accounting firm of Peat, Marwick, Mitchell & Co. (hereinafter Peat, Marwick) to perform an independent review of Trawlers' credit memos, boat sales contracts, accounts receivable, checks, and other records. On March 5, 1981, Hoover and Smeaton met with O'Neal. When Hoover informed O'Neal of the accounting discrepancies, O'Neal told Hoover that he and Thompson had split some of the cash coming into Trawlers. The conclusions reached by Peat, Marwick essentially confirmed those reached by Hoover. On March 23, 1981, Peat, Marwick reported several problems to Luedke, including a $ 1.2 million overstatement in accounts receivable and Trawlers' use of double (inflated) boat173 contracts, which will be discussed below. These double boat contracts resulted in a fraud on the banks that financed the boat purchases. Accordingly, Luedke reported the matter to the Federal Bureau of Investigation (FBI), which initiated an investigation, particularly since one of the transactions was financed by an agency of the United States Government. During this same time period, the Internal Revenue Service (IRS), independently and as a result of computer selection for audit, began a civil examination of Trawlers' corporate tax returns. By May of 1981, Smeaton was trying to renegotiate the January purchase agreement for Trawlers' stock. Since Smeaton had made only the first payment due on the notes, O'Neal brought suit to reacquire the shares and regain control of Trawlers. Pursuant to a local court order, the Trawlers shares were returned to O'Neal and Thompson in the spring of 1981. In October of 1981, O'Neal purchased Thompson's interest in Trawlers. In return for his stock, O'Neal paid Thompson $ 100,000 and gave him a $ 500,000 promissory note. However, he stopped payments on the note after 5 or 6 months. Thompson then sued O'Neal because of the default on the174 note. O'Neal counterclaimed against Thompson. By letter dated October 12, 1981, Thompson tendered his resignation as secretary and director of Trawlers. However, Thompson had not been involved in the active operation of Trawlers at any time after January or early February of 1981. Personnel at the Trawlers ShipyardUntil 1980, O'Neal lived in Key West, Florida, where he operated a shrimping business. O'Neal was only present at the Trawlers shipyard for about four or five days a month. After moving to St. Augustine, Florida in early 1980, O'Neal was regularly present at the shipyard. During the years in issue, Thompson was the general manager of Trawlers. Virginia Weatherly was the bookkeeper from 1971 up to the time of the trial, and was responsible for the bookkeeping, payroll, and general accounting records for Trawlers. Ida Wheeler was sales manager and vice president of marketing from 1978 until August 1983 and was responsible for preparing contracts for boat sales. Ida Wheeler was aware that cash payments were coming into the shipyard and were not being recorded on the books and records of Trawlers. George DeAntonis was the comptroller during 1979 and 1980 and175 was responsible for receiving and recording payments on the corporate books. Trawlers' Corporate Books and RecordsTrawlers reported income from boat sales at the time the boat was completed, but reported income from sales of supplies, maintenance, and repairs at the time of sale or as the payments were received. The corporation maintained for each boat a separate folder containing the records of sales and repairs. When payments came in to Virginia Weatherly, she would first record the income on a bank deposit slip. 5 She would then record the payment in the sales journal and on the invoice. The information from the sales journal would be transferred to the customers' individual account cards. At the end of each month, Virginia Weatherly prepared summaries of the sales journal entries. A keypunch operator then transferred the summaries to the general ledgers. A public accounting firm later used these general ledgers to prepare the income tax returns for Trawlers. 176 Some of Trawlers' customers were engaged in drug smuggling and did not want the fact that they paid in cash to be recorded on the corporate books. These customers, for obvious reasons, did not want to leave a paper trail. Trawlers also wanted to avoid the reporting requirements for sums of cash exceeding $ 10,000. 6 In such cases, Trawlers would issue "dummy invoices". Instead of writing a single invoice for a large sum, Virginia Weatherly, at the direction of Thompson, would issue to fictitious persons at out-of-state addresses two or more invoices in amounts less than $ 10,000 each. To accomplish this same purpose and in a similar manner, Trawlers would also bill some supplies to fictitious out-of-state persons. Although both of these practices created false corporate records, neither practice necessarily generated any increased or unreported income for Trawlers. In a third practice whereby the corporate books were falsified (by omission), Trawlers would issue177 a tentative or draft bill for supplies, fuel, and boat repairs, payment would be made in cash, and then the tentative or draft bill would be destroyed. These cash payments were not recorded on the corporate books. As a fourth practice, Trawlers would issue a contract (for a boat, supplies, or repairs) at less than the actual price, with the difference between the contract price and the actual price being paid in cash. These cash payments were not recorded on the corporate books. These last two practices were means by which Trawlers and the individual shareholders received unrecorded and unreported income. Beginning in 1974, Trawlers received cash payments that were not recorded on the corporate books or records. This unrecorded and unreported cash was used in two different ways. Thompson and O'Neal split most of the unrecorded and unreported cash on a 50-50 basis. On a few occasions, some of the unrecorded and unreported cash was used for corporate expenditures. Between 1977 and 1980, Trawlers purchased for cash a dozen used trucks at $ 700 each, for a total of $ 8,400. These truck purchases were not recorded on Trawlers' books, and the corporation did not depreciate the178 trucks for Federal tax purposes. Between 1978 and 1980, Trawlers purchased for cash six paintings at $ 300 each, for a total of $ 1,800. At some point between 1976 and 1978, the corporation purchased for cash a used crane for $ 35,000. This crane purchase was not recorded on the corporate books, and the crane was not depreciated for Federal tax purposes. In 1974 or 1975, Trawlers purchased a piece of adjacent land for $ 15,000 in cash. Some of the unrecorded and unreported cash was used to pay for a few of Thompson's business trips. Safe-Deposit BoxDuring 1979 and 1980, Trawlers leased a safe-deposit box from Barnett Bank in St. Augustine, Florida. O'Neal and Thompson opened the box in August 1979, and they were the only persons who had access to the box. Some of the unreported cash received by Trawlers was placed in this safe-deposit box. Neither O'Neal nor Thompson kept a record of the amount of cash placed in the box. They intended to split this cash and not to report it on either their personal or the corporate tax returns. If O'Neal was at the shipyard when Thompson received cash payments, they would split the cash at that time. If O'Neal was elsewhere at 179 the time, Thompson would put the money in the safe-deposit box either that day or shortly thereafter. When O'Neal came back to St. Augustine, he and Thompson, or just Thompson, would go to the bank safe-deposit box and remove half of the money for O'Neal. O'Neal was aware that the safe-deposit box was being used to store part of the unrecorded and unreported cash. Specific Sources of Trawlers' Unrecorded and Unreported Income1. Archie "Woody" MooreBetween June 30, 1978, and early 1981, Thompson received cash and check payments from Archie "Woody" Moore for work done by Trawlers. Some of these payments were not recorded on Trawlers' books and records. With respect to the cash payments, Moore dealt exclusively with Thompson. When he received cash from Moore, Thompson would put it in his desk drawer. Although Thompson did not specifically say he was not going to report the cash, this was understood between him and Moore. Moore was engaged in drug smuggling and did not want Trawlers to keep records of the amounts he paid in cash. 7180 In 1976, Moore purchased the "Carl Moore" from Trawlers. The completion date for this boat was December 13, 1976. The total purchase price was about $150,000. Of this total, $ 30,000 was paid in cash. In 1978, Moore purchased the "Lady Lisa". The completion date for this boat was March 17, 1978. Of the total purchase price of approximately $ 230,000, $ 50,000 was paid in cash. On April 8, 1979, Trawlers completed the "Belfast Lady I". That boat was constructed in a period of 3 months, and the total purchase price was $ 300,000. Of this price, at least $ 90,000 was paid to Thompson in cash. In 1979, Moore had maintenance work done by Trawlers on two of his boats, the "Carl Moore" and the "Lady Lisa". Moore paid approximately $ 30,000-$ 35,000 in cash for the work on the "Carl Moore" and approximately $ 80,000 in cash for the work on the "Lady Lisa" throughout the year. Moore did not want, and did not get, receipts acknowledging payment for this work. About half of the $ 110,000-$ 115,000 cash payments for repairs were made in the first half of 1979, and the rest in the second half of 1979. At the beginning of 1980, Moore purchased two boats from Trawlers -- the "Lady181 Lisa II" and the "Belfast Lady II". The completion date for the "Lady Lisa II" was February 9, 1980. The completion date for the "Belfast Lady II" was February 28, 1980. The purchase price of the "Lady Lisa II" was $ 235,000, of which $ 50,000 was paid in cash to Thompson. Approximately $ 90,000 of the "Belfast Lady II" purchase price was paid in cash to Thompson. For its fiscal years 1979 and 1980, Trawlers recorded and reported only the following cash payments from Moore: DateAmount12/08/78$ 2,000.00 01/17/7937,960.0004/10/7915,225.0008/16/79508.80$ 55,693.80Sometime late in 1980 or early 1981, Moore received a telephone call from Ida Wheeler telling him that he should come to the Trawlers shipyard to see Thompson. When Moore got there, he met with Wheeler and Thompson, who talked about destroying some records. Moore was not told that Trawlers was under investigation and assumed initially that whatever problems there were pertained to his own personal income taxes. Moore apparently was under investigation by a Federal grand jury around this same time. Ida Wheeler had a folder with Moore's boat contracts and other records in it. Wheeler182 and Thompson questioned Moore about the amount of cash, if any, he had reported on his tax returns and then removed and destroyed some of the records from the folder. During a taped conversation between Thompson and O'Neal on July 21, 1982, O'Neal told Thompson that he had testified before the grand jury that all of the cash payments had been recorded on the corporate books, and then the following colloquy occurred: Thompson: How can [the grand jury], how can they trace that that cash that we took? How can they trace that? O'Neal: I I don't think there's anybody out there that ah, I don't know that they can. (Pause) But they're aware of some things going on from the people we've dealt with. Thompson: Uh uh. O'Neal: Such as namely Woody Moore. They . . . Thompson: Right. Has (O'Neal inaudible) has Woody Moore said that he gave us cash? O'Neal: I have no idea. Don't think he has because he's just like we we are -- he's got to hide it if he can. I don't think he has. * The O'Neals did not report any of the unrecorded cash payments on their Federal income tax returns for 1979 and 1980. Trawlers did not report any of the unrecorded cash payments on its183 Federal income tax returns for its fiscal years ended June 30, 1979, and June 30, 1980. 2. Ken KikenBetween June 30, 1978, and early 1981, Thompson received cash and check payments from Ken Kiken for maintenance work performed by Trawlers and for supplies and boats purchased from Trawlers. Kiken was engaged in drug smuggling throughout this period. Kiken first had business dealings with Trawlers around 1978 or 1979 and dealt primarily with Thompson. Kiken usually did not get a receipt from Thompson, nor did Kiken want one. He would give Thompson the cash in Thompson's office, and Thompson would put the money in his desk drawer. O'Neal was aware that Kiken paid some of his accounts in cash, but only Thompson and Ida Wheeler physically received the cash from Kiken. In 1981, after Thompson had left Trawlers and Kiken was dealing with O'Neal and Virginia Weatherly, Kiken was given receipts. Kiken's business dealings with Trawlers ceased in 1983. Trawlers built the "Elizabeth Ann", a fiberglass trawler, for Kiken in 1980. The completion date for this boat was June 8, 1980. The purchase price was approximately $ 330,000-$ 350,000. In addition to the purchase price, Kiken184 paid $ 75,000 in cash for extras on the boat. Trawlers also built the "Patricia Ann" (a.k.a. "The Capricorn"), another fiberglass trawler, for Kiken. The completion date of the "Patricia Ann" was November 3, 1981. The purchase price of this boat was about $ 350,000-$ 360,000. Kiken paid an extra $ 30,000 to $ 50,000 in cash at the time this boat was completed. Kiken bought the "Miss Suzanne" (a.k.a. "Coral Ray"), a used boat, from O'Neal in late 1979. Kiken paid $ 178,000 for the boat. O'Neal personally financed the purchase price for Kiken over a period of 5 years. O'Neal reported this amount on his tax returns. Kiken also paid $ 100,000 in cash for extras on the boat. Kiken owned a wooden boat called the "Freddie J" (a.k.a. "Miss Victoria"). Kiken had about $ 200,000 worth of work done on the "Freddie J" throughout 1979. He paid approximately $ 30,000 of the cost by check and the remaining $ 170,000 was paid in cash throughout the year. Each year, Kiken left his boats at Trawlers for about 6 to 8 weeks for maintenance work. In 1979, Kiken paid about $ 200,000 in cash for maintenance work on his boats. In 1980, he paid a minimum of $ 200,000 in cash for maintenance. 185 And in 1981, he paid approximately $ 350,000 in cash for such maintenance. About 95 percent of the cost of the boat supplies that Kiken purchased from Trawlers was paid in cash. In addition to the extras on the boats mentioned above, the supplies for the boats included fuel. The cost was about $ 10,000 per boat each time the boats were refueled. Kiken always paid cash for fuel. It is unclear how many times per year each boat was refueled, although it is clear that each boat was refueled at least one time per year. Between 1979 and 1981, Trawlers recorded on its corporate books the following cash payments received from Kiken: DateAmount08/21/79$ 2,000.0004/04/8037.5010/06/80621.1601/08/81414.6902/13/81133.0605/07/8115,000.0011/06/815,200.0011/09/814,600.00$ 28,006.41The O'Neals did not report any of the unrecorded cash payments on their Federal income tax returns for 1979 and 1980. Trawlers did not report any of these amounts of unrecorded cash on its corporate tax returns for its fiscal years ended June 30, 1979, and June 30, 1980. 3. Gene CulmerBetween 1977 and 1980, Trawlers received $ 100,000 in unrecorded and unreported186 cash payments from Gene Culmer. In 1979 and 1980, Trawlers listed on its books and records a total of only $ 26,533 in cash payments received from Culmer: 8DateAmount01/31/79$ 2,000 01/31/792,00002/12/8022,533$ 26,533The unrecorded amount of cash was split between Thompson and O'Neal. None of the unrecorded amount of cash was reported on the Federal income tax returns of the O'Neals for 1979 and 1980 or on the corporate returns of Trawlers for its fiscal years ended June 30, 1979, and June 30, 1980. 4. William "Billy" WellsIn 1979, William "Billy" Wells and O'Neal became equal owners of the Seaford Scallop Company, Inc., a scallop and fishing business located in Seaford, Virginia. When doing business with Trawlers, Wells dealt primarily with O'Neal. Between July 1978 and June 1982, Trawlers reported receiving from Wells almost $ 2.5 million in checks, but no cash. Between 1977 and 1980, however, 187 Trawlers also received $ 200,000 in cash from Wells. This amount was not recorded on the corporate books and was split between Thompson and O'Neal. The O'Neals did not report any of this cash on their individual Federal tax returns. Trawlers did not report any of this cash on its corporate income tax returns. 5. Scrap Metal SalesBetween August 1979 and December 1980, Trawlers received a total of $ 21,000 in cash from the sale of scrap metal. None of this amount was recorded on the corporate books. Thompson and O'Neal split this money equally. Neither the O'Neals nor Trawlers reported any of this cash on their Federal income tax returns. O'Neal was aware that Trawlers was selling scrap metal, and that he and Thompson were splitting the proceeds from such sales. 6. Hemmingway TransactionIn late 1980, Jack Hemmingway paid $ 90,000 in cash towards a new boat he purchased from Trawlers. Ida Wheeler received the cash and turned it over to O'Neal. Around January 7, 1981, O'Neal gave $ 61,000 of this cash to Smeaton; O'Neal and Thompson split the remaining $ 29,000. None of the $ 90,000 was reported on Trawlers' corporate tax return for its fiscal year ended June188 30, 1981. The O'Neals did not report any of this cash on their personal income tax returns for 1980 or 1981. 7. Vending MachinesThere were vending machines at Trawlers shipyard from 1972 to 1980. Thompson got the payments from the vending machines, which totaled about $ 20,000. None of the vending machine income was recorded on Trawlers' books. Thompson did not give any of the vending machine money to O'Neal or Trawlers. O'Neal knew that Thompson was receiving this money. Neither the O'Neals nor Trawlers reported vending machine income on their Federal income tax returns for the years at issue (i.e., 1979 and 1980 for the O'Neals and fiscal years ending June 30, 1979, and June 30, 1980, for Trawlers). 8. $ 35,550In 1980, O'Neal received $ 35,550 in cash from Thompson. O'Neal got the first part of this money from Thompson around May or June 1980. The money was paid in four or five installments. This cash came from the sale of supplies, scrap metal, and surplus equipment and not from boat sales or repairs. O'Neal kept this cash in a bank bag in the trunk of his car. He did not report it on his Federal income tax return for 1980 even though he knew and believed189 that he could have spent the money anytime he wanted to. 9 O'Neal understood that he had a duty to file an accurate return. In July of 1982, O'Neal filed an amended return for 1980 and, again, did not report this income. Around June of 1981, O'Neal gave the bank bag to Virginia Weatherly and told her to put it in the file cabinet in her office for safekeeping. On June 13, 1983, 3 days after O'Neal's sentencing hearing on his conviction for perjury, Virginia Weatherly deposited the cash into Trawlers' bank account. On July 11, 1983, Trawlers filed an amended corporate tax return (Form 1120X) for its fiscal year ended June 30, 1981, reporting $ 35,550 of additional income. On that amended corporate return, below the statement of income not previously reported, was the following statement: "Note: 190 There may be additional income to be reported at a later date." George DeAntonis prepared and signed this amended return. Virginia Weatherly testified at the trial of this case that she did not know how much money was in the bank bag until she deposited it. However, at O'Neal's sentencing hearing on June 10, 1983, 3 days before she deposited the money, she testified that approximately $ 35,000 was in the bag. O'Neal testified at the trial in the present case that he did not tell the grand jury about this money because he had forgotten about it. 109. Use of AutomobilesDuring 1979 and 1980, O'Neal used cars owned191 by Trawlers for both business and personal use. He did not report the personal use of the car as constructive dividends on his Federal income tax return for either year. Double ContractsBetween 1974 and 1981, Trawlers prepared at least 40 double contracts for boat sales or boat repairs. The two contracts for the same transaction would contain different prices. The contract with the lower price reflected the actual contract price for the boat or boat repairs. The contract with the higher price was a phony contract that Trawlers furnished to its customer so that the customer could obtain financing for 100 percent, or more, of the actual purchase price. To the extent that the amount received from the lending institution exceeded the actual contract price, Trawlers would dispose of the excess funds in one of three ways: (1) transfer the balance to a supply account for the customer; (2) transfer the balance to another boat or boats of the same customer; or (3) issue credit memos to the customer. O'Neal knew of the double-contract practice, at least with respect to customer Marion Duzich. The double-contract transactions generally did not generate any unreported income for192 Trawlers but constituted a fraud upon the bank or other lending institution financing the transaction. O'Connell/HUD TransactionJohn O'Connell was the president of O'Connell Seafood in Boston, Massachusetts. James Norton was his corporate attorney. In 1980, O'Connell Seafood applied for and received a $ 2.1 million grant from the United States Department of Housing and Urban Development (HUD) to build a fishing facility in Boston Harbor. This facility included a floating dry dock to be built by and purchased from Trawlers. O'Connell and Norton gave HUD a phony sales contract for the dry dock, the "Eleanor Eileen XIV", that showed a sales price of $ 890,000. Ida Wheeler executed that phony contract on behalf of Trawlers. The actual contract price of the "Eleanor Eileen XIV" was only $ 425,000. O'Connell and Norton were ultimately convicted of conspiracy to defraud HUD; making false material declarations before the grand jury; influencing, obstructing and impeding the due process of justice; and obstructing a witness, in violation of 18 U.S.C. sections 371, 1503, 1623, and 2. Trawlers received payments from the bank and/or HUD relating to the "Eleanor Eileen XIV" in excess193 of $ 425,000. The invoices showing payments from O'Connell Seafood to Trawlers were "dummy" invoices, evidenced by the fact that they did not have stamped invoice numbers on them. They were unrelated to and not part of the corporation's regular books and records and had no corporate purpose. These "dummy" invoices were prepared at the direction of Thompson. Trawlers issued four checks to O'Connell Seafood in the total amount of $ 200,000. Trawlers falsely characterized these payments as "sales commissions". The checks represented amounts received from the financing bank or HUD that exceeded Trawlers' actual contract price. In this manner the excess funds were channeled to O'Connell Seafood in the guise of "sales commissions". On December 30, 1980, a letter containing the following statement was presented to John Marcus Thompson, Trawlers' financial manager, for his signature: 1. Upon receipt of $ 123,200.00 the outstanding balance due on a total contract price of $ 890,000.00, St. Augustine Trawlers Inc. will release same to O'Connell Seafood Co., Inc. the Dry Dock Eleanor Eileen XIV, free of any liens.He refused to sign this false statement. At the bottom of194 this letter, John Marcus Thompson wrote and signed the following: This document was given to me by John O'Connel [sic] & Jim Norton at a meeting on December 30, 1980. I refused to have this executed because of the statement in #1.O'Neal later signed a builder's affidavit indicating that the contract price had been paid and that the dry dock was free of any liens, but his affidavit was silent as to the total contract price or as to the total amount actually paid to Trawlers. This double-contract scheme did not generate any income for Trawlers. IndictmentsIn November 1981, during the criminal investigation arising out of the O'Connell/HUD transactions, Thompson agreed to be a cooperating witness for the United States and secretly record conversations with O'Neal. On October 12, 1982, Thompson was charged with conspiracy to defraud the United States, specifically HUD, in connection with the O'Connell dry dock transaction, in violation of 18 U.S.C. section 371. On October 14, 1982, pursuant to the understanding reached in November 1981, Thompson signed a plea agreement with the United States. Between January 18, 1982, and July 21, 1982, at the request of the FBI, 195 Thompson taped several conversations between himself and O'Neal. On January 19, 1982, the following conversation took place: Thompson: Is there, is there any records on ah amount of cash that we took in? O'Neal: No, I don't think there's anything. The only thing ah, only thing there, Jerry, is some whole lot ah, I'm not so sure that I really got my part of some of that money. Ah, in fact I'm I'm sure I didn't. Because ah it's a lot, it's a lot of ah repair jobs been done here and ain't no records nowhere and I know that I didn't get that money. * * * O'Neal: And you know it. Thompson: Ah some of it yes, I'm I know you didn't get it all, but ah you you got a lot of it. (Laughs). * * * O'Neal: And you know, you know that, I ah ah that's not saying nothing about the the cash money and the other things that was happening. Now the cash money we split ah, I don't think it that that's gonna come up, it hasn't been mentioned and I, and I'm not gonna mention it. Cause that's, that's dangerous, too. Thompson: Yeah, it damn sure is, O'Neal: That's dangerous. Thompson: that, that's one thing bothers me the the ah the cash that we took in and O'Neal: Well196 now Thompson: ah out. . . O'Neal: I don't, I don't really think that's gonna come up. That hadn't been mentioned and I'm sure as hell not gonna mention anything and shouldn't be mentioned. Thompson: No. O'Neal: Because ah that's dangerous as hell and ah ah not only is it taxable, that that is dam, that is penitentiary. Thompson: Right. O'Neal: That's pure old income tax evasion.And on March 18, 1982, the following conversation took place: O'Neal: But ah the thing that's getting serious now is cash money. (Pause) Internal Revenue's gettin' in on it. Internal Revenue's coming back. . . . Thompson: Well. . . O'Neal: Monday. Thompson: you just talking about ah Woody Moore, ah. . . O'Neal: (Inaudible) no, not necessarily Woody Moore. They said that a lot of cash has come in here so I said, no, no, ain't no lotta cash. The only cash I know that's come in here has been recorded and put in the bank and our bank records show it. Thompson: Uh uh. O'Neal: Ain't no way that I'd tell 'em that ah about these other things because, * * it'd (pause) that's, that's real dangerous. Thompson: Sure would. O'Neal: But I don't know where they 197 got the information than ah only out of these records. Thompson: Well, Woody. . . . O'Neal: Thought that was taken care of. Thompson: Woody didn't have any records to show that he paid cash, did he? O'Neal: Not that I know of. Thompson: Unless he made some records of his own.On May 27, 1982, O'Neal testified before a Federal grand jury in the Middle District of Florida. During the proceedings before the grand jury, O'Neal testified to the following: Q: To your knowledge, you have not been involved in any way to evade income tax by obtaining cash payments under the table? A: No, sir.This testimony formed the basis for the indictment handed down against O'Neal on October 14, 1982. That indictment charged O'Neal with knowingly making false statements to the grand jury, in violation of 18 U.S.C. section 1623. On March 18, 1983, O'Neal pled guilty to this charge. On June 10, 1983, O'Neal was given a 5-year suspended sentence, placed on 5 years' probation, fined $ 10,000, and ordered to contribute 4 hours a week of community service. ULTIMATE FINDINGS OF FACT 1. Velton J. O'Neal and Jerry D. Thompson acted in concert between 1977 and 1981 in splitting198 unrecorded and unreported cash income of their corporation, Trawlers. 2. In 1979, the O'Neals had unreported income of at least $ 329,391.35. 3. In 1980, the O'Neals had unreported income of at least $ 293,965.97. 4. The O'Neals underpaid their Federal income tax in 1979 and 1980, and all or a substantial part of the underpayment each year was due to fraud on the part of Velton J. O'Neal. 5. For the taxable year ended June 30, 1979, Trawlers had unreported income of at least $ 365,337.28. 6. For the taxable year ended June 30, 1980, Trawlers had unreported income of at least $ 748,031.28. 7. Trawlers underpaid its Federal income tax for its fiscal years ended June 30, 1979, and June 30, 1980, and all or a substantial part of the underpayment each year was due to fraud. OPINION This is a fraud case with the normal split burden of proof. The taxpayers must prove by a preponderance of the evidence any errors in the deficiency determinations, except that respondent has the burden with respect to any increases in deficiency pleaded in the answers and amendments to answers. Rule 142(a). Respondent must prove by clear and convincing evidence the elements of fraud. Sec. 199 7454(a); Rule 142(b); Henson v. Commissioner, 887 F.2d 1520">887 F.2d 1520, 1525 (11th Cir. 1989), affg. T.C. Memo. 1988-275; Zack v. Commissioner, 692 F.2d 28">692 F.2d 28, 29 (6th Cir. 1982), affg. T.C. Memo 1981-700">T.C. Memo. 1981-700. At the outset, we note that resolution of the issues involves a credibility determination as between Thompson and petitioner O'Neal. We do not find Thompson's testimony wholly credible, especially with respect to the amount of unreported cash he split with O'Neal. 11 However, we find petitioner O'Neal's testimony to be utterly unworthy of belief. O'Neal's trial testimony was controverted by virtually every credible witness as well as by O'Neal's own taped conversations with Thompson. O'Neal, moreover, is a convicted perjurer and his conviction stemmed from his denial of receiving cash payments under the table. We are not required to accept the unpersuasive, self-serving testimony of petitioner O'Neal. Tokarski v. Commissioner, 87 T.C. 74">87 T.C. 74, 77 (1986). 200 During trial, after extensive stipulations, all of the nonfraud issues were resolved. Respondent had the burden of proof on all issues remaining in this case, i.e., the fraud issues and the increased deficiency amounts. Petitioners contend that respondent has not met her burden as to the deficiencies. We find, however, that the evidence of substantial amounts of unreported income is overwhelming. The amounts of unreported cash income of Trawlers and of the O'Neals are tabulated in Appendices I and II to this opinion. Both "Woody" Moore and Ken Kiken testified as to the amounts of cash paid to Trawlers, the particular transactions to which the cash related, and the years in which the cash was paid. Although both of these men are convicted drug smugglers, we found their testimony in this Court to be candid and truthful. The fact that unreported cash was received from both Moore and Kiken was corroborated by Thompson both at trial and during interviews with FBI agents. Moreover, O'Neal's own taped conversations compel the finding that he and Thompson were receiving substantial amounts of unreported income. See supra note 10. Bruce Hoover, an independent certified public201 accountant and disinterested third party, testified that the following transpired at a meeting with O'Neal on March 5, 1981: So, I said [to O'Neal], Well, just suppose a fisherman wanted to buy a boat for $ 275,000, and he had $ 50,000 worth of cash he wanted to launder, so you give him an invoice for two and a quarter, and somebody in the yard takes $ 50,000, be it some employee or an officer of the yard. What about that sort of situation? And he said, Oh, yes. We [he and Thompson] did that.On January 19, 1982, in a secretly taped conversation with Thompson, O'Neal made the following statements: Thompson: Is there, is there any records on ah amount of cash that we took in? O'Neal: No, I don't think there's anything. The only thing ah, only thing there, Jerry, is some whole lot ah, I'm not so sure that I really got my part of some of that money. Ah, in fact I'm I'm sure I didn't. Because ah it's a lot, it's a lot of ah repair jobs been done here and ain't no records nowhere and I know that I didn't get that money. Thompson: Ahm, (Inaudible voices in background) O'Neal: And you know it. Thompson: Ah some of it yes, I'm I know you didn't get it all, 202 but ah you you got a lot of it. (Laughs) O'Neal: Maybe I got a lot of it, but a lot and what's what you entitled to Thompson: Yeah. O'Neal: is two different things.Kiken testified that he got receipts for his cash dealings with Trawlers only after Thompson had left Trawlers. In one conversation with Thompson, on July 21, 1982, O'Neal explained why Kiken's cash dealings took on an air of legitimacy at this time. O'Neal stated: "Ken's done some cash business, quite a bit of cash business since since we've taken it back over but ah, but we we put it in the bank. Course we had to cause we need it." In that same conversation, O'Neal stated he knew that some of the cash coming into Trawlers was being diverted from the corporate books: O'Neal: I've been keeping [Ida Wheeler] and paying her this damn big price she's collecting until this damn thing's over. She's costing us a fortune. Well, you know what her salary was. Thompson: Yeah. O'Neal: And she's the only one we didn't raise last year, and ah ah (pause), but I been keeping her mainly for that reason because I don't wanna antagonize her, get her mad, because she can be vindictive you know and I says, all203 you can do, Ida, is say is ah if any of the customers did pay you, you just you just turned it in to ah ah the accounts receivable and that, what happened to it then you don't know. Thompson: But she's too smart for that. O'Neal: Yeah, she's, yeah, she's too smart, she knows that it went to some other place. Thompson: Yeah. She's, she's gonna, I betcha (O'Neal inaudible) when they do call her, she's gonna go up there and tell 'em that Woody Moore paid thirty thousand or whatever and I give it to Jerry or I give it to Virginia and I give it to Puck [O'Neal] and they (O'Neal in background - inaudible) went and put it in a box and. . . . O'Neal: I told her when she went up there before. . . . Thompson: that's what she's gonna say. I guarantee ya.Petitioner TrawlersTrawlers' arguments are based on the assumption that Thompson was acting without the knowledge and acquiescence of O'Neal. The facts are otherwise. Because we reject this assumption, we need not further address Trawlers' contentions. "Diverted amounts taxed to a shareholder as constructive dividends also remain fully taxable to the corporation to which attributable." Truesdell v. Commissioner, 89 T.C. 1280">89 T.C. 1280, 1300 (1987).204 The full amount of the unreported cash receipts is income to Trawlers. The O'NealsThe O'Neals contend that the only money Velton J. O'Neal received was the $ 35,550 cash purportedly from the sale of scrap metal or used equipment. The record shows otherwise. The O'Neals' first argument is that none of the money (the $ 35,550) should be taxable because the funds were segregated and were never actually used for personal benefit. In support of this argument, petitioners direct us to two memorandum opinions of this Court. In Rosencrans v. Commissioner, a Memorandum Opinion of this Court dated Feb. 26, 1954, the taxpayer withdrew funds from his wholly owned corporation and placed the money in his safe-deposit box. The money was held for safekeeping until the taxpayer could locate a piece of property for the corporation to purchase. This Court held that those funds were neither a loan nor a dividend to that taxpayer and that he derived no benefit from holding the funds in his safe-deposit box. There was no indication in Rosencrans, as there is in the instant case, that the corporation omitted the money from its books and from its tax returns. On this point, the 205 O'Neals direct us to Hammer v. Commissioner, T.C. Memo. 1989-396, in which the unreported income of the corporation was deposited by the two shareholders into a brokerage account. The diversion of funds took place over the course of 3 years. The funds and the earnings thereon were returned to the corporation a year later. The Court found that the facts of that case were akin to the facts in Rosencrans, that those shareholders did not realize income because they derived no personal benefit from the diverted funds. Moreover, the corporation in Hammer filed amended returns, reported the omitted income, and paid additions to tax for fraud under section 6653(b). Here Trawlers never received the vast majority of the unrecorded and unreported cash, only this $ 35,550 that played so prominently in O'Neal's change of plea and sentencing for perjury. Here, Thompson and O'Neal derived substantial benefits since they kept the bulk of the cash they split. The present case is wholly distinguishable on its facts from the Memorandum Opinions petitioners rely on. We hold that O'Neal did realize the $ 35,550 as income in 1980. We follow the reasoning of the Supreme206 Court in Corliss v. Bowers, 281 U.S. 376">281 U.S. 376, 378 (1930), that "the income that is subject to a man's unfettered command and that he is free to enjoy at his own option may be taxed to him as his income, whether he sees fit to enjoy it or not." (Emphasis supplied.) [Gain] constitutes taxable income when its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it. Burnet v. Wells, 289 U.S. 670">289 U.S. 670, 678; [53 S. Ct. 761">53 S.Ct. 761, 764, 77 L. Ed. 1439">77 L.Ed. 1439;]Corliss v. Bowers, 281 U.S. 376">281 U.S. 376, 378. [50 S. Ct. 336">50 S.Ct. 336, 337, 74 L. Ed. 916">74 L.Ed. 916.]That occurs when cash, as here, is delivered by its owner to the taxpayer in a manner which allows the recipient freedom to dispose of it at will, even though it may have been obtained by fraud and his freedom to use it may be assailable by someone with a better title to it.Rutkin v. United States, 343 U.S. 130">343 U.S. 130, 137 (1952). See also North American Oil Consolidated v. Burnet, 286 U.S. 417">286 U.S. 417, 424 (1932), wherein the Supreme Court stated: If a taxpayer receives207 earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent.O'Neal had no intention to return the money to the corporation at the time he received it from Thompson. See Kaplan v. Commissioner, 43 T.C. 580">43 T.C. 580, 592-593 (1965). O'Neal kept the $ 35,550 in the trunk of his car for a year before giving it to Virginia Weatherly. He testified that he could have spent the money anytime he wanted. See supra note 9. It is noteworthy that the money was not deposited in the corporate bank account until 3 days after O'Neal's sentencing hearing. O'Neal did not hold the money for any corporate purpose. 12 We hold that the $ 35,550 was income to the O'Neals in 1980.The O'Neals' second argument is that208 a portion of the $ 35,550 may contain some of the money from the Hemmingway transaction, which the O'Neals contend was received in early 1981. Therefore, they argue that only a portion of the $ 35,550 is taxable in 1980. For several reasons, we find this argument to be meritless. We have found as a fact that the Hemmingway money was received by O'Neal in late 1980, not in early 1981. Further, there is no persuasive evidence that any part of the $ 35,550 money received from Hemmingway. The $ 35,550 was received from the sale of scrap metal and used equipment. The Hemmingway money was received as a $ 90,000 down payment on the purchase of a boat. The O'Neals' third argument is that if O'Neal received any money in 1980, it was no more than $ 35,550, which he now "readily admits" he received throughout the latter part of 1980. For the reasons noted above in our discussion of the evidence of record, we find this argument wholly without merit. O'Neal received this $ 35,550 plus other substantial amounts of unreported cash income in 1980. The O'Neals received one-half of Trawlers' unreported income that was not used for corporate expenditures. "Funds (or other property) distributed209 by a corporation to its shareholders over which the shareholders have dominion and control are to be taxed under the provisions of section 301(c)." Truesdell v. Commissioner, 89 T.C. at 1298. Although neither party has addressed the amount of Trawlers' earnings and profits account, we will make a few observations as pertains to the constructive dividends issue. This case is appealable to the United States Court of Appeals for the Eleventh Circuit, and thus we will follow a decision of that court that is directly on point. 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), cert. denied 404 U.S. 940">404 U.S. 940 (1971). The Eleventh Circuit's decision in United States v. Williams, 875 F.2d 846 (11th Cir. 1989), however, is distinguishable. In that case, the court held that, in criminal tax cases, the Government need not characterize diverted income and, therefore, does not have to present evidence as to earnings and profits. United States v. Williams, supra at 852, 850. Because that court's holding specifically applies only to criminal tax 210 cases, it is not within the ambit of the Golsen rule. Thus, we will follow our opinion in Truesdell v. Commissioner, supra.Pursuant to section 301(c), the amount of unreported cash that is a constructive dividend to the O'Neals would be limited, first, to Trawlers' current earnings and profits and, second, to its accumulated earnings and profits. Any excess amount of the constructive distribution would reduce, but not below zero, O'Neal's basis in Trawlers. Any further excess would be treated as capital gain. In determining the amount of corporate earnings available for a dividend, the amount of unreported income is added into the corporation's earnings and profits. Bernstein v. United States, 234 F.2d 475">234 F.2d 475, 481-482 (5th Cir. 1956). While the amount of earnings and profits is then reduced by the corporate tax liability, it is not further reduced by any fraud addition: It is not consistent with our ideas of proper accounting practice for officers and directors of a corporation to be permitted to conduct the affairs of their corporation in such a way as to defraud the government and then assert the existence of a fraud penalty211 as a corporate liability, and thus translate what would otherwise be a dividend distribution to themselves into a distribution of capital.Bernstein v. United States, supra at 482. We do note, however, for the sake of completeness, that some small portion of the unreported receipts is not to be treated as constructive distributions to O'Neal. In Herman v. Commissioner, 84 T.C. 120">84 T.C. 120, 134-135 (1985), we found that if there is a substantial corporate purpose for an expenditure, it is not a dividend to the shareholder. There is "no constructive dividend so long as * * [the taxpayer] can show that his intent 'was to use such funds for corporate purposes as an agent of the corporation.'" Stone v. Commissioner, 865 F.2d 342">865 F.2d 342, 343 (D.C. Cir. 1989), revg. Rosenbaum v. Commissioner, T.C. Memo. 1983-113 (citing Nasser v. United States, 257 F. Supp. 443">257 F. Supp. 443, 449 (N.D. Cal. 1966)). The unreported income that was used for corporate expenses is not available for dividend treatment. However, the amounts paid for trucks and paintings in the taxable years at issue have been excluded from the212 amounts of unreported income in the ultimate findings of fact. 13 See Appendices I and II. Sec. 6653(b) AdditionsRespondent has the burden of proving by clear and convincing evidence the elements of fraud for the section 6653(b) additions to tax. Sec. 7454; Rule 142(b); Henson v. Commissioner, supra; Zack v. Commissioner, supra. The two elements are (1) the existence of an underpayment of tax each year and (2) that some part of that underpayment of tax each year was due to fraud. Petzoldt v. Commissioner, 92 T.C. 661">92 T.C. 661, 699 (1989). Fraud is actual, intentional wrongdoing, and the intent is the specific purpose to evade a tax 213 believed to be owing. Candela v. United States, 635 F.2d 1272">635 F.2d 1272, 1275 (7th Cir. 1980); 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). Respondent must show that the taxpayer intended to evade taxes by conduct calculated to conceal, mislead, or otherwise prevent the collection of such taxes. Stoltzfus v. United States, supra; Beaver v. Commissioner, 55 T.C. 85">55 T.C. 85, 92 (1970); Acker v. Commissioner, 26 T.C. 107">26 T.C. 107, 112 (1956), affd. in part, revd. in part 258 F.2d 568">258 F.2d 568 (6th Cir. 1958), affd. 361 U.S. 87">361 U.S. 87 (1959). Fraud will never be presumed. Beaver v. Commissioner, supra.Fraud is a question of fact to be determined on the basis 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), cert. denied 379 U.S. 827">379 U.S. 827 (1964), cert. denied 389 U.S. 912">389 U.S. 912 (1967). Fraud, however, can seldom be proved by direct proof of the taxpayer's intention. Therefore, fraud214 must be determined from the taxpayer's entire course of conduct and can, and usually must, be proved by circumstantial evidence. Spies v. United States, 317 U.S. 492">317 U.S. 492, 499 (1943); Bradford v. Commissioner, 796 F.2d 303">796 F.2d 303, 307-308 (9th Cir. 1986), affg. T.C. Memo. 1984-601; Gajewski v. Commissioner, 67 T.C. 181">67 T.C. 181, 200 (1976), affd. without published opinion 578 F.2d 1383">578 F.2d 1383 (8th Cir. 1978). This and other courts frequently list various factors or "badges of fraud", but such lists of various kinds of circumstantial evidence from which fraudulent intent can be inferred are nonexclusive. Bradford v. Commissioner, supra; Meier v. Commissioner, 91 T.C. 273">91 T.C. 273, 297-298 (1988). The fact finder must weigh all of the evidence in the record. While not a checklist, some of the factors this Court has considered as indicative of fraud are: (1) an understatement of income; (2) inadequate records; (3) implausible or inconsistent explanations of behavior; (4) concealment of assets; (5) failure to cooperate with tax authorities; (6) engaging in illegal activities; and (7) 215 dealing in cash. Meier v. Commissioner, 91 T.C. at 297-298 (citing Bradford v. Commissioner, 796 F.2d at 307-308). In this case, one of the taxpayers, Trawlers, is a corporation and the requisite fraudulent intent must be found in the acts of its officers and shareholders. Loftin and Woodard, Inc. v. United States, 577 F.2d 1206">577 F.2d 1206, 1244 (5th Cir. 1978); American Lithofold Corp. v. Commissioner, 55 T.C. 904">55 T.C. 904, 925-926 (1971); Benes v. Commissioner, 42 T.C. 358">42 T.C. 358, 382 (1964), 14 affd. without opinion 355 F.2d 929">355 F.2d 929 (6th Cir. 1966), cert. denied 384 U.S. 961">384 U.S. 961 (1966); Ace Tool & Eng., Inc. v. Commissioner, 22 T.C. 833">22 T.C. 833, 843 (1954). It is proper to attribute to the corporation the fraudulent acts of the majority shareholder when those acts are "in substantial part for the tax benefit of, and intended to be for the tax benefit of, * * * [the corporation]." Ruidoso Racing Association, Inc. v. Commissioner, 476 F.2d 502">476 F.2d 502, 507 (10th Cir. 1973), affg. in part, remanding in part T.C. Memo. 1971-194. 216 Looking at the entire record, we find both petitioner O'Neal and petitioner Trawlers liable for the additions to tax for fraud. The record is replete with evidence of intent to conceal income and evade the payment of tax. "Once a taxpayer has taken control of funds diverted from a corporation and then fails to report such funds as income or to make any adjustment in the corporate books to reflect a return of capital, that is sufficient to imply willful intent to evade taxes." United States v. Thetford, 676 F.2d 170">676 F.2d 170, 175 (5th Cir. 1982), cert. denied 459 U.S. 1148">459 U.S. 1148 (1983). Aside from circumstantial evidence, there is evidence of fraudulent intent from O'Neal's own mouth in conversations with Thompson. On January 19, 1982, in a secretly taped conversation with Thompson, O'Neal stated as follows: O'Neal: And you know, you know that, I ah ah that's not saying nothing about the the cash money and the other things that was happening. Now the cash money we split an, I don't think it that that's gonna come up, it hasn't been mentioned and I, and I'm not gonna mention it. Cause that's, that's dangerous, too. Thompson: Yeah, it damn sure is, 217 O'Neal: That's dangerous Thompson: that, that's one thing bothers me the the ah the cash that we took in and O'Neal: Well now Thompson: ah out . . . O'Neal: I don't, I don't really think that's gonna come up. That hadn't been mentioned and I'm sure as hell not gonna mention anything and shouldn't be mentioned. Thompson: No. O'Neal: Because ah that's dangerous as hell and ah ah not only is it taxable, that that is dam, that is penitentiary. Thompson: Right. O'Neal: That's, that's pure old income tax evasion.On March 18, 1982, the following conversation took place: O'Neal: IRS is coming in here, ah, IRS is coming in here Monday, done called me and told me and ah they did a routine audit but now they they got all this information of so much cash, and I'm just gonna tell 'em that (inaudible) only cash coming in here is is going in the bank and and I really don't know that they'll find too much of that, of the cash (inaudible) The only thing that I. . . . Thompson: They shouldn't be able to find any. O'Neal: Only thing that I've considered bringing out or revealing would be the sixty-one thousand dollars we gave Smeaton (pause) ah to show where218 some of that cash went. Thompson: But . . . O'Neal: We gave him sixty-one thousand. Thompson: how how can you prove that you gave him the sixty-one and we didn't keep it? O'Neal: Because I've got, I've got a letter. I've got a letter from Luedke to him and it's involved in it.This refusal to cooperate with respondent and the statements of O'Neal indicating his intent to conceal sources of cash are indicative of fraud. Stringer v. Commissioner, 84 T.C. 693">84 T.C. 693, 715 (1985), affd. without published opinion 789 F.2d 917">789 F.2d 917 (4th Cir. 1986). In another taped conversation with Thompson on July 21, 1982, O'Neal discussed his prior testimony before a grand jury. That testimony was designed to conceal the receipt of cash payments on behalf of the corporation. O'Neal: * * And ah (pause) course they catch ya lying they'll put your ass in jail for perjury and then. . . . Thompson: Yeah. O'Neal: then you've had it. I just wanted to make you aware if you're called that's, that was my answer, and I told him, I said no sir, the only thing that ah eh that we have done some cash business and it's all been recorded.During a later219 part of the same conversation, it becomes even more apparent that O'Neal was concealing the unreported cash. Thompson: That that kinda scares me about that Grand Jury -- they checking on the cash. O'Neal: Well. . . . Thompson: Son of a bitch. O'Neal: that that's the main reason I wanted to tell ya so you can be aware. Thompson: How can they, how can they trace that that cash that we took? How can they trace that? O'Neal: I I don't think there's anybody out there that ah, I don't know that they can. (Pause) But they're aware of some things going on from the people we've dealt with . . . Thompson: Uh uh. O'Neal: Such as namely Woody Moore. They . . . Thompson: Right. Has (O'Neal inaudible) has Woody Moore said that he gave us cash? O'Neal: I have no idea. Don't think he has because he's just like we are -- he's got to hide it if he can. I don't think he has. * In late 1980 or early 1981, Ida Wheeler and Jerry Thompson destroyed the records of Woody Moore's cash dealings with Trawlers. Thompson and O'Neal were acting together to conceal income for their own benefit as well as for the benefit of the corporation. Moreover, O'Neal's knowledge220 of the destruction of Moore's records is apparent from the following conversation concerning respondent's investigation of unreported cash: O'Neal: But I don't know where they got the information than ah only out of these records. Thompson: Well, Woody . . . O'Neal: Thought that was taken care of. The willful and intentional destruction of business records designed to conceal income is evidence of fraud. Spies v. United States, 317 U.S. 492">317 U.S. 492, 499 (1943); Stringer v. Commissioner, 84 T.C. at 715. Moreover, Trawlers' records were consistently altered and falsified for both tax and nontax reasons. The failure to keep complete and accurate records of income is further evidence of fraud. Grosshandler v. Commissioner, 75 T.C. 1">75 T.C. 1, 20 (1980). "Consistent and substantial understatement of income is evidence of fraud, as are inadequate or nonexistent records." Wilson v. Commissioner, 76 T.C. 623">76 T.C. 623, 633 (1981). A substantial understatement of income over the course of several years exists with respect to both the corporate and the individual petitioners in this case. Between 1976 and 1981, Trawlers221 failed to report well over $ 1.7 million in cash receipts. O'Neal received a sizable portion of this money, yet failed to report any of it as income. We find that respondent has carried her burden and thus sustain the section 6653(b) additions to tax for fraud for both Trawlers and O'Neal for the pertinent taxable years. To reflect the above holdings and concessions by the parties, Decisions will be entered under Rule 155. APPENDIX I Trawlers' Unreported Cash IncomeFYE 6/30/791.Archie "Woody" MooreCash Received1979-"Belfast Lady I" $ 90,000.00 1979: $ 110,000/2 Maintenance on "Carl Moore" and "Lady Lisa" 55,000.00$ 145,000.00Amts. reported by Trawlers12/08/78$ 2,000.00 1/17/79 37,960.004/10/79 15,225.00$ 55,185.00 Total Unreported Cash:$ 89,815.00 2.Ken KikenCash Received1979: $ 170,000/2--work on "Freddie J" $ 85,000.00 1979 (maintenance) 200,000/6 months 100,000.00fuel (2 boats--1979) 20,000.00$ 205,000.00Amts. reported by Trawlers0Total Unreported Cash:$ 205,000.003.Gene CulmerCash Received$ 100,000/4 yrs. $ 25,000.00 Cash reported by Trawlers1/31/79 $ 2,000.00 1/31/79 2,000.00$ 4,000.00 Total Unreported Cash:$ 21,000.00 4.William "Billy" WellsCash Received$ 200,000/4 years $ 50,000.00 Cash Reported0 Total Unreported Cash:$ 50,000.00 5.Vending MachinesCash Received$ 20,000/108 months $ 185.19/mo x 12 $ 2,222.28 Total Unreported Cash: $ 368,037.28(Corporate Expenditures)1.12 trucks/4 years @ $ 700 per truck ($ 2,100.00) 2.6 paintings/3 years @ $ 300 per painting (600.00) Unreported income: $ 365,337.28FYE 6/30/801.Archie "Woody" MooreCash Received1979: $ 110,000/2 $ 55,000.00 Feb. 1980--"Belfast Lady II" and "Lady Lisa II" 140,000.00$ 195,000.00Amts. reported by Trawlers8/16/79 $ 508.80 Total unreported cash$ 194,491.202.Ken KikenCash Received1980: "Elizabeth Ann" $ 75,000.00 1979: $ 170,000/2 "Freddie J" 85,000.001979 (maintenance) $ 200,000/2 100,000.001979/1980--extras on "Miss Suzanne" 100,000.001980 (maintenance) $ 200,000/2 100,000.00fuel (3 boats) 30,000.00$ 490,000.00Amts. reported by Trawlers8/21/79 $ 2,000.00 4/04/80 37.50$ 2,037.50 Total Unreported Cash:$ 487,962.503.Gene CulmerCash Received$ 100,000/4 yrs. $ 25,000.00 Cash reported by Trawlers2/12/80 $ 22,533.00 Total Unreported Cash:$ 2,467.00 4.William "Billy" WellsCash Received$ 200,000/4 years $ 50,000.00 Cash Reported0 Total Unreported Cash:$ 50,000.00 5.Scrap MetalCash Received$ 21,000/17 months per month $ 1,235.30 8/79 - 6/80 $ 13,588.30 Cash Reported0 Total Unreported Cash:$ 13,588.30 6.Vending MachinesCash Received$ 20,000/108 months $ 185.19/mo x 12 $ 2,222.28 Total Unreported Cash:$ 750,731.28(Corporate Expenditures)1.12 trucks/4 years @ $ 700 per truck ($ 2,100.00) 2.6 paintings/3 years @ $ 300 per painting (600.00) Unreported income $ 748,031.28222 APPENDIX II O'Neal's Unreported Cash Income19791.Archie "Woody" MooreCash Received1979-" Belfast Lady I" $ 90,000.00 1979-maintenance on "Carl Moore" and "Lady Lisa" 110,000.00$ 200,000.00Amts. reported by Trawlers1/17/79 37,960.004/10/79 15,225.008/16/79 508.80$ 53,693.80 Total Unreported Cash:$ 146,306.202.Ken KikenCash Received1979 "Freddie J" $ 170,000.001979 (maintenance) 200,000.00fuel (2 boats) 20,000.001979-extras on "Miss Suzanne" $ 100,000/2 50,000.00$ 440,000.00Amts. reported by Trawlers8/21/79 $ 2,000.00 Total Unreported Cash:$ 438,000.003.Gene CulmerCash Received$ 100,000/4 yrs. $ 25,000.00 Cash reported by Trawlers1/31/79 $ 2,000.00 1/31/79 2,000.00$ 4,000.00 Total Unreported Cash:$ 21,000.00 4.William "Billy" WellsCash Received$ 200,000/4 years $ 50,000.00 Cash Reported0 Total Unreported Cash:$ 50,000.00 5.Scrap MetalCash Received$ 21,000/17 months per month $ 1,235.30 8/79 - 12/79 $ 6,176.50 Cash Reported0 Total Unreported Cash:$ 6,176.50 Total Unreported Cash: $ 661,482.70 (Corporate Expenditures)1.12 trucks/4 years @ $ 700 per truck ($ 2,100.00) 2.6 paintings/3 years @ $ 300 per painting (600.00) $ 658,782.70 1/2 Unreported Cash: $ 329,391.35 19801.Archie "Woody" MooreCash ReceivedFeb. 1980-"Lady Lisa II" and "Belfast Lady II" $ 140,000.00Amts. reported by Trawlers1980 0 Total Unreported Cash:$ 140,000.002.Ken KikenCash Received1980-"Elizabeth Ann" $ 75,000.00 1980 (maintenance) 200,000.00fuel (3 boats) 30,000.001980-extras on "Miss Suzanne" $ 100,000/2 50,000.00$ 355,000.00Amts. reported by Trawlers4/4/80 $ 37.50 10/6/80621.16$ 621.16 Total Unreported Cash:$ 354,341.343.Gene CulmerCash Received$ 100,000/4 yrs. $ 25,000.00 Cash reported by Trawlers2/12/80 $ 22,533.00 Total Unreported Cash:$ 2,467.00 4.William "Billy" WellsCash Received$ 200,000/4 years $ 50,000.00 Cash Reported0 Total Unreported Cash:$ 50,000.00 5.Scrap MetalCash Received$ 21,000/17 months per month $ 1,235.30 1/80 - 12/80 $ 14,823.60 Cash Reported0 Total Unreported Cash:$ 14,823.60 6.HemmingwayReceived $ 90,000;to Smeaton $ 61,000 Total Unreported Cash:$ 29,000.00 Total Unreported Cash: $ 590,631.94 (Corporate Expenditures)1.12 trucks/4 years @ $ 700 per truck ($ 2,100.00) 2.6 paintings/3 years @ $ 300 per painting (600.00) $ 587,931.94 1/2 Unreported Cash Total 1980 Amount $ 293,965.97 *223 Footnotes1. All of the nonfraud issues have been settled in the cases at both docket numbers, including the so-called Meyerhoff/"The Moose" issue, which was severed and tried in a separate trial. Stipulations of Settled Issues have been filed in both docket numbers to reflect the settlements. ↩2. Petitioners O'Neal have conceded the innocent spouse issue under sec. 6013(e). However, respondent did not determine a fraud addition with respect to petitioner Pearl W. O'Neal.↩3. Jerry D. Thompson was originally a petitioner in this consolidated case, but settled his case after the trial. ↩4. Jerry D. Thompson was not related to Joseph T. Thompson or to John Marcus Thompson, who is referred to later in these findings of fact.↩5. Occasionally she was not available and other individuals would prepare the deposit slips.↩6. See generally 31 C.F.R. sec. 103.22 (1979)↩.7. On Sept. 21, 1981, Moore pled guilty to one count of importing marijuana, in violation of 21 U.S.C. sec. 952(a), two counts of attempted income tax evasion, in violation of 26 U.S.C. sec. 7201, and one count of engaging in a conspiracy to defraud the United States by impeding the functions of the Internal Revenue Service, in violation of 18 U.S.C. sec. 371↩.8. Thompson had personal knowledge that Culmer was engaged in drug smuggling.↩9. O'Neal testified later in the trial that he did not report this money because he did not intend to keep it. At his change of plea hearing on March 18, 1983, however, O'Neal admitted that he did intend to keep this money.↩10. That explanation is at odds with his testimony in this Court that he was keeping the $ 35,500 as "evidence" and that he was conducting his own little investigation of Thompson. O'Neal's efforts to explain away his incriminating statements in the taped conversations with Thompson as part of his purported personal investigation of Thompson were wholly incredible. The Court did not believe him.↩11. We note that the plea agreement between Thompson and the United States does not encompass immunity from civil tax liability. The agreement specifically provides that it "does not restrict the right of the Internal Revenue Service to make any proper civil collection of taxes owed, if any." While Thompson settled his case after the consolidated trial, at the time he testified in this case, he had a strong financial motive to try to minimize the amount of unreported cash income he diverted from Trawlers and split with O'Neal.↩12. Cf. Alisa v. Commissioner, T.C. Memo. 1976-255↩.13. Some undetermined amount of unreported corporate income was used for travel expenses of the officers. However, the officers, O'Neal and Thompson, also received constructive dividend income in the form of personal use of corporate vehicles. These amounts are relatively small and we treat these items as a wash.↩14. Another holding in the Benes case in regard to constructive dividends has been overruled by this Court in Truesdell v. Commissioner, 89 T.C. 1280">89 T.C. 1280, 1301 (1987). That is unrelated to the principle for which Benes↩ is cited herein.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621079/	HENRY L. BURKART, JR. AND MARGARET B. BURKART, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBurkart v. CommissionerDocket No. 5696-83.United States Tax CourtT.C. Memo 1984-429; 1984 Tax Ct. Memo LEXIS 239; 48 T.C.M. (CCH) 867; T.C.M. (RIA) 84429; August 13, 1984. Henry L. Burkart, Jr., for the petitioners. Janice C. Taylor, for the respondent. KORNERMEMORANDUM FINDINGS OF FACT AND OPINION KORNER, Judge: Respondent determined deficiencies in income tax and additions to tax against petitioners for the calendar years 1979 and 1980 as follows: ADDITIONS TO TAX 1YEARSINCOME TAXSECTION 6651(a)SECTION 6653(a)1979$2,053.0019801,227.00$306.75$256.85240 Ptitioners, husband and wife, filed joint Federal income tax returns for the years 1979 and 1980. Their joint return for the year 1979 was timely filed, and their 1980 return was filed on December 28, 1981. At the time the petition herein was filed, petitioners resided at Metairie, Louisiana. After concessions, the following issues remain for us to resolve: (a) Medical expenses claimed by petitioners for the year 1979 in the amount of $2,466.62. (b) A net farm loss of $4,259 in the year 1979, resulting from numerous claimed farming expenses and depreciation on equipment in that year. (c) A casualty loss of $3,500 claimed by petitioners for the year 1980. (d) Claimed charitable contributions of $520 for the year 1980. (e) Additions to tax under section 6651(a) for 1980. (f) Additions to tax under section 6653(a) for 1980. (g) Claimed overpayments by petitioners in the amounts of $2,120 for 1979 and $1,850.70 for 1980. 2241 For convenience and ease of understanding, our findings and opinion as to the issues will be combined. (a) Additional Medical Deductions of $2,466.62 for 1979.(b) Net Farm Loss of $4,259 in 1979.(c) Casualty Loss of $3,500 in 1980.In April of 1980, as the result of torrential rains, petitioners' farm near Poplarville, Mississippi, where they then maintained their home, was flooded. Most of the ground was covered with water to a depth of several feet, and a utility room on the ground floor of petitioner's house where he kept his various business records was badly damaged. Either as the result of the flooding or subsequent cleaning out of the flooded premises, petitioner's records were lost. Petitioner Henry L. Burkart, Jr. testified in general terms as to the nature and amounts of the various items of expense making up his claimed additional medical deductions for 1979, which he testified were not compensated for by insurance, as well as the various deduction items making up his claimed net farm loss for that year, and the casualty loss to the animals, his fences and the tools and equipment on his farm. Petitioners, however, were unable to furnish any substantiation242 for any of the items of claimed expense and loss, either as to the fact or the cost basis of the assets which were claimed to have been lost in the flood, the various expense items in connection with petitioners' farming operations, or their claimed medical expenses. While we believe that petitioner was honest and truthful, and was doing the best he could in the circumstances, it still remains the law that petitioners had the burden of proof on all of these items. ; Rule 142(a). Unfortunately for petitioners, they have been unable to meet their necessary burden of proof here. While we do not doubt, and respondent has conceded, that a severe flood took place at petitioners' farm in April of 1980, petitioners have not provided us with any basis upon which we could make any findings with respect to any of the claimed items of loss or expense covered by the above three issues, although we are satisfied that some loss and expenses undoubtedly occurred. Accordingly, we have no choice but to hold in favor of respondent on these three issues. (d) Charitable Contribution of $520 in 1980.Petitioner claimed an amount of $520243 for the year 1979, and also for the year 1980, as charitable contributions to his church. Petitioner Henry L. Burkart, Jr. testified that he is a practicing Roman Catholic; that he attended church every week either at Poplarville, Mississippi, or in one of several churches in New Orleans, Louisiana; that he always made his contributions to the collection plate by cash, either in the amount of $5 or $10; and that he never asked for nor received any receipts for such contributions. Respondent, while allowing the claimed contributions for 1979, has disallowed them for 1980, although there appears to be no difference in the factual pattern involved. Respondent's different attitude with respect to the two years is not otherwise explained. We found petitioner to be honest and credible, and his testimony with respect to these contributions was entirely circumstantial and reasonable. Although concededly petitioner had no canceled checks, receipts or other physical evidence of the claimed contributions, we bear in mind that no issue was raised with respect to the identical contributions in 1979. We are satisfied that petitioner did attend church in 1980 and that he did make contributions. 244 Doing the best we can, considering the testimony which was presented, and bearing in mind that petitioner was somewhat vague about whether his weekly contributions were $5 or $10, we find that petitioner made weekly contributions of $5 to his church during 1980, for a total of $260. . (e) Additions to Tax For 1980 Under Section 6651(a).The statutory deadline for the filing of petitioners' income tax return for 1980 was on or before April 15, 1981. Section 6072(a). The parties have stipulated that petitioners' 1980 return was not filed until December 28, 1981. Petitioner Henry L. Burkart, Jr. honestly and candidly admitted that the return was filed late and that he had no excuse for so doing. Since no reasonable cause for late filing has been shown, we must sustain respondent's determination of additions to tax for this year under section 6651(a). (f) Additions to Tax Under Section 6653(a) for 1980.Respondent determined that petitioners' underpayment of tax for 1980 ". . . is due to negligence or intentional disregard of rules and regulations." Respondent accordingly proposed a five percent addition245 to tax under the provisions of section 6653(a). Although the basis for such determination is not explicit in respondent's statutory notice, it is apparent to the Court, from reading the record as a whole, that respondent's determination was based upon petitioner's alleged failure to keep proper books and records for 1980, from which his income and deductions could be determined. Although petitioners bear the burden of proof to show that they were not negligent, as determined by respondent, , the parties have stipulated that petitioners' farm in Poplarville, Mississippi, was badly flooded in April 1980, and we believe petitioner's testimony that his books and records were lost in that flood. Accordingly, although this disaster does nothing to aid petitioner in his burden of proof with regard to the challenged deductions, which are the first three issues discussed above herein, we accept petitioner's testimony that he did have such books and records, and that their loss was not due to any negligence on his part. We therefore think that petitioners have adequately shown that they were not negligent for the year 1980, within*246 the meaning of section 6653(a), and respondent's determination on this point is not approved. Decisions will be entered under Rule 155.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect in the years in issue, and all Rule references are to the Rules of Practice and Procedure of the Tax Court, except as otherwise noted.↩2. Although so stated in petitioners' petition herein, no ground for such claimed overpayments are stated, and no reference to them was made in the stipulation filed by the parties, in the parties' opening statements, nor in any evidence adduced at trial. We accordingly deem these issues to be abandoned by petitioners.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621080/	Kathryn E. T. Horn, Petitioner, v. Commissioner of Internal Revenue, RespondentHorn v. CommissionerDocket No. 5612United States Tax Court5 T.C. 597; 1945 U.S. Tax Ct. LEXIS 102; August 17, 1945, Promulgated 102 Decision will be entered for the respondent. Petitioner is the life beneficiary of a testamentary trust. The trust corpus included an undivided interest in certain real estate owned by testator at his death. During the years 1929 to 1940 the expenses of the trust incident to this real estate exceeded the income therefrom by approximately $ 6,500. These excess expenses were deducted from the other trust income before distributions were made to petitioner. In 1940, in an accounting of the trust and at the request of petitioner, the court having jurisdiction over the trust ordered that $ 6,500 (representing this accumulated excess of expenses over income) be awarded from trust principal to trust income, and thereupon awarded the trust income, increased by the $ 6,500 to petitioner, who received payment thereof from the trust in 1940. Held, this $ 6,500 is includible in petitioner's gross income for the year 1940. Walter T. Fahy, Esq., for the petitioner.William H. Best, Jr., Esq., for the respondent. Kern, Judge. KERN 597 In this proceeding respondent has determined a deficiency in petitioner's income tax for the year 1940 in the sum of $ 1,280.69. This deficiency arises by reason of respondent's determination that a certain payment made to petitioner during that year by the trustees of a testamentary trust created by her deceased husband should be included in her gross income for the taxable year.598 FINDINGS OF FACT.The parties have filed herein a stipulation of facts. We find them to be as stipulated and set out below those facts necessary for an understanding of the issue here presented.Franklin S. Horn, the husband of petitioner, died testate on April 15, 1928. By his will, which was duly probated in Philadelphia County, Pennsylvania, he named the petitioner and104 one John C. Tracy as executors and trustees. To them he devised and bequeathed the residue of his estate remaining after the payment of his funeral expenses, masses for the repose of his soul, and a bequest of personal belongings to his wife. This residue was to be held in trust and the net amount of the income therefrom was to be paid pursuant to the will to petitioner during her life. Upon her death certain specific bequests were to be paid to numerous legatees out of principal, and the balance of the principal was to be divided among three charities. Among the properties of which decedent died seized was an undivided 7/36 interest in certain real estate located at 1515 Arch Street, Philadelphia, Pennsylvania.On March 1, 1929, the first account of the executors was filed. On May 1, 1940, the executors and trustees under decedent's will filed with the clerk of the Orphans' Court of Philadelphia County, Pennsylvania, the account of the trust created under the will, and this account was duly called for audit on June 30, 1940. In the account it was indicated that the expenses incident to the real estate above described from the period 1929 to June 30, 1940, inclusive, exceeded105 the income therefrom in the amount of $ 6,483.46, as follows:RentsYearreceivedExpenses1929$ 473,25$ 1,165.7119309.64850.5819318.751,064.3319322.32734.601933313.96664.43193435.00616.06193535.00772.441936204.17545.051937$ 221.67$ 502.471938221.66493.701939221.67507.431940none313.75Total1,747.098,230.551,747.096,483.46The account also indicated that during that period of time the excess of expenses over income with regard to this property had been deducted by the trustees from the other income of the trust estate which was distributable to petitioner under decedent's will.On June 6, 1940, an adjudication upon the trustee's account was filed by the presiding judge of the Orphans' Court of Philadelphia County. The pertinent parts of this adjudication are as follows: * * This account is filed to determine the right of the life beneficiary to have carrying charges of non-productive real estate charged against principal.599 The widow and life tenant requests that carrying charges of a 7/36ths interest in premises 1515 Arch Street for the time since the decedent's death and amounting106 to $ 6,483.46 should be charged to principal instead of income. This sum represents the excess cost of carrying the property, chiefly taxes, over and above the income therefrom. The persons interested in opposition to request are the pecuniary legatees who are to be paid at her death, and the three charities. All have had notice of the audit and make no objection. The remainder of the estate was stated at the audit to be valued at $ 300,000.00 and it appears that the money legacies, listed in the petition for distribution, approximate $ 47,000.00. The real parties in interest would therefore appear to be the three charities (interested at the widow's death after the legatees), which expressly agree. Under the authority of Develon's Estate, 26 D. & C. 19, Levy's Estate, 333 Pa. 440">333 Pa. 440, and Mark's Estate, 2598 of 1932, the request is granted. * * There was no objection to the account which shows a balance of principal personalty of $ 53,181.34, and a deficit real estate principal of $ 5,993.39, which, composed as indicated, less one-half costs of this accounting (counsel fee $ 750.00), filing fee $ 125.00, and 107 affidavits $ .75, total $ 875.75), or $ 437.87, is awarded: $ 6,483.46 to income in reimbursement of overdraft re premises 1515 Arch Street, as above, and the balance to the accountant in trust for the uses and purposes of the will.The account of income shows a balance of income personalty of $ 5,968.15, income 1225 Market Street of $ 51,312.76; income 304 East Baltimore Street of $ 58,533.68; which balances, with income to date of payment, less one-half costs of this accounting as above, $ 437.88, together with award from principal, $ 6,483.46, in reimbursement of deficit re 1515 Arch Street, is awarded to Kathryn E. T. Horn, subject to distribution properly made.Leave is given to execute and deliver all necessary transfers and assignments.* * * Pursuant to this adjudication the trustees of the decedent's estate paid to the petitioner during the taxable year the sum of $ 6,483.46, but this amount was not reported by petitioner in her Federal income tax return for that year.OPINION.The respondent has determined that the amount paid to petitioner in 1940 as beneficiary of a trust pursuant to a decree of the Orphans' Court of Philadelphia County, Pennsylvania, is includible in108 the gross income of petitioner for the taxable year 1940 under sections 22 (a) and 42 of the Internal Revenue Code. This amount represented the carrying charges of unproductive trust real estate accumulated for twelve years which had been deducted from the gross income of the trust and had therefore in that amount reduced the income distributed to petitioner, the life beneficiary, by the trust during those years. Petitioner contends that she was entitled to the amounts so deducted in each of the prior years on account of carrying charges, that therefore such amounts were in effect distributable to her in those years, and concludes that to the extent the payment made in the taxable year represents the carrying charges for prior years it is not properly includible in her gross income for the taxable year.600 The background of state law necessary to an understanding of the issue here involved is to be found in Commissioner v. Lewis, 141 Fed. (2d) 221, affirming 1 T.C. 449">1 T. C. 449. Carrying charges of unproductive trust real estate are ordinarily payable from trust income and not chargeable to principal. However, when the109 equities in the case demand a contrary rule a court of first instance in its sound discretion can so decree. See Levy's Estate, 333 Pa. 440">333 Pa. 440.In the instant case the state court having jurisdiction over the trust, in an account of the trustees and upon a request of petitioner, entered an order in 1940 awarding $ 6,483.46 from trust principal "to income in reimbursement of overdraft re premises 1515 Arch Street [the unproductive trust real estate in question]" and awarding the balance of income personalty of the trust as shown by the trustees' account plus the "award from principal $ 6,483.46, in reimbursement of deficit re 1515 Arch Street" to the petitioner, the life beneficiary of the trust.It does not appear that the petitioner made any such request before 1940. Nothing in the record suggests that if such a request had been made the equities of the case would have warranted a court in granting it. See the Lewis case, supra. Therefore, before the order entered by the Orphans' Court in 1940 we are unable to agree with petitioner that she was entitled of right to have the carrying charges of the unproductive trust real estate paid from trust*110 principal rather than trust income. Not until the state court entered this order in 1940 was the income account of the trust increased by charging these expenses against principal, and not until then were any additional payments on account of trust income distributable to petitioner. It is for that year that the total amount of the payment in question should be included in petitioner's gross income. See Theodore R. Plunkett, 41 B. T. A. 700; affd., 118 Fed. (2d) 644; Robert W. Johnston, 1 T. C. 228; affd., 141 Fed. (2d) 208.Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621081/	SIGURD A. EMERSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Emerson v. CommissionerDocket Nos. 77307, 77309.United States Board of Tax Appeals35 B.T.A. 901; 1937 BTA LEXIS 821; April 20, 1937, Promulgated 821 1. A township attorney appointed to a statutory office pursuant to statute, held an officer of the township. 2. Compensation by both retainer and fees were received as an officer of the township and although fees were approved by township committee retroactively there was no statutory requirement that compensation be fixed in advance. Held, all compensation exempt from taxation since it was received for performance of ordinary duties of a township attorney. Clark McK. Whittemore, Esq., for the petitioner. S. L. Young, Esq., for the respondent. HARRON 901 These proceedings, which have been consolidated, involve deficiencies of $117 and $86.09 in income taxes for the years 1930 and 1932, respectively. For 1930 the respondent added $5,993.53 and for 1932, $3,262.79 to the petitioner's distributive share of the income of a law partnership and the petitioner claims $4,011 of the amount added for 1930 and all of the amount added for 1932 to be exempt from Federal taxation because received by him as an officer of a subdivision of the state, the township of Hillside, Union County, New Jersey. The balance of the respondent's additions822 to the petitioner's taxable income is not in issue. FINDINGS OF FACT. The petitioner is an attorney at law of the State of New Jersey. During the tax years in question he was one of four members of the law partnership of Whittemore & McLean of Elizabeth, New Jersey. The General Act Concerning Townships of 1899, a New Jersey statute, makes provision for elective and appointive officers of townships. 902 Section 5 of that act, amended, is set forth in the margin. 1 This act also provides that the term of appointive officers shall be one year and requires the making and filing of an oath to faithfully execute the duties of the office to which appointed. In the "General Powers of Township Committees" this act further authorizes the township committee to enact ordinances for various purposes including the fixing of annual salary or compensation to be paid each person elected or appointed to any township office and the time and manner of payment. This statute is found in volume 4 of the Compiled Statutes of New Jersey, sections 5, 6, 7, 32, at pages 5571, 5572, 5585. The minutes of organization meetings of the township committee of Hillside, January 1, 1930, and January 1, 1932, show823 that the petitioner was appointed township attorney for the year 1930 on "a $500 retainer" and township attorney for the year 1932 on "a retainer $500of per annum and fees." Petitioner subscribed and filed an oath to perform all duties of the office of township attorney for both years. The petitioner during the two years involved handled all the legal matters of the township of Hillside. He attended all meetings of the township committee, the board of health, the adjustment board, and all subordinate boards of the township; 824 prepared all contracts regarding construction of improvements in the township; prepared all ordinances pertaining to improvements, regulations, licenses; prepared all resolutions of the township committee; advised the township committee or any officer of the township on legal questions referred to him; rendered opinions to the tax collector, the tax assessor, and the zoning adjustment board; advised the assessment commissioner and handled tax appeals; and in 1932 represented the township in court proceedings in a certiorari tax suit instituted to review a proceeding before the township committee. No other attorney was employed by the township. The township of Hillside did not own or operate any public utilities. Frequently the officials of the township would call upon the petitioner for legal opinions without any formal request by the township committee. Citations in litigation against the township were sometimes forwarded directly to the petitioner by the township clerk before they came to the attention of the township committee and he would prepare the case immediately before the meeting of the township 903 committee. In matters of litigation the township committee825 would take whatever action the petitioner suggested. The petitioner was paid by the township a retainer of $500 a year both in 1930 and 1932 as compensation for attending meetings of the township committee, board of health, and subordinate boards. For the balance of his services to the township he submitted vouchers in whatever amount he thought reasonable, and they were always paid as a matter of course. This additional compensation amounted to $7,182 in 1930 and $2,762.79 in 1932. The petitioner's total receipts of $7,682 and $3,262.79 from the township of Hillside in 1930 and 1932, respectively, were deposited in the partnership bank account. The petitioner was engaged in private law practice and did not devote all his time to the work of the township. He did much of the work of the township at his own offices with the assistance of employees of the partnership. The partnership allocated its office expenses between its public and private work. The petitioner was entitled to one-fourth of the net income of the partnership. OPINION. HARRON: On the pleadings petitioner raises an issue with respect to the bar of the statute of limitations against the assessment of826 a deficiency for both of the taxable years involved. This contention appears to have been abandoned but in any case it must fail in the absence of evidence showing the date on which the petitioner's returns were filed. Fremont Canning Co.,17 B.T.A. 484">17 B.T.A. 484; Mary G. Iba,20 B.T.A. 222">20 B.T.A. 222. The remaining issue in these proceedings is whether petitioner's compensation as township attorney for the township of Hillside, New Jersey, in 1930 and 1932 is exempt from Federal income tax under the constitutional immunity of officers of state instrumentalities from Federal taxation. Petitioner contends that he was an officer of a political subdivision of the State of New Jersey. We agree that the petitioner was an officer of the township of Hillside. Under the Township Act of New Jersey, a township attorney is specifically designated as one of the "appointive township officers" to be appointed by the township committee. Pursuant to the statute the township committee duly appointed the petitioner to that office by official resolution. He took the oath of office which the statute requires of all officers whether elective of appointive. 827 His term was fixed by statute at one year and he handled all the legal business of the township during his two terms of office. It is conceded by the respondent that in all of his work for the township the petitioner was engaged in the performance of essential governmental functions. The case of Halsey v. Helvering, 75 Fed.(2d) 234, 904 held that a township engineer in New Jersey, another of the "appointive township officers" provided for in the same section of the New Jersey Township Act involved here, was a township officer within the constitutional immunity of officers of state subdivisions from Federal taxes. On the authority of that case we hold the petitioner to be an officer of the township of Hillside. The question then arises whether the petitioner's entire compensation received from the township of Hillside was received by him as an officer and is therefore exempt from tax, or whether the fees he received over and above his retainer were for services outside of his official duties and were therefore not received by him as an officer. Where the local statutes require that the compensation of an officer be fixed in advance and shall828 not be subject to increase or diminution during his term of office, it has been held that any compensation in addition to that fixed in advance was necessarily paid under special engagements for the performance of services outside of the duties of office because of the well established principle that where the emoluments of an office are fixed no additional compensation can be paid for the performance of the required duties of office. George M. Stevens,31 B.T.A. 1035">31 B.T.A. 1035. That principle, by its terms, applies where the compensation is "fixed" in amount in advance. The compensation of this petitioner was not fixed in amount, in advance, except the retainer covering his attendance at meetings, nor does it appear from the terms of the New Jersey Township Act, or from any local decisions which we have been able to find, that the statute requires the amount of the compensation of the township attorney to be fixed in advance. Comp. Stats. of New Jersey, vol. 4, p. 5585, § 32. Cf. Smathers v. Board of Chosen Freeholders,113 N.J.L. 281">113 N.J.L. 281; 829 174 Atl. 336, where the amount of compensation was fixed after the performance of services. The Township Act apparently provides that if the amount of compensation is fixed in advance it shall not be altered so as to affect any one then in office. Potter v. Union Township,103 Atl. 78, affirming 106 Atl. 215. In the case of Halsey v. Helvering, supra, the compensation of the township engineer was fixed as to a retainer of $200 per annum, plus 5 percent of the amount of all contracts for public improvements awarded by the township during his administration. It is apparent that the amounts Halsey received above the retainer were subsequently approved by the township committee each time contracts were approved and these amounts were at a rate of 5 percent. His compensation was not fixed in advance except as to the rate and method of payment. The Court of Appeals for the District of Columbia found that all of Halsey's services were performed in execution of his duties as township engineer. In this proceeding, 905 all the service performed by petitioner were those ordinarily performed by a township attorney830 and we conclude were in the execution of his official duties. Cf. State Consolidated Publishing Co. v. Hill,3 Pac.(2d) 525 (Ariz., 1931). While no rate of compensation was fixed, as in the Halsey case, the method was clearly to pay him on a quantum meruit basis by approving payment of fees to him after services were completed. The township committee approved all the payments made to him during his two terms of office in the amounts involved here, thereby fixing his compensation retroactively. We believe this is permissive under the Township Act governing the township of Hillside, Comp. States. of New Jersey, vol. 4, p. 5585, § 32, which gives the township committee authority to fix the method of compensation as well as the compensation. See also, Smathers v. Board of Chosen Freeholders, supra, where the fixing of compensation retroactively is approved under a similar statute. It is accordingly held, following the authority of Halsey v. Helvering, supra, that in view of the pertinent statute of New Jersey governing townships, the entire compensation paid by the township to its officer, the petitioner, for831 services in execution of his duties, is properly exempt from Federal taxation. Reviewed by the Board. Decision will be entered for the petitioner.DISNEYDISNEY, dissenting: I dissent except as to the amount of the retainer received by petitioner. The appointment of petitioner was on "a $500 retainer" for the year 1930, and on "a retainer of $500 per annum and fees" for the year 1932. It seems obvious that the "fees" above the retainer were necessarily the subject, in each instance, of agreement. Agreement is contract. It seems to me therefore, that it is inescapable that as to the compensation received above the retainer the petitioner was an independent contractor. Certainly, as to said fees, his original employment did not comprise a completed contract, the amount of compensation being left undecided. If petitioner and the township had been unable to agree upon the fees, the township, so far as I can see, could have employed someone else to do the work in any particular instance; or, if petitioner had performed the services in any particular instance without previous agreement as to fees, he would have had to rely upon quantum meruit. His original832 appointment, therefore, offered no means of determining his compensation. Further contract being necessary as to all amounts except the retainer, in my opinion petitioner was an independent contractor. 906 Furthermore, his duties were not prescribed either by statute or township ordinance, and, except for the attendance of meetings of the township committee for which he was paid $500, he had no tenure of office, but each case in which he rendered service was a separate matter, subject to agreement as to payment of fees. This situation seems to me squarely to negative the essential elements of the definition of the term "officer." The very fact that the $500 was received for definite services - attendance of township committee meetings - seems to exclude the remainder of petitioner's earnings from consideration in the same category with those earned under the continuous tenure of an officer, on a fixed basis, and necessarily to leave them subject to contract in each instance. In Saxe v. Anderson,19 Fed.Supp. 21, the earnings of a special guardian and referee appointed by the court were refused exemption with the statement: "Here the taxpayer's tenure*833 and jurisdiction were limited to the case referred to him." Except as to the attendance at township committee meetings, duly compensated for by a fixed sum and contracted for a fixed period, I must apply the above language to the present petitioner. LEECH agrees with this dissent. Footnotes1. Section 5. Appointive township officers.↩ - In addition to the officers to be elected, the township committee may employ or appoint a township attorney, a township engineer, and a township building inspector, none of whom need be a resident of the township, and a township physician; no member of the township committee shall be eligible for appointment to any office that is now or hereafter may be required to be filled by said committee, except as may be otherwise expressly provided by law. Cumulative Supplement to Compiled Statutes of New Jersey, 1911-1924, Vol. 2, p. 3672. (Amending P. L 1899, Sec. 5, p. 374, Compiled Statutes, Vol. 4, p. 5571.)	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621089/	Bradford C. and Marybeth B. Bernardo, Petitioners v. Commissioner of Internal Revenue, RespondentBernardo v. CommissionerDocket No. 24694-93United States Tax Court104 T.C. 677; 1995 U.S. Tax Ct. LEXIS 36; 104 T.C. No. 33; June 20, 1995, Filed 36 An appropriate order will be issued. R filed a motion to compel production of documents. Ps objected to the production of certain documents on the grounds of attorney-client privilege, work product, or both. As to Ps' claim of privilege, R contends that, because Ps' attorneys never engaged Ps' accountant, documents prepared by and received by Ps' accountant are not privileged. As to Ps' claim of work product, R contends that documents prepared prior to the issuance of the notice of deficiency do not constitute work product because they were not prepared in anticipation of litigation. Finally, R, relying on Karme v. Commissioner, 73 T.C. 1163 (1980), affd. on other grounds 673 F.2d 1062">673 F.2d 1062 (9th Cir. 1982), contends that, by filing a petition with this Court, Ps impliedly waived both the attorney-client privilege and the protection afforded by the work product doctrine. Held, the attorney-client privilege protects communications or reports by third parties, made at the request of P, to Ps' attorneys. Held, further: The accountant was not engaged by Ps to assist their attorneys in providing them with legal advice. Consequently, 37 the attorney-client privilege does not attach to the accountant's communications to Ps' attorneys. Held, further: Documents prepared by Ps' representatives after Ps received the report of the IRS's Art Advisory Panel, but before the notice of deficiency was issued, were prepared in anticipation of litigation. Consequently, such documents constitute work product. Held, further: Ps did not impliedly waive the attorney-client privilege or the work product doctrine by virtue of filing a petition with this Court.Ps filed a motion to compel R to produce documents and to compel R to respond to Ps' interrogatories. R contends that all documents contained in the files of R's counsel have been provided to Ps except the following: (1) Internal notes of counsel; (2) draft statutory notices of deficiency that were never issued to Ps; (3) a memorandum written by an Appeals officer in response to the comments of R's counsel; (4) notes of the Art Advisory Panel concerning the fair market value of the sculpture donated by Ps. R objects to the discovery of such documents on grounds that the notes of R's counsel and the memorandum of the Appeals officer are work product; that the draft statutory38 notices are not relevant to the issues to be decided in the instant case; and that notes of the Art Advisory Panel are protected from discovery by executive privilege. Held, as to the notes of R's counsel, the draft statutory notices of deficiency and memorandum of the Appeals officer, R's objections to Ps' motion to compel are sustained. Held, further, the notes of the Art Advisory Panel are not protected from discovery by executive privilege. E. Hans Lundsten and Christopher C. Whitney, for petitioners.Powell W. Holly and Meryl Silver, for respondent. Wells. WELLS678 OPINIONWELLS, Judge: The instant case is before us on respondent's motion to compel production of documents and petitioners' motion to compel answers to interrogatories and to compel production of documents. Respondent determined deficiencies in petitioners' Federal income taxes for their taxable years 1987, 1988, and 1989, as well as additions to tax and penalties for such years.BackgroundThe facts leading up to the parties' motions to compel are summarized as follows. On their 1986 Federal income tax return, petitioners claimed a $ 593,000 charitable contribution deduction for the donation39 of a 21-foot granite sculpture entitled Omphalos 1 to the Massachusetts Bay Transportation Authority (the authority). The Omphalos sculpture was created by Dimitri Hadzi. It is currently situated in Harvard Square, Cambridge, Massachusetts. Petitioners' contribution base under section 170 2 was zero for their taxable year 1986. Petitioners claimed carryover charitable contribution deductions 679 in the amounts of $ 40,406, $ 262,355, and $ 188,057 for their taxable years 1987, 1988, and 1989, respectively.In the notice of deficiency, respondent denied the charitable contribution deductions petitioners claimed on their 1987, 1988, and 1989 Federal income tax returns on the grounds that petitioners failed to establish that they are entitled to a deduction under any40 section of the Internal Revenue Code. The notice of deficiency alternatively states that, if petitioners are able to establish that they are entitled to claim a deduction for the donation of Omphalos to the authority, the amount of the deduction petitioners are entitled to claim is limited to $ 100,000, rather than the $ 593,000 petitioners claimed on their 1986 Federal income tax return.Petitioners resided in Wakefield, Rhode Island, when the petition in the instant case was filed.Respondent's Motion To CompelRespondent filed a motion to compel the production of documents, and petitioners timely filed an objection to respondent's motion. Respondent filed a response to petitioners' objection. A hearing on respondent's motion to compel the production of documents was set, and petitioners were directed to file a response to respondent's response to petitioners' objection. Petitioners then filed a supplement to their objection, which stated that petitioners opposed the production of certain documents on the grounds that such documents are privileged, and that such documents, therefore, are not subject to discovery. As part of their supplement, petitioners submitted a privilege41 log that listed the 39 documents they are withholding from production to respondent. Subsequently, petitioners filed a second supplement listing an additional seven documents that they are withholding based upon privilege.At the hearing, petitioners offered the affidavit of Mr. Benjamin G. Paster, a partner in the law firm of Adler, Pollock & Sheehan. 3 Mr. Paster was engaged by petitioners during 680 the early 1980's to render legal advice concerning a possible donation of Omphalos to the authority. Mr. Paster provided petitioners with legal advice concerning the structure of the donation of the sculpture to the authority, and whether petitioners should claim a charitable contribution deduction on their Federal income tax return based upon that donation.42 In his affidavit, Mr. Paster states that he would not have been able to render the legal advice concerning petitioners' donation without the assistance of Mr. Kenneth J. Linsner, a professional art appraiser, and Mr. Daniel J. Ryan, a certified public accountant. As to Mr. Linsner's services, Mr. Paster states:Mr. Linsner, [was] the professional art appraiser who in early 1987 produced the appraisal of Omphalos of $ 596,000 [sic] that the * * * [petitioners] submitted to the Internal Revenue Service ("IRS") in support of the charitable deduction which * * * [petitioner Marybeth Bernardo] claimed in connection with the gifting of Omphalos, [and] it was I who first interviewed Mr. Linsner, and who engaged him on behalf of Marybeth Bernardo.The only communications which I have ever had with Mr. Linsner were with respect to the valuation of Omphalos. All of my communications with him were for the sole purpose of obtaining his best professional opinion as to the fair market value of Omphalos as to which, for lack of training and expertise, I had no opinion, either professional or personal. In turn, the sole purpose of seeking his opinion as to fair market value was to assist me in43 providing legal advice to the * * [petitioners] regarding the proposed gifting of the sculpture to the MBTA * * .During the hearing, petitioners' counsel stated that Mr. Paster did not pay Mr. Linsner's fee but that he engaged him "in the sense that he located Mr. Linsner as the professional art adviser, talked to him about the terms of his engagement and saw to the engagement of Mr. Linsner". In his affidavit, Mr. Paster states that he expected that his communications with Mr. Linsner would be kept confidential, and that, to the best of his knowledge, Mr. Linsner has kept such communications 681 confidential. Mr. Paster acknowledged sharing the substance of those communications with petitioners and Mr. Ryan.During the hearing, Mr. Ryan testified to the following facts. Petitioners engaged him to assist them with the preparation of their Federal income tax returns beginning in 1982. Mr. Ryan oversaw the preparation of petitioners' Federal income tax returns for the taxable years 1987, 1988, and 1989, the taxable years in issue in the instant case. 4 Mr. Ryan also represented petitioners during the Internal Revenue Service's (IRS's) audit of petitioners' Federal income44 tax returns for the taxable years in issue, and filed a protest with the IRS's Appeals Office. The notice of deficiency indicates that a copy of the notice was sent to Mr. Ryan in his capacity as petitioners' authorized representative.Mr. Ryan was aware that petitioners had engaged Mr. Paster to structure the donation of Omphalos to the authority. Mr. Ryan provided Mr. Paster with information regarding petitioners' Federal income tax returns. During April of 1991, the IRS notified Mr. Ryan that its Art Advisory Panel had determined that the fair market value of Omphalos was substantially less than the amount of the charitable contribution deduction petitioners claimed on their 1986 Federal income tax return. Upon receiving the notice of the Art Advisory Panel's findings, Mr. Ryan informed petitioners that he believed that they would have to legally challenge the IRS's position as to the fair market45 value of the sculpture.Mr. Ryan also provided information about petitioners' Federal income tax returns to Mr. Lawrence McCarthy III and Mr. Gerald DeMaria. Messrs. McCarthy and DeMaria are partners in the law firm of Higgins, Cavanagh & Cooney, and they represented petitioner Bradford C. Bernardo in his divorce from petitioner Marybeth Bernardo.Mr. Ryan testified that he kept all of his communications with petitioners and their attorneys confidential. Mr. Ryan was hired and paid by petitioners. Mr. Ryan never received a letter of engagement from petitioners' attorneys.682 DiscussionRule 70(b) provides that "The information or response sought through discovery may concern any matter not privileged and which is relevant to the subject matter involved in the pending case." The party opposing the production of information has the burden of establishing that the documents sought by the other party are not relevant or that they are otherwise not discoverable. Rutter v. Commissioner, 81 T.C. 937">81 T.C. 937, 948 (1983); Branerton Corp. v. Commissioner, 64 T.C. 191">64 T.C. 191, 193 (1975); Hospital Corp. of America v. Commissioner, T.C. Memo. 1994-100.46 Accordingly, petitioners bear the burden of showing that the documents sought by respondent are privileged.1. Attorney-Client PrivilegeThe attorney-client privilege "applies to communications made in confidence by a client to an attorney for the purpose of obtaining legal advice, and also to confidential communications made by the attorney to the client if such communications contain legal advice or reveal confidential information on which the client seeks advice." Hartz Mountain Indus. v. Commissioner, 93 T.C. 521">93 T.C. 521, 525 (1989) (citing Upjohn Co. v. United States, 449 U.S. 383">449 U.S. 383, 389 (1981)).Disclosure of a privileged communication may result in a waiver of the attorney-client privilege. Id. The party asserting the attorney-client privilege must prove that it has not waived the privilege. Id. Blanket claims of privilege without any allegations that the production of the documents requested would reveal, directly or indirectly, confidential communications between the taxpayer and the attorney, or without any allegations that the particular documents were related to the securing of legal advice, are insufficient47 to sustain a claim of attorney-client privilege. Zaentz v. Commissioner, 73 T.C. 469">73 T.C. 469, 475 (1979).Section 7453 provides that the Tax Court is bound by the rules of evidence applicable in a trial without a jury in the U.S. District Court for the District of Columbia. Rule 143(a); Fu Inv. Co. v. Commissioner, 104 T.C. 408">104 T.C. 408 (1995); Von Tersch v. Commissioner, 47 T.C. 415">47 T.C. 415, 418-419 (1967). The Court of Appeals for the District of Columbia "adheres to the axiom that the attorney-client privilege must be 'strictly confined 683 within the narrowest possible limits consistent with the logic of its principle.'" Linde Thomson Langworthy Kohn & Van Dyke, P.C. v. Resolution Trust Corp., 5 F.3d 1508">5 F.3d 1508, 1514 (D.C. Cir. 1993) (quoting In re Sealed Case, 676 F.2d 793">676 F.2d 793, 807 n.44 (D.C. Cir. 1982)). In Linde Thomson, the Court of Appeals for the District of Columbia held that there was no insurer-insured privilege similar to the attorney-client privilege. In reaching its decision, the Court of Appeals analyzed the "logic" of the attorney-client48 privilege "principle" as follows:The attorney-client privilege undeniably extends to communications with "one employed to assist the lawyer in the rendition of professional legal services." Supreme Court Standards 503(a)(3), 503(b), cited in United States v. (Under Seal), 748 F.2d 871">748 F.2d 871, 874, n.5 (4th Cir. 1984). In FTC v. TRW, Inc., 628 F.2d 207">628 F.2d 207, 212 (D.C. Cir. 1980), we explored the ambit of this logic. Tracing the line of cases beginning with Judge Friendly's opinion in United States v. Kovel, 296 F.2d 918">296 F.2d 918 (2d Cir. 1961), we observed that the privilege logically encompassed "reports of third parties made at the request of an attorney or client where the purpose of the report was to put in usable form information obtained from the client." [5] TRW, 628 F.2d at 212. We stressed that the critical factor for purposes of the attorney-client 684 privilege was that the communication be made "in confidence for the purpose of obtaining legal advice from the lawyer." Id. * * * We cited cases consistent with this limitation extending the attorney-client49 privilege to a psychiatrist hired by a defense lawyer to aid in an insanity defense, United States v. Alvarez, 519 F.2d 1036">519 F.2d 1036, 1045-1046 (3d Cir. 1975), to an accountant hired by an attorney to assist the attorney in giving the client tax advice, United States v. Cote, 456 F.2d 142">456 F.2d 142, 144 (8th Cir. 1972), and to an accountant who prepared a statement of a client's net worth at the attorney's request, United States v. Judson, 322 F.2d 460">322 F.2d 460, 462-63 (9th Cir. 1963). We cautioned restraint, however, lest the privilege be construed to engulf "all manner of services" that should not be summarily excluded from the adversary process. TRW, 628 F.2d at 212. [Id. at 1514-1515.]As stated above, the attorney-client privilege protects communications or reports by third parties, made at the request of the client, to the client's attorney.50 Petitioners contend that log Nos. 1-10, 12-38, and 40-46 are protected from discovery by the attorney-client privilege. During the hearing on respondent's motion to compel, respondent conceded that, absent a waiver of the privilege by petitioners, the documents listed in petitioners' privilege log as Nos. 1-9, 14, 38, and 46 are protected from discovery by the attorney-client privilege. Respondent conceded on brief that privilege log No. 39, absent a waiver, is also protected from discovery by the attorney-privilege. 6 (All documents listed in petitioners' privilege log as supplemented will hereinafter be referred to as log No. followed by its corresponding number in petitioners' privilege log as supplemented.)Many of51 the documents petitioners contend are protected by the attorney-client privilege were prepared by or sent to Mr. Ryan, a certified public accountant. 7 The attorney-client privilege is waived by any voluntary disclosure to a third party. In re Horowitz, 482 F.2d 72">482 F.2d 72, 81 (2d Cir. 1973); Chubb Integrated Sys. Ltd. v. National Bank, 103 F.R.D. 52">103 F.R.D. 52, 63 (D.D.C. 1984). Voluntary disclosure to a third party implies a waiver of all communications on the same subject. Hartz Mountain Indus. v. Commissioner, 93 T.C. at 526; Chubb Integrated Sys. Ltd. v. National Bank, supra at 63. Accordingly, 685 unless petitioners engaged Mr. Ryan to assist their attorneys in providing them with legal advice, the attorney-client privilege will not attach to Mr. Ryan's communications to petitioners' attorneys (or to their communications to him).52 The majority of petitioners' privilege claims relate to documents produced by Mr. Ryan during the IRS's audit of petitioners. Mr. Ryan was no doubt acting as petitioners' representative when he communicated with their attorneys. If, however, Mr. Ryan was petitioners' primary representative, and his communications with petitioners' attorneys were incidental to his representation of petitioners, the attorney-client privilege does not attach to such communications. 8United States v. Kovel, 296 F.2d 918">296 F.2d 918, 922 (2d Cir. 1961) ("If what is sought is not legal advice but only accounting service * * or if the advice sought is the accountant's rather than the lawyer's, no privilege exists."). In the instant case, the record shows that Mr. Ryan was performing accounting services on behalf of petitioners, and that such services included representing petitioners before the IRS. 9 If we were to allow petitioners to cloak the services of their accountant in the robe of the attorney-client privilege in the instant case merely because the accountant communicated with petitioners' attorneys during the course of an audit (an audit which the accountant was responsible53 for conducting), the privilege would be expanded beyond the parameters of its logic. Accordingly, we hold that log Nos. 13, 16-18, 20-22, 24, 26-27, 29-36, and 40-45 are not protected from discovery by the attorney-client privilege.Log No. 15 is a letter from Mr. Paster to petitioner Bradford C. Bernardo. Log No. 19 is a letter from Mr. McCarthy to petitioner Bradford C. Bernardo regarding the charitable contribution deduction claimed for the donation of Omphalos to the authority. Log No. 37 is a letter 54 from Mr. E. Hans Lundsten, a partner in Adler, Pollock & Sheehan, to Mr. Joseph Houlihan 10 regarding petitioners' Federal income tax 686 returns. Log Nos. 15 and 19 constitute privileged attorney-client communications and are not subject to discovery. Similarly, log No. 37 is also protected from discovery by the attorney-client privilege. 11Log No. 23 is a letter from Mr. McCarthy to "Jean", a secretary employed by Providence Granite Co. Log No. 25 is a letter from Mr. DeMaria to "Jean" of Providence Granite Co. Log No. 55 28 is also a letter by Mr. Ryan to "Jean" of Providence Granite Co. Jean was not petitioners' agent. Consequently, we hold that log Nos. 23, 25, and 28 are not protected by the attorney-client privilege.Log No. 10 is a letter from Mr. Paster to Mr. Linsner regarding an "estimate of course of materials for sculpture." Log No. 12 is a draft appraisal of Omphalos prepared by Mr. Linsner. Mr. Paster stated that he engaged Mr. Linsner on "behalf of petitioner Marybeth Bernardo." Mr. Linsner was under Mr. Paster's direct supervision and control. Accordingly, we find that Mr. Paster engaged Mr. Linsner to assist him in providing legal advice to petitioners and that log Nos. 10 and 12 are protected by the attorney-client privilege, absent a waiver of the privilege by petitioners.Materials provided by a taxpayer to his attorney for tax preparation purposes are intended to be disclosed to the IRS in the taxpayer's return. Consequently, under such circumstances, the taxpayer is considered to have waived the attorney-client privilege as to such information. See, e.g., United States v. Lawless, 709 F.2d 485">709 F.2d 485, 487-488 (7th Cir. 1983); United States v. Cote, 456 F.2d 142">456 F.2d 142, 144-145 (8th Cir. 1972);56 Colton v. United States, 306 F.2d 633">306 F.2d 633, 638 (2d Cir. 1962); Olender v. United States, 210 F.2d 795">210 F.2d 795, 806 (9th Cir. 1954). In the instant case, Mr. Paster engaged Mr. Linsner on behalf of petitioners, who, in turn, attached Mr. Linsner's appraisal of the fair market value of Omphalos to their 1986 Federal income tax return. 12 By disclosing Mr. Linsner's 687 appraisal on their 1986 Federal income tax return, petitioners waived the attorney-client privilege with respect to log Nos. 10 and 12. United States v. Cote, supra at 144-145; Hartz Mountain Indus. v. Commissioner, 93 T.C. at 526; Chubb Integrated Sys. Ltd. v. National Bank, 103 F.R.D. at 63.57 2. Work ProductThe work product doctrine protects documents, interviews, statements, memoranda, correspondence, briefs, mental impressions, and tangible things prepared by an attorney in anticipation of litigation or trial. Hickman v. Taylor, 329 U.S. 495">329 U.S. 495, 510-511 (1947); Hartz Mountain Indus. v. Commissioner, supra at 526-527; Branerton Corp. v. Commissioner, 64 T.C. at 198; P.T. & L. Constr. Co. v. Commissioner, 63 T.C. 404">63 T.C. 404, 408 (1974). Litigation is frequently anticipated prior to the time a lawsuit is actually commenced. To show that a document was prepared in anticipation of litigation "A litigant must demonstrate that the documents were created 'with a specific claim supported by concrete facts which would likely lead to [the] litigation in mind,' not merely assembled in the ordinary course of business or for other nonlitigation purposes." Linde Thomson Langworthy Kohn & Van Dyke, P.C. v. Resolution Trust Corp., 5 F.3d at 1515 (quoting Coastal States Gas Corp. v. Department of Energy, 617 F.2d 854">617 F.2d 854, 865 (D.C. Cir. 1980)).58 The scope of the protection provided by the work product doctrine is broader than the protection afforded by the attorney-client privilege. Id. The work product doctrine protects documents and other materials prepared in anticipation of litigation by a representative of a party, regardless of 688 whether the representative was retained by the party directly or by his attorney. See Fed. R. Civ. P. 26(b)(3) (extending protection to "documents and tangible things * * prepared in anticipation of litigation or trial by or for another party or by or for that other party's representative (including the other party's attorney, consultant, surety, indemnitor, insurer or agent)"); 13Branerton Corp. v. Commissioner, supra at 198; Carver v. Allstate Ins. Co., 94 F.R.D. 131">94 F.R.D. 131, 133 (S.D. Ga. 1982); Westhemeco, Ltd. v. New Hampshire Ins. Co., 82 F.R.D. 702">82 F.R.D. 702, 708 (S.D.N.Y. 1979), modified on other grounds Commercial Union Ins. Co. v. Albert Pipe & Supply Co., 484 F. Supp. 1153">484 F. Supp. 1153 (S.D.N.Y. 1980).59 Respondent contends that only documents prepared after the notice of deficiency was issued to petitioners were prepared in anticipation of litigation. We disagree. Once the IRS informed petitioners that its Art Advisory Panel concluded that Omphalos had a fair market value that was substantially less than the charitable contribution deduction petitioners claimed on their 1986 Federal income tax return, it was reasonable for petitioners and their representatives to anticipate litigation concerning those deductions. Log Nos. 16-22, 24, 26-27, 29-40, and 42-45 were prepared by petitioners or their representatives after the IRS informed petitioners of the Art Advisory Panel's findings. Consequently, we conclude that such documents were prepared in anticipation of litigation and are protected by the work product doctrine. 1460 689 Log Nos. 10-13 were prepared prior to the date the IRS notified petitioners of the Art Advisory Panel's findings. Consequently, we find that log Nos. 10-13 were not prepared in anticipation of litigation and are therefore not protected from discovery by the work product doctrine. Log No. 27 gives no indication as to the contents of the letter. Consequently, petitioners have failed to prove that log No. 27 is work product.Log Nos. 23, 25, and 28 are letters to "Jean", a secretary employed by Providence Granite Co., and are by Mr. McCarthy, Mr. DeMaria, and Mr. Ryan, respectively. Jean was neither petitioners' agent nor their representative. Consequently, we conclude that log Nos. 23, 25, and 28 are not work products.Respondent, relying on Radiant Burners, Inc. v. American Gas Association, 207 F. Supp. 771">207 F. Supp. 771, 776 (N.D. Ill. 1962), revd. on other grounds 320 F.2d 314">320 F.2d 314 (7th Cir. 1963), also contends that the protection afforded by the work product doctrine may only be claimed by the attorneys who actually prepared or supervised the preparation of the documents the other party is seeking to discover. Respondent argues61 that petitioners have not introduced affidavits or any other evidence showing that Messrs. DeMaria, McCarthy, and Houlihan object to production of the documents listed above. In Radiant Burners, the court merely stated that the fact that the client was a corporation did not prevent its attorney from invoking the work product doctrine. The court in Radiant Burners did not state that the attorney who actually prepared the documents sought by the discovering party was the only person entitled to claim the protection afforded by the work product doctrine. Accordingly, we find respondent's reliance on Radiant Burners to be misplaced.3. Implied Waiver of Attorney-Client Privilege and Work ProductFinally, respondent, relying on Karme v. Commissioner, 73 T.C. 1163 (1980), affd. on other grounds 673 F.2d 1062">673 F.2d 1062 (9th Cir. 1982), contends that, by filing a petition with this Court, petitioners have waived both the attorney-client privilege and work product doctrine with respect to all subjects set forth in the petition. In Karme, we held, inter alia, that the 690 documents the taxpayers sought to withhold were62 not protected by the attorney-client privilege. Our holding was based on the fact that the documents the taxpayers sought to protect did not contain legal advice or summaries of confidential communications the taxpayers made to their attorneys. Id. at 1183. We also stated that, even assuming that the documents were protected by the attorney-client privilege, the taxpayers had waived the privilege because they, along with the attorneys who structured the transactions for the taxpayers, had testified at trial about some of the transactions in issue, and, therefore, they had waived the privilege with respect to all of the transactions in issue. Id. at 1183-1184.We then stated:by taking the affirmative step of petitioning this Court for a redetermination of respondent's finding of deficiency, petitioners have waived the privilege. By challenging respondent's determination that in substance petitioners did not make an interest payment, petitioners thereby put the substance of these transactions (including all the underlying facts which petitioners claim are protected) in issue. * * * [Id. at 1184;63 citation omitted.] 15In Karme, we relied on Hearn v. Rhay, 68 F.R.D. 574">68 F.R.D. 574 (E.D. Wash. 1975), as support for our statement that a taxpayer, by filing a petition with this Court, impliedly waives the attorney-client privilege with respect to the transactions in issue. Other courts, relying on the rationale of Hearn v. Rhay, supra, have held that the attorney-client privilege is impliedly waived when the party claiming the privilege raises an issue64 as to its own knowledge, intent, state of mind, or the reasonableness of its actions, etc. When a party raises the issue of its own knowledge or state of mind as the basis for a claim or defense in an action, courts, relying on Hearn, have frequently held that such party impliedly waives the privilege as to attorney-client communications because such communications may be the only probative evidence of the party's state of mind or knowledge, and therefore, it would be unfair to the other party to deny access to such communications. See, e.g., United States v. Bilzerian, 926 F.2d 1285">926 F.2d 1285, 1292691 (2d Cir. 1991); Conkling v. Turner, 883 F.2d 431">883 F.2d 431, 434 (5th Cir. 1989); Greater Newburyport Clamshell Alliance v. Public Serv. Co., 838 F.2d 13">838 F.2d 13, 22 (1st Cir. 1988); Afro-Lecon, Inc. v. United States, 820 F.2d 1198">820 F.2d 1198, 1204 (Fed. Cir. 1987); GAB Business Servs., Inc. v. Syndicate 627, 809 F.2d 755">809 F.2d 755 (11th Cir. 1987); United States v. Exxon Corp., 94 F.R.D. 246">94 F.R.D. 246, 248-249 (D.D.C. 1981). 1665 As petitioners have yet to affirmatively raise a claim 17 that can only be effectively disproven through the discovery of attorney-client communications, we hold that petitioners have not impliedly waived the attorney-client privilege.Petitioners' Motion To CompelPetitioners served respondent with a request for the production of documents along with a set of interrogatories. Respondent timely served petitioners with a response to petitioners' request for the production of documents and a response to petitioners' interrogatories. Subsequently, petitioners filed a motion to compel the production of documents and to compel a response to their interrogatories pursuant to Rules 71(c), 72(b), and 104(b). Respondent was directed to file a response to petitioners' motion to compel at the hearing set for respondent's motion to compel discussed supra. 66 At the hearing, respondent filed an objection to petitioners' motion to compel along with a motion for a protective order.As stated above, Rule 70(b) provides that "The information or response sought through discovery may concern any matter not privileged and which is relevant to the subject matter involved in the pending case." The party opposing the production of information has the burden of establishing that the documents sought by the other party are not relevant, or that they are otherwise not discoverable. Rutter v. Commissioner, 81 T.C. at 948; Branerton Corp. v. Commissioner, 64 T.C. at 193; Hospital Corp. of America v. Commissioner, T.C. Memo. 1994-100. Accordingly, respondent bears the burden 692 of showing that the documents sought by petitioners are not relevant or privileged.Respondent contends that all documents that are contained in the files of respondent's counsel have been provided to petitioners except the following: (1) The internal notes of counsel; (2) draft statutory notices of deficiency that were never issued to petitioners; (3) a memorandum written by an Appeals67 officer in response to counsel's comments about the draft statutory notices of deficiency; and (4) two pages of notes by the Art Advisory Panel. We address each of the foregoing items separately.1. Internal Notes of CounselRespondent contends that the notes of counsel assigned to litigate the instant case are protected from discovery because they constitute an attorney's work product. The work product doctrine protects documents, interviews, statements, memoranda, correspondence, briefs and mental impressions, and tangible items prepared by attorneys in anticipation of litigation. Hickman v. Taylor, 329 U.S. at 510-511; Hartz Mountain Indus. v. Commissioner, 93 T.C. at 526-527; Branerton Corp. v. Commissioner, supra at 198. We hold that the notes of respondent's counsel are work product and are not subject to discovery.2. Draft Notices of DeficiencyRespondent contends that the draft notices of deficiency are not relevant to the issues for decision in the instant case. Under Rule 70(b) a party may seek discovery of information even if the information sought would not be admissible68 at trial as long as the information or response sought is reasonably calculated to lead to the discovery of admissible evidence. P.T. & L. Constr. Co. v. Commissioner, 63 T.C. at 414.The issues for decision in the instant case include the issue of whether petitioners are entitled to claim a charitable contribution deduction for their donation of the sculpture Omphalos to the authority, and, if so, the amount of the deduction petitioners are entitled to claim. We are not persuaded that the discovery of the draft statutory notices of deficiency would lead to the discovery of admissible evidence 693 Accordingly, we hold that respondent is not required to produce the draft statutory notices of deficiency.3. Appeals Officer's MemorandumRespondent contends that the Appeals officer's memorandum is protected from discovery by the work product doctrine. Generally, documents prepared by the revenue agents and Appeals officers during the course of an investigation are not considered to have been prepared in anticipation of litigation, and therefore, such documents are not considered work product. Branerton Corp. v. Commissioner, supra at 198.69 If, however, the document is prepared by a revenue agent or Appeals officer at the direction of an attorney, then such documents may, in certain circumstances, be prepared in anticipation of litigation. Id. According to respondent, the Appeals officer's memorandum was prepared in response to the comments of respondent's counsel concerning the draft statutory notices of deficiency. Because the memorandum was prepared in response to the comments of respondent's counsel and subsequent to the decision of the Art Advisory Panel, we hold that it was prepared in anticipation of litigation and therefore constitutes work product. Consequently, respondent is not required to provide petitioners with a copy of the Appeals officer's memorandum.4. Art Advisory Panel NotesRespondent contends that the Art Advisory Panel's notes are not discoverable because they "contain purely predecisional, deliberative statements that * * * fall directly within the governmental privilege." In P.T. & L. Constr. Co. v. Commissioner, supra at 410, we held that "executive privilege, unlike the work product doctrine, does not protect all opinions, conclusions, mental impressions, 70 and thought processes of governmental officials." Statements that a governmental official "would hesitate to make for fear of disclosure to the public" may be protected by the doctrine of executive privilege. Id. In holding that the doctrine of executive privilege is not absolute, we stated:[executive] privilege is qualified in that it recognizes there are instances in which justice will require disclosure of such material. A balancing of interests is required; the gravity of the individual's need for disclosure 694 must be weighed against the harm that disclosure may do to intragovernmental candor. [Id. at 409.]The Art Advisory Panel (panel) was first authorized by the Secretary of the Treasury in 1968, and the panel is now composed of 25 prominent art specialists and authorities who are charged with assisting the IRS in determining the authenticity and fair market value of works of art. According to 2 Audit, Internal Revenue Manual (CCH), sec. 42(16)4.2, at 7347-4, any income tax case involving a claimed value for a single work of art of $ 20,000 or more must be referred to the National Office for consideration by the panel. The panel's71 meetings are closed to the public in order to prevent the disclosure of confidential tax return information. 18 As stated above, executive privilege is designed to protect the candor of intragovernmental communications. The panel's meetings are closed to the public in order to protect the confidentiality72 of the information provided to the panel by taxpayers and not to insure the candor of intragovernmental communications. 19 Accordingly, we hold that the panel's notes concerning its valuation of Omphalos are not protected by executive privilege from discovery by the taxpayers whose appraisal is under consideration by the panel. Consequently, we hold that respondent must provide the panel's notes to petitioners.In addition to the documents listed above, respondent has not produced documents, or answered interrogatories, that "are fully responsive" to the following requests for documents or information contained in petitioners' discovery requests:(1) All documents referring, regarding, or relating to any of Dimitri Hadzi's sculptures, including but not limited to appraisals of the Art Advisory Panel regarding73 his work;695 (2) all appraisals of the Art Advisory Panel of granite sculptures since 1980;(3) all appraisals of the Art Advisory Panel of so-called monumental works of art since 1980;(4) curricula vitae of all members of the Art Advisory Panel who participated in the appraisal of Omphalos; 20(5) all documents referring to, regarding, or relating to the qualifications of Kenneth J. Linsner to render professional art appraisal advice and services;(6) all documents referring to, regarding, or relating to any art appraisals by Kenneth J. Linsner or about his art;(7) documents regarding the scope and nature of any services performed by Kenneth J. Linsner for or on behalf of the Internal Revenue Service since 1980;(8) reports since 1980 summarizing the closed meetings of the Art Advisory Panel;(9) the identity of every person who has knowledge of the value of Dimitri Hadzi's sculpture, Omphalos, or any other sculptures, including but not limited to all persons on the Art Advisory Panel, and describing in detail the knowledge of such person.74 Respondent contends that petitioners' requests are overly broad, unduly burdensome, not reasonably calculated to lead to the discovery of admissible evidence, protected by executive privilege, and constitute an attempt by petitioners to go behind the notice of deficiency. In support of respondent's contention that satisfying petitioners' requests would be unduly burdensome, respondent submitted an affidavit by Ms. Karen E. Carolan, chief of the IRS's Art Advisory Services Section and chair of the Art Advisory Panel. According to Ms. Carolan's affidavit, the panel's records are not computerized, and the panel does not index records that identify documents by artist, materials used in the art, or the size of the art. As to petitioners' requests that are not limited to the work of the panel, Ms. Carolan's affidavit states that the Commissioner keeps no central file or computerized file wherein the information petitioners seek could be readily located. According to Ms. Carolan, complying with petitioners' 696 requests "would entail making a nationwide search of all records, of all examinations, since 1980."We agree with respondent's contention that petitioners' requests are overly75 broad and unduly burdensome. Moreover, we do not believe that the furnishing of such information is reasonably calculated to lead to the discovery of admissible evidence. In light of the breadth of the search respondent would have to conduct in order to satisfy petitioners' requests, and the unlikelihood that the production of the documents sought by petitioners would lead to the discovery of admissible evidence, we hold that, with the exception of petitioners' request No. 8, respondent is not required to produce the documents or the information sought in the requests listed above. To the extent that the information sought in request No. 8 may be provided without disclosure of confidential materials, respondent is directed to provide petitioners with such information.Based upon the foregoing,An appropriate order will be issued. Footnotes1. Omphalos is the Greek word for navel.↩2. Unless otherwise stated, all section references are to the Internal Revenue Code in effect for the taxable years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩3. During the hearing, respondent objected to the introduction of Mr. Paster's affidavit into evidence on the grounds of hearsay. Petitioners' counsel informed the Court that Mr. Paster was unable to testify at the hearing because he was recovering from chemotherapy treatment and was advised by his doctor not to travel. Fed. R. Evid. 804(b)(5)↩ provides an exception to the hearsay rule for witnesses who are unavailable if the statement is offered as evidence of a material fact, it is more probative on the point for which it offered than any other evidence which the proponent can procure, and the interests of justice will be best served by admitting the statement into evidence. We find that Mr. Paster's affidavit is material to the issue of whether his communications with Messrs. Ryan and Linsner fall within the scope of the attorney-client privilege, that the affidavit is more probative than any other evidence petitioners could offer, and that the interests of justice would be best served by admitting the affidavit into evidence. Accordingly, we will admit Mr. Paster's affidavit into evidence. We note that affidavits are a staple of motions practice, particularly where the parties assert that documents are protected from discovery by the attorney-client privilege or the work product doctrine. Indeed, respondent offered the affidavit of Ms. Karen E. Carolan as support for respondent's objection to petitioners' discovery requests.4. Mr. Ryan also prepared Federal income tax returns for petitioners' wholly owned business, the Providence Granite Co.↩5. In United States v. Kovel, 296 F.2d 918">296 F.2d 918 (2d Cir. 1961), an accountant employed by a tax law firm to sit in on a client's conversations with attorneys was held properly to have exercised an attorney-client privilege when he refused to answer questions in a grand jury concerning one such conversation. The Court of Appeals for the Second Circuit drew the following distinction with respect to a client's communication with an accountant prior to consulting with an attorney:this draws what may seem to some a rather arbitrary line between a case where the client communicates first to his own accountant (no privilege as to such communications, even though he later consults his lawyer on the same matter, Gariepy v. United States, 189 F.2d 459">189 F.2d 459, 463 (6th Cir. 1951)), and others, where the client in the first instance consults a lawyer who retains an accountant as a listening post, or consults the lawyer with his own accountant present. But this is the inevitable consequence of having to reconcile the absence of a privilege for accountants and the effective operation of the privilege of client and lawyer under conditions where the lawyer needs outside help. * * [Id. at 922; fn. ref. omitted.]The Court of Appeals for the Second Circuit also stated thatWe do not deal in this opinion with the question under what circumstances, if any, such communications could be deemed privileged on the basis that they were being made to the accountant as the client's agent for the purpose of subsequent communication by the accountant to the lawyer; communications by the client's agent to the attorney are privileged. [Id. n.4; citations omitted.]The issue of who engaged the accountant or other expert (i.e., the client or the attorney) and when the accountant or expert was retained (i.e., before or after the attorney) are factors that other courts have also considered when deciding whether the accountant's or expert's input into the attorney's legal advice is entitled to protection under the attorney-client privilege. See, e.g., United States v. Judson, 322 F.2d 460">322 F.2d 460, 461-462 (9th Cir. 1963) (holding that the attorney-client privilege applied to a net worth statement prepared by accountants who were retained by the client to assist the attorney in providing legal advice); Samuels v. Mitchell, 155 F.R.D. 195">155 F.R.D. 195, 198-199↩ (N.D. Cal. 1994) (holding that it was irrelevant whether the attorney or the client engaged the expert as long as the purpose of the engagement was to provide the attorney with legal advice).6. Respondent's concession is curious in light of the fact that petitioners did not claim attorney-client privilege with respect to this document. We will treat respondent's statement on brief as conceding that document No. 39 is protected by the work product doctrine, absent a waiver by petitioners.↩7. Federal law does not recognize an accountant-client privilege. Couch v. United States, 409 U.S. 322">409 U.S. 322, 335↩ (1973).8. Conversely, if the attorney is the primary representative of the taxpayer, and the attorney-accountant communications are incidental to the attorney's representation of the client, the attorney-client privilege may attach and protect such communications from discovery. United States v. Kovel, supra↩ at 922.9. Mr. Ryan was petitioners' authorized representative during the IRS's audit of petitioners' Federal income tax returns for the taxable years in issue in the instant case.↩10. Documents in the record indicate that Mr. Houlihan is an attorney with the law firm of Corcoran, Peckham & Hayes, and that he represented petitioner Marybeth Bernardo during her divorce from petitioner Bradford C. Bernardo.↩11. Petitioners have joint representation in the instant proceeding. Consequently, we do not view the disclosure of information regarding petitioners' Federal income tax returns to Mr. Houlihan as a voluntary disclosure of privileged information to a third party.↩12. The petition in the instant case states:5. The facts upon which Petitioners rely, as the basis of Petitioners' case, are as follows:(a) On December 23, 1986, the Petitioner, Marybeth B. Bernardo, pursuant to a Deed of Gift transferred to the MASSACHUSETTS BAY TRANSIT AUTHORITY ("MBTA") title to the 21 foot granite sculpture, OMPHALOS, which had been created by the sculptor, Dimitri Hadzi. At the time of the gift the sculpture was on loan from the Petitioner, Marybeth B. Bernardo, to the MBTA and was located in Harvard Square, Cambridge, Massachusetts.* * * (c) Petitioners received an appraisal dated 20 February, 1987 from Kenneth Jay Linsner which stated, based on his academic and experiential qualifications and as a result of research conducted by him "through the collection of verifiable sales data as directed under sec. 170A-1(a)(2)(ii)(e) of the Income Tax Regulations," that the fair market value of the sculpture as of December 1986 was $ 593,000.(d) Based on the appraisal Petitioners claimed on their 1986 Joint U.S. Individual Income Tax Return a charitable gift of $ 593,000 and attached to that return IRS Form 8283, "Noncash Charitable Contribution", which described this gift and stated that the appraised value of the gift was $ 593,000. Part III of that form, entitled "Certification of Appraiser" which verified the appraised value of this gift, was signed by Mr. Linsner.↩13. We have not adopted a corresponding rule to Fed. R. Civ. P. 26(b)(3), but the explanatory note to Tax Court Rule 70(b) states:With certain exceptions and subject to the limitations of these Rules, the scope of allowable discovery under these Rules is intended to parallel the scope of allowable discovery under the Federal Rules. * * The other areas, i.e., the "work product" of counsel and material prepared in anticipation of litigation or for trial, are generally intended to be outside the scope of allowable discovery under these Rules, and therefore the specific provisions for disclosure of such materials in FRCP 26(b)(3) have not been adopted. Cf. Hickman v. Taylor, 329 U.S. 495">329 U.S. 495 (1947). [60 T.C. 1098">60 T.C. 1098↩.]14. The work product doctrine also protects documents prepared in anticipation of another trial or litigation, regardless of whether the documents are directly related to the case at bar. Wright et al., Federal Practice and Procedure, sec. 2024, at 351 (2d ed. 1994). Log Nos. 18, 22, 24, 26, 30-31, 33, and 35 are letters from Mr. McCarthy or Mr. DeMaria sent directly to Mr. Ryan or letters sent by them to other persons, with copies sent to Mr. Ryan. Log No. 44 was prepared by Mr. Houlihan. All of the documents prepared by Messrs. Ryan, DeMaria, McCarthy, and Houlihan concern the IRS's audit of petitioners' Federal income tax returns. Based on the record in the instant case, we conclude that documents produced by Messrs. Ryan, DeMaria, McCarthy, and Houlihan were prepared in anticipation of litigation; i.e., either for the instant litigation or in anticipation of any litigation that might have resulted from petitioners' divorce.↩15. In Karme v. Commissioner, 73 T.C. 1163">73 T.C. 1163 (1980), affd. on other grounds 673 F.2d 1062">673 F.2d 1062↩ (9th Cir. 1982), we did not address the issue of whether the taxpayers impliedly waived the protection afforded by the work product doctrine merely by filing a petition with this Court. Consequently, respondent's contention that petitioners waived any protection provided by the work product doctrine by filing a petition in the instant case is wholly without merit.16. Once the client impliedly waives the attorney-client privilege by raising a claim or defense that places his state of mind or knowledge in issue, the client is deemed to have waived the privilege with respect to all attorney-client communications reflecting on its state of mind or knowledge. See United States v. Exxon Corp., 94 F.R.D. 246">94 F.R.D. 246, 249↩ (D.D.C. 1981).17. The penalties determined in the notice of deficiency, although refuted in the petition, do not appear to raise any question as to petitioners' state of mind.↩18. The Annual Summary Report For 1991 Of Closed Meeting Activity Of The Art Advisory Panel Of The Commissioner Of The Internal Revenue Service states:All meetings were closed to the public by determination of the Commissioner that the substantive discussions and records of the Panel dealt with value of works of art involved in federal tax returns and are thus concerned with matters listed in section 552b(c)(3), (4), (6), and (7) of Title 5 of the United States Code. Consequently, the meetings at which such matters are discussed and the records of such meetings should not be open to the public. This is necessary to protect the confidentiality of tax returns under section 6103 of Title 26 of the United States Code↩.19. Respondent has made no attempt to demonstrate that the candor of the Art Advisory Panel's discussions will be damaged as a result of the disclosure of the panel's notes concerning its valuation of Omphalos.↩20. Respondent contends that the background and qualifications of each of the panel members who participated in the appraisal of Omphalos were included in the appraisal report already provided to petitioners.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621090/	Medical Arts Hospital of Dallas v. Commissioner.Medical Arts Hosp. of Dallas v. CommissionerDocket No. 108768.United States Tax Court1943 Tax Ct. Memo LEXIS 347; 1 T.C.M. (CCH) 935; T.C.M. (RIA) 43189; April 22, 1943347 George S. Atkinson, Esq., Dallas Nat'l Bank Bldg., Dallas, Tex., and J. R. Nelson, C.P.A., for the petitioner. Frank B. Appleman, Esq., for the respondent. OPPERMemorandum Findings of Fact and Opinion OPPER, Judge: Respondent has determined that petitioner is liable for a deficiency in its income tax for the year 1939 in the sum of $5,353.35 under section 102, Internal Revenue Code. Petitioner's liability under this section is the only issue in the case. Findings of Fact The facts stipulated by the parties are hereby found accordingly. They, together with facts found from the evidence adduced at the hearing, disclose the following: Petitioner was chartered under the laws of the State of Texas on January 5, 1938, for the purpose of "the erection, maintenance, conduct and control of a sanitarium." It took over the operation of a sanitarium or hospital which had previously been operated as the Medical Arts Diagnostic Center, Inc., in Dallas, Texas. Petitioner kept its books on the accrual basis and filed its returns with the collector of internal revenue for the second collection district at Dallas, Texas. The Cary-Schneider Investment Company, hereinafter called the Investment348 Company, was chartered under the laws of the State of Texas on January 23, 1922. Its purpose, as stated in its charter, was as follows: * * * for the erection or repair of any building or improvement, and the accumulation and loaning of money for said purposes, and for the purchase, sale and subdivision of real property in towns, cities and villages, and their suburbs not extending more than two miles beyond their limits and for the accumulation and loaning of money for that purpose. The Investment Company owns and operates a large building in Dallas known as the Medical Arts Building. In the year 1939 the building was occupied by physicians, dentists, optical offices, and related enterprises, and petitioner which operated a hospital on the 17th, 18th, and 19th floors of the building. The hospital had about 86 beds, practically all of which were in private rooms. The stock of petitioner from January 5, 1938, to December 31, 1939, was owned as follows: Dr. E. H. Cary140 sharesE. H. Cary, Jr5 sharesGeorge L. Moore5 sharesTotal150 sharesThe stock of the Investment Company on the dates indicated was owned as follows: January 1, 1938 toMay 5, 1938 toJuly 5, 1939 toMay 4, 1938July 4, 1939Dec. 31, 1939CommonPreferredCommonPreferredCommonPreferredDr. and Mrs. E. H. Cary12,5802,54011,2602,2768,8602,268* E. H. Cary, Trustee for hisfour children7,3001,4608,6201,72411,0201,732Dr. C. N. Rosser505050Dr. A. I. Folsom505050Geo L. Moore202020Total Capital Stock20,0004,00020,0004,00020,0004,000349 On January 25, 1922, the Investment Company executed a trust deed by which it assigned and conveyed to a trustee to secure a bonded indebtedness of $900,000 the land on which the Medical Arts Building was located "together with any and all buildings, improvements and appurtenances now standing, or at any time hereafter constructed or placed upon said land, or any part thereof, including all boilers, dynamos, motors, screens, curtain fixtures, window shades, wall beds, ice boxes, ranges, furnaces, vacuum cleaners, refrigerators, heating, plumbing, ventilating, gas and electric light fixtures, elevators and fittings, and machinery, appliances, plants, apparatus and fittings and fixtures of every kind in, or that shall be placed in, any building or buildings now or hereafter standing on said premises or any part thereof." At that time the construction of the Medical Arts Building was contemplated. The building was completed in 1923, an annex built in 1927, and the building was air-conditioned in 1937. In 1928 the Investment Company equipped certain space in the building350 for a diagnostic center, which later became a hospital or sanitarium. The Medical Arts Diagnostic Center, Inc., filed its charter on August 28, 1928, which declared that it was formed for benevolent and charitable purposes, "especially for the maintenance of a hospital * * * at which members of the corporation will administer to the sick, infirm and afflicted, of all creeds and nations * * ." It was provided that the corporation should exist for a term of 50 years; that it should have no capital stock; that its members were Dr. Cary, George L. Moore, and Clarice Dudley, who had been operating a hospital and diagnostic center, all of the equipment and properties of which were placed in trust by them for the charitable purpose. The Medical Arts Diagnostic Center, Inc., had no assets, kept no books, had no bank account and prior to 1938 all of its income and deductions were reported by the Investment Company. For 1937 income in the amount of $181,113.98 and deductions in the amount of $60,386.20 of the hospital were reported by the Investment Company. Depreciation on the equipment in the hospital was also claimed by the Investment Company. It paid a tax for 1937. The Medical Arts Diagnostic351 Center, Inc., was dissolved on January 5, 1938, when petitioner was chartered. Prior to 1939 the Investment Company had refinanced its bonded indebtedness created in 1922, increasing the indebtedness, giving deeds of trust on the lot and building and extending the lien securing the bonded indebtedness originally in the amount of $900,000. At the beginning of the year 1939 its indebtedness was $1,399,999.98, secured as above set out. In the year 1939 the Investment Company paid $143,333.42 on this indebtedness, leaving a balance at the end of 1939 of $1,256,666.58. The Investment Company was not in default during 1938 or 1939 on either the principal or interest due on the indebtedness. In December, 1938, petitioner purchased from the Investment Company furniture and fixtures in the hospital for the book value of $11,045.63. Petitioner paid the same rent for the three floors of the building which it occupied and used as a hospital that other tenants would have paid for the space. For the years 1938 and 1939 it paid an annual rental of $41,832.36. For 1938 and 1939 the Investment Company and petitioner each filed its own income tax returns and reported its own income. In 1938 petitioner352 advanced to the Investment Company the sum of $19,000 against which was credited the purchase price of the above-mentioned furniture and fixtures, leaving a net balance due petitioner of $7,954.37 at the end of the year 1938. In 1939 petitioner advanced the Investment Company the sum of $24,000 against which was credited the amount of $1,180.74 which consisted of collections on accounts receivable originating prior to January 1, 1938, and insurance premiums paid in 1939 by the Investment Company for petitioner's benefit, leaving a net balance due petitioner at the end of the year 1939 of $30,773.63. Both of the loans in 1938 and 1939 were made without any charge for interest and without any written evidence of indebtedness. The Investment Company placed the moneys advanced to it by petitioner in 1939 in its general bank account, together with its other funds and drew on the account to pay its obligations and expenses of every character and to make the payments which were charged to the personal account of Dr. Cary, as hereinafter related. Dr. Cary and his wife also pledged their personal assets in order to finance the building and at times borrowed money for such purposes. In financing353 the building and enterprise and in payment for the stock, there was charged from 1922 to 1938, inclusive, to Dr. Cary on the books of the Investment Company $310,090.43, composed of $260,077 cost of Investment Company stock and $68,012.69 personal withdrawals, less a net $18,000 bank advance to which reference is hereafter made. Dr. and Mrs. Cary endorsed notes of the Investment Company. In the year 1938 Dr. Cary borrowed $60,000 which was put into the bank account of the Investment Company. This amount was credited to the personal account of Dr. Cary by the Investment Company. In 1938 the company paid $42,000 of this note and charged the payments to Dr. Cary's account, leaving an unpaid balance of $18,000. In 1939 the company paid this balance. In the year 1939 Dr. Cary's personal account on the books of the Investment Company was credited with $31,224.18 and charged with $15,638.35. Mrs. Cary withdrew from the Investment Company on November 6, 1939, $4,500 which was repaid January 3, 1940. Petitioner and the Investment Company neither declared nor paid any dividends for the years ending December 31, 1938, and December 31, 1939. A summary of petitioner's profit and loss statement354 as of December 31, 1938, is as follows: Income: Patients' Accounts$197,789.00Expenses: Services to Patients: Salaries$ 45,155.75Supplies32,264.66Total$77,420.41Food36,180.56Total Service and Food cost$113,600.97General Expenses (including $41,832.36 Rent)67,751.07Total Expenses181,352.04Net Profit for 1938$ 16,436.96A summary of petitioner's profit and loss statement as of December 31, 1939, is as follows: Income: Patients' Accounts$210,946.34Coca Cola Sales134.70$211,081.04Expenses: Services to Patients: Salaries$ 44,189.79Supplies29,762.66Total$ 73,952.45Food36,507.33Total Service and Food cost$110,459.78General Expense (including $41,832.36 Rent)79,207.84Total Expenses189,667.62Net Profit for 1939$ 21,413.42A summary of petitioner's balance sheet as of December 31, 1938, is as follows: AssetsCurrent AssetsCash$ 535.78Accounts Receivable - Patients6,917.81Cary-Schneider Investment Co. general account7,954.37Lewis Taylor20.00Total Current Assets$ 15,427.96Equipment (less depreciation reserve)12,639.95Total Assets$ 28,067.91LiabilitiesCurrent LiabilitiesAccounts Payable$ 4,487.50Cary-Schneider Investment Co. Current Account717.53Income Taxes - 19382,588.57Social Security - Taxes728.99Property Taxes50.36$ 8,630.95Capital and SurplusCapital Stock$ 3,000.00Surplus - Profit 193816,436.96Total Capital and Surplus19,436.96Total$28,067.91355 A summary of petitioner's balance sheet as of December 31, 1939, is as follows: AssetsCurrent AssetsCash$ 1,183.84Accounts Receivable - Patients6,351.75Cary-Schneider Investment Co.Advance account$31,954.37Current account(1,180.74)30,773.63Total Current Assets$ 38,309.22Equipment (less depreciation reserve)11,760.81Total Assets$ 50,070.03LiabilitiesCurrent Liabilities$ 9,219.65Capital and SurplusCapital Stock$ 3,000.00Surplus - Profit 1938$16,436.96Profit 193921,413.4227,850.38Total Capital and Surplus$ 40,850.38Total Liabilities$ 50,070.03A summary of the Investment Company's profit and loss statement for 1938 is as follows: Income: Rent from Building$396,115.06Light and Water Sales3,401.11Profit - Barber Shop38.83Collections - 1937 Hospital Accounts3,363.41Total Income$402,918.41Operating Expenses: Salaries - Administrative$ 17,500.00Other Salaries58,773.98Total Salaries$ 76,273.98Other Expenses94,183.63Total Operating Expenses170,457.61Net profit from operations$232,460.80Interest, Taxes, etc.: (Including interest and discount on mortgage loans, $60,923.32 andcurrent interest and discount $7,883.54)115,766.49Net Profit Before Depreciation$116,694.31Depreciation66,441.53Net Profit to Surplus$ 50,252.78356 A summary of the Investment Company's profit and loss statement for 1939 is as follows: Income: Rent from Building$401,742.00Light and Water Sales3,712.08Profit - Barber Shop232.66Collections - Old Hospital Accounts269.65Dr. Extras1,367.86Sale of Fans902.00Coca Cola Sales171.65Total Income$408,397.90Operating Expenses: Salaries - Administrative$ 17,470.00Other61,523.09Total Salaries$ 78,993.00Other Expenses76,147.09Total Operating Expenses$155,140.18Net Profit from Operations$253,257.72Interest, Taxes, etc. (Including interest and discount on mortgage loans, $60,923.32 andcurrent interest $9,592.15)121,872.84Net Profit Before Depreciation$131,384.88Depreciation61,956.48Net Profit for Year$ 69,428.40A summary of the Investment Company's balance sheet as of December 31, 1938, is as follows: AssetsCurrent Assets: Cash$ 499.91Accounts and Notes Receivable - Tenants (less re-serve for losses)21,334.71Other Accounts Receivable1,329.29Total Current Assets$ 23,163.91Fixed Assets: Real Estate: Land and Building and Equipment Minus Depreciation1,770,734.74Other Assets18,310.52Dr. E. H. Cary - Personal Account310,090.43Total$2,122,299.60LiabilitiesCurrent Liabilities: Medical Arts Hosp. of Dallas$ 7,954.37Accounts Payable1,757.34Notes Receivable Discounted5,384.22Republic National Bank - Barber Shop Account O.D.48.31Accrued Interest - First Mortgage Loan25,000.00Accrued Interest - Indenture with Republic NationalBk.4,583.30Accrued Taxes25,756.12Maturities in 1939 on Fixed Indebtedness110,000.00Total Current Liabilities$ 180,483.66Fixed Indebtedness (After deduction of $110,000 Maturities for 1939)$1,289,999.98Endowment Fund Reserve1,000.00Capital and SurplusStock authorized and outstanding: Preferred$400,000.00Common25,000.00Total$ 425,000.00SurplusBalance - 1/1/38$175,563.18Profit and Loss (1938)50,252.78225,815.96Total Capital and Surplus650,815.96Total$2,122,299.60357 $A summary of the Investment Company's balance sheet as of December 31, 1939, is as follows: AssetsCurrent Assets: Cash$ 733.69Accounts and Notes Receivable -Tenants (less reserve for losses)13,335.56Other Accounts Receivable579.08Total Current Assets$ 14,648.33Fixed Assets: Real Estate: Land and Building and Equipment Minus Depreciation1,721,102.26Other Assets13,151.57Dr. E. H. Cary: Personal Account$ 312,504.604,500.00317,004.60Total$2,065,906.76LiabilitiesCurrent Liabilities: Accounts Payable$ 2,803.69Notes Receivable Discounted1,889.00Accrued Interest - First Mortgage Loan23,750.00Accrued Interest Indenture2,673.61Medical Arts Hospital of Dallas30,773.63Accrued Taxes26,050.84Maturities in 1940 on Fixed Indebtedness112,500.00Total Current Liabilities$ 200,440.77Fixed Indebtedness (After deduction of $112,500 Maturities for 19401,144,166.58Capital and Surplus: Stock Authorized and Outstanding: Preferred$400,000Common25,000Total$ 425,000.00Surplus: Balance - Jan. 1$225,815.96Depreciation Adjust. 19381,375.04Profit and Loss 193969,428.40$296,619.40Loss: 1938 Income Tax Adjustment319.99Surplus December 31, 1939296,299.41Total Capital and Surplus$ 721,299.41Total$2,065,906.76358 Dr. Cary and his wife filed separate income tax returns for the years 1938 and 1939, reporting their income on the community property basis. Each reported and paid a normal tax of $525.14 and a surtax of $622.81 for 1938. Each reported and paid a normal of $638.47 and a surtax of $929.80 for 1939. If petitioner had distributed its earnings and profits for 1939 as dividends, Dr. Cary and his wife each would have had to pay an additional surtax for 1939 of $1,703.22 or a total additional surtax of $3,406.44. Petitioner permitted its earnings and profits for 1939 to accumulate instead of being divided or distributed. The earnings and profits so accumulated were beyond the reasonable needs of petitioner's business. Petitioner's shareholders avoided surtax by petitioner's failure to divide or distribute its earnings and profits for 1939. Petitioner in 1939 was availed of for the purpose of preventing the imposition of surtax on its shareholders through the medium of permitting its earnings and profits to accumulate instead of being divided or distributed. Opinion Viewed realistically, the principal distinction between the present facts and those found sufficient to justify applying359 the statutory predecessor of section 102, Internal Revenue Code, in Helvering v. Chicago Stock Yards Co., 318 U.S. 693">318 U.S. 693, 87 L. Ed. 1086">87 L. Ed. 1086, 63 S. Ct. 843">63 S. Ct. 843, is their respective magnitudes. Petitioner's transactions may have been in the thousands, where those of the taxpayer in the Stock Yards case ranged into the millions; but proportionately, the relationships are similar, and there is no suggestion that mere size alone should lead to an opposite result. There are other distinctions, but we regard them as, if anything, unfavorable to the present petitioner. We are confronted here with the now familiar situation of a dominant individual who as stockholder controls different enterprises. The resources of the one are employed to advance the interests of another. But, unlike the situation in the Stock Yards case, the business connection between them here is actually insubstantial; the significance of their relationship arises rather from the common direction which they both receive. The advantage accruing to that common directing force by such an interplay between the two enterprises may be self-evident. By the same token so is the related advantage which the individual secures360 through reduction of his putative tax obligations. See Trico Products Corp., 46 B.T.A. 346">46 B.T.A. 346. In the present situation the ground assigned for accumulating petitioner's earnings is that they were needed to finance the Investment Company, an undertaking which was apparently the chief commercial pre-occupation of petitioner's principal stockholder. Again, unlike the ventures in the Stock Yards case, it is not clear that the Investment Company was actually in need of such assistance. Its financial statements indicate a prosperous, solvent, and increasingly successful enterprise, with substantial earnings which were also being industriously plowed back. But assuming that it required cash for purposes of intermediate financing, and assuming that loans from friendly sources might have been more advantageous to it than resort to usual banking channels, there is still no escape from the natural and by now stereotyped rejoinder that there was no reason for the funds to come from petitioner, rather than from petitioner's principal stockholder. Helvering v. National Grocery Co., 304 U.S. 282">304 U.S. 282, 82 L. Ed. 1346">82 L. Ed. 1346, 58 S. Ct. 932">58 S. Ct. 932; Helvering v. Chicago Stock Yards Co., supra;361 Stanton Corp., 44 B.T.A. 56">44 B.T.A. 56, 80. On the face of things, in fact, there would seem to be less. For this dominant stockholder was indebted to the Investment Company to the tune of about $50,000, a sum approximately half again as much as the total advanced by petitioner in the two years covered by this record. If that individual had received in dividends what petitioner loaned in those same years, and had in turn reduced his own obligations to the Investment Company in an equivalent amount, the books of the latter would have reflected the more favorable position of a reduction in loans receivable rather than an increase in loans payable, the Investment Company's cash position would have been identical, petitioner would have been no worse off, and the only difference in the ultimate result would have been an income tax obligation on petitioner's controlling stockholder which the present procedure eliminated. If that was the true purpose of the transaction, it goes without saying that it did not constitute a reasonable need of petitioner's business. The acknowledgment of such an object would, on the contrary, at once expose petitioner to the thrust of the362 section which respondent is seeking to invoke. Yet no other reason for the manner in which the matter was handled is suggested. For these reasons, and upon a survey of all the circumstances, we have found as a fact that petitioner's earnings and profits were permitted to accumulate in lieu of being divided or distributed, that such accumulation was beyond the reasonable needs of petitioner's business, and that this action had the purpose of preventing the imposition of surtax upon the stockholders of petitioner. It follows, of course, that respondent committed no error. Decision will be entered for respondent. Footnotes. A trust was created in 1935 by Dr. E. H. Cary and Mrs. E. H. Cary for the benefit of their four children.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621052/	Appeal of PORTLAND RAILWAY, LIGHT AND POWER CO.Portland R., L. & P. Co. v. CommissionerDocket No. 750.United States Board of Tax Appeals1 B.T.A. 1150; 1925 BTA LEXIS 2644; May 20, 1925, decided Submitted February 17, 1925. 1925 BTA LEXIS 2644">2644 Advances to an operating corporation, which corporation is not terminated by bankruptcy proceedings or otherwise, may not be deducted as worthless debts in the absence of definite and convincing proof of worthlessness. Henry A. McCarthy, Esq., for the taxpayer. A. Calder Mackay, Esq., for the Commissioner. JAMES 1 B.T.A. 1150">1150 Before JAMES, STERNHAGEN, and TRUSSELL. This is an appeal from a deficiency asserted by the Commissioner in income and profits taxes for the years 1918, 1919, and 1920, in a net sum of $14,330.50, and in amounts by years as follows: 1918 Overassessment$1,737.171919 Deficiency8,138.321920 Deficiency7,929.35Three errors are alleged by the taxpayer: 1. That the Commissioner refused to allow as deductions from income in the several years in question, respectively, $52,161, $51,710, and $51,259, being payments on account of interest and sinking fund on bonds of the Willamette Valley Southern Railway Company, dated February 2, 1914. 2. That, in the year 1920, the taxpayer suffered a loss on account of sale of capital assets in an alleged sum of $59,006.91, of which loss the Commissioner has allowed1925 BTA LEXIS 2644">2645 as a deduction $21,254.98. 3. That, by reason of a mathematical error in computation, the Commissioner has overstated the net income for the year 1920 by $20,000. The last-named allegation is admitted by the Commissioner in his 1 B.T.A. 1150">1151 answer. On the other two issues hearing was had on February 17, 1925, oral testimony taken, and documentary evidence submitted, from which the Board makes the following FINDINGS OF FACT. The taxpayer is a corporation incorporated under the laws of the State of Oregon, with its principal office in the City of Portland. Its name was, in the years in question, the Portland Railway Light and Power Company, which name has since been changed, on April 26, 1924, to the Portland Electric Power Company. During the year 1914, the Willamette Valley Southern Railway Company was constructed and, for the purpose of financing such construction, issued its capital stock, preferred and common, and its first mortgage bonds. The taxpayer entered into a joint agreement with the bondholders and trustees under the mortgage of the Willamette Valley Southern Railway Company, whereby it guaranteed the performance by the railroad company of the payments of1925 BTA LEXIS 2644">2646 interest and principal covenanted in the bonds. The taxpayer was, during the taxable years here in question, the owner of all of the preferred stock of the railroad company, in the amount of $182,000 outstanding, and is the owner of common stock in the amount of $547,900 out of a total of $990,500 outstanding. At the close of business December 31, 1915, the Willamette Valley Southern Railway Company showed a deficit from operations and otherwise in the sum of $70,601.68, which deficit continuously increased from that date to and including the end of the taxable and calendar year 1924, the amounts of the annual deficits being as follows: 1915$70,601.68191661,291.82191767,791.55191872,274.90191974,338.30192089,044.69192198,316.251922108,972.261923144,502.251924139,319.82Total accumulated deficit to Dec. 31, 1924926,453.52The total assets of the said railroad company as of the close of the several years were as follows: 1915$1,978,683.0619161,982,560.0919171,989,075.6419181,982,619.9819191,981,080.8419201,990,525.9419211,988,322.8619221,997,211.9619231,987,335.2919241,983,474.231925 BTA LEXIS 2644">2647 1 B.T.A. 1150">1152 As of the close of each year above mentioned, the railway company was indebted to the taxpayer for advances as follows: 1915$250,498.261916142,181.411917200,092.161918264,116.621919324,032.511920400,240.251921479,014.851922569,932.691923670,257.331924770,696.14In addition to the above, the railway company was indebted to the taxpayer for matured and unpaid interest on its indebtedness to the taxpayer as follows: 1915$3,980.6519164,240.00191715,100.00191829,775.00191947,985.00192070,820.00192197,775.001922129,840.001923167,570.001924211,740.00As of December 31 of each of the same years, the funded debt of the railway company was as follows: 1915$750,000.001916750,000.001917750,000.001918735,000.001919727,000.001920720,000.001921712,000.001922704,800.001923697,700.001924687,200.00Throughout the above period, and in particular in the taxable years in question, the taxpayer advanced to the railroad company the funds necessary to meet its operating deficits and its interest and sinking-fund charges, said1925 BTA LEXIS 2644">2648 advances on interest and sinking fund being, in the year 1918, $52,161; in 1919, $51,710; and in 1920, $51,259; and the said sums were credited to the taxpayer by the Willamette Valley Southern Railway Company upon its books. During the year 1920 the taxpayer sold certain property for $88,000, purchased in the year 1907 at a cost of $119,628.49, the fair market value of which on March 1, 1913, was $151,538.50. The Commissioner computed a loss on account of the foregoing transaction in the sum of $21,254.98, said computation being arrived at by subtracting the sales price from the cost in 1907, less depreciation in a sum of $10,373.51 from 1907 to the date of sale. The taxpayer alleges that the loss should be computed by subtracting the sales price from the value on March 1, 1913, of $151,538.50, less depreciation from 1913 to 1919 in the sum of $4,531.59. The values and figures are not in dispute between the parties, the sole dispute being as to the method of computation, that is, whether the cost in 1907 1 B.T.A. 1150">1153 or the fair value as of March 1, 1913, shall be taken as the basis for the computation of gain or loss. DECISION. The deficiency should be computed in accordance1925 BTA LEXIS 2644">2649 with the following opinion. Final decision will be settled on consent or on ten days' notice, in accordance with Rule 50. OPINION. JAMES: Upon the first point the determination, under prior decisions of the Board, must be in favor of the Commissioner. The taxpayer in this appeal alleges that the railway company was insolvent; that it was forced to advance the sums of money in question to pay the interest and sinking-fund requirements of the bonds which it had guaranteed, and is, therefore, entitled to deduct such payments. The Board decided, however, in the Appeal of Winthrop Ames,1 B.T.A. 63">1 B.T.A. 63, that advances for operating expenses or advances otherwise made to a corporation and carried as a charge against that corporation without any attempt to liquidate the debtor corporation or otherwise terminate the transaction, may not be charged off as worthless debts or as advances so long as the corporation to which such advances are made continues as an active corporate entity, is not actually adjudged bankrupt, and no effort is made to close or liquidate the account. To the same effect is the 1925 BTA LEXIS 2644">2650 Appeal of Steele Cotton Mill Co.,1 B.T.A. 299">1 B.T.A. 299. The facts in the instant appeal are not so strong as those in the Appeal of Winthrop Ames. Here it is apparent that the debtor corporation, on the basis of its book assets, is able to satisfy the existing debt, even at the close of 1924, in full. During the years 1918, 1919, and 1920, the total indebtedness to the taxpayer ranged approximately from $295,000 to $470,000, including the advances here in question. At the close of the year 1920 the railway company had assets of $1,990,000, an unmatured funded debt of $720,000, and the unfunded debt to the taxpayer as above stated of approximately $470,000. Liabilities other than to the taxpayer and on funded debt were negligible in amount. As stated in the Ames appeal: The duty to determine that a debt is worthless in a definite sum is upon the taxpayer, he to support his conclusion with equally definite and certain evidence. The taxpayer relies upon Solicitor's Memo., 1298, 2 C.B. 113. An examination of the opinion indicates that the facts of the case there in question were materially different from the facts in this appeal, particularly in1925 BTA LEXIS 2644">2651 the way in which the accounts of the two corporations were treated. We believe this opinion is not authority for the position taken by the taxpayer. The amounts deducted on account of interest and sinking fund, paid by the taxpayer on account of the indebtedness of the Willamette Valley Southern Railway Company, may not be allowed in computing net taxable income in the years in question. Upon the second point the taxpayer relies on the decision of the Board in the Appeal of Even Realty Co.,1 B.T.A. 355">1 B.T.A. 355. In that 1 B.T.A. 1150">1154 appeal, the question was whether the taxpayer could be taxed upon a computation of gain or loss, one of the elements of which was depreciation actually sustained but not reflected upon the taxpayer's books of account. In this appeal the question is whether the taxpayer may deduct a loss on selling price as compared with March 1, 1913, value in excess of the loss computed by comparing cost with selling price. In this appeal, there is no dispute as to the deduction of depreciation through all the years, and it appears to be conceded that the value of the depreciable property should be reduced on account of depreciation, either from the date1925 BTA LEXIS 2644">2652 of purchase or from March 1, 1913, depending upon which basis is used for the computation of gain or loss. There is even no dispute as to the amount of depreciation to be duduced each year. The question here presented, then, is not the question presented in the Appeal of Even Realty Co., but is the question presented by United States v. Flannery,268 U.S. 98">268 U.S. 98, and McCaughn v. Ludington,268 U.S. 106">268 U.S. 106. In these cases the question presented was whether losses shall be computed from the single basis of value as of March 1, 1913, regardless of cost, to arrive at the deduction allowed by Congress with respect to capital transactions terminated by loss, or whether losses shall be measured by value as of March 1, 1913, or cost, whichever is lower. The Commissioner in this appeal has computed the loss of the taxpayer upon the basis of March 1, 1913, value or cost, whichever is lower, and his contention must, therefore, under the authority of the above-cited cases, be sustained, and the taxable income computed by allowing, as the Commissioner has done, a loss of $21,254.98.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621035/	Estate of Joseph E. Reilly, Deceased, Grace F. Reilly, Administratrix, Petitioner, v. Commissioner of Internal Revenue, RespondentReilly v. CommissionerDocket No. 53221United States Tax Court25 T.C. 366; 1955 U.S. Tax Ct. LEXIS 38; November 30, 1955, Filed 1955 U.S. Tax Ct. LEXIS 38">38 Decision will be entered under Rule 50. The proceeds of insurance policies on the life of the decedent were payable in equal installments to the surviving spouse for life. If she were to die within 10 years the installments were to continue to be paid for the remainder of the 10 years to certain contingent beneficiaries. Held, the right to all of the installments was one "property" within the purview of section 812 (e) (1) (B), Internal Revenue Code of 1939, and therefore, as persons other than the surviving spouse might possess or enjoy some part of the property after the termination of the interest of the surviving spouse, no part of the property qualifies for the marital deduction. G. Norman1955 U.S. Tax Ct. LEXIS 38">39 Widmark, Esq., for the petitioner.Norman A. Peil, Jr., Esq., for the respondent. Bruce, Judge. BRUCE 25 T.C. 366">366 Respondent determined a deficiency in the estate tax of petitioner in the amount of $ 35,560.12. A recomputation under Rule 50 will be required in order to make adjustments for the cost of this action and for any additional inheritance taxes shown to have been paid to the State of New Jersey. The sole issue for decision is whether the 25 T.C. 366">367 respondent erred in not allowing any marital deduction under section 812 (e) of the Internal Revenue Code of 1939 with respect to the proceeds of insurance policies on the life of the decedent under which the surviving spouse received an annuity for life, but if she should die within the first 10 years the payments were to continue to be made to certain contingent beneficiaries for the remainder of the 10-year period.FINDINGS OF FACT.All of the facts have been stipulated and are so found.Joseph E. Reilly died intestate in 1950 and his widow, Grace E. Reilly, was appointed administratrix of his estate. Petitioner filed a Federal estate tax return with the collector of internal revenue for the fifth district of New Jersey. 1955 U.S. Tax Ct. LEXIS 38">40 Included in the gross estate of the decedent was the sum of $ 58,430.09, representing the proceeds of eight policies of insurance upon decedent's life issued by the Penn Mutual Life Insurance Company (hereinafter referred to as the insurance company). Decedent filed a beneficiary designation and settlement option with the insurance company in 1944 which provided that in the event his wife should survive him the proceeds of each policy were to be distributed to her in equal monthly installments for 10 years certain and thereafter for life; and if his wife should die within the 10-year period, the remainder of installments for the 10-year period were to be paid to his surviving children or to the estate of the last survivor of his wife and children. The option was in effect at his death.Decedent was survived by his wife and two children. At that time the surviving spouse was 47 years of age. Each policy specified the amount payable in monthly installments under the above option to a female, age 47, for each $ 1,000 of proceeds. The total amount she was to receive under the eight policies was $ 270.85 per month. On the basis of the calculations used by the insurance company to1955 U.S. Tax Ct. LEXIS 38">41 determine the amount of the monthly installments, of the total proceeds in amount of $ 58,430.09 the sum of $ 28,149.63 was necessary to provide the above monthly income for 10 years certain and $ 30,280.46 was required to provide the above monthly income thereafter for the life of the surviving spouse.Under all eight of the policies the installment payments during the 10-year certain period, but not the installment payments thereafter, were to be increased by any surplus additions as may be awarded by the board of trustees of the insurance company. All of the policies provide that the right to the income payments could not be commuted, alienated, assigned, or anticipated by the beneficiary without the written permission of the insured, which in the instant case was not given. Under five of the policies the insured could not have granted 25 T.C. 366">368 the right to commute, alienate, assign, or anticipate the installment payments beyond the certain period of 10 years.Nothing in the policies provided, and the insured did not request, that there be any segregation of the proceeds of the policies.The petitioner claimed a marital deduction in the estate tax return with respect to the 1955 U.S. Tax Ct. LEXIS 38">42 entire proceeds of the policies in the amount of $ 58,430.09; but petitioner now concedes that that portion of the proceeds required to provide the monthly payments for 10 years certain, or $ 28,149.63, does not qualify for the marital deduction. Respondent disallowed the full amount of the deduction.OPINION.The present controversy turns upon the meaning of the word "property" as used in section 812 (e) (1) 1 of the Internal Revenue Code of 1939. Section 812 (e) (1) (B) provides that the value of an interest in property passing to the surviving spouse shall not qualify for the marital deduction where such interest may terminate and thereafter some other person "may possess or enjoy any part of such property," which passes to that person from the decedent for less than the full consideration. (Emphasis supplied.)1955 U.S. Tax Ct. LEXIS 38">43 Here the proceeds of insurance policies on the life of the decedent were payable in equal installments to the surviving spouse for 10 years certain and thereafter for life. If the surviving spouse should die before the end of the 10-year period, the installments for the remainder of the 10 years were payable to the decedent's children or to the estate of the last survivor of his wife and children.Petitioner concedes that the value of the right to the installments for 10 years certain was a terminable interest which may pass to persons other than the surviving spouse and therefore does not qualify for the marital deduction. Estate of Thomas J. White, 22 T.C. 641. On the 25 T.C. 366">369 other hand, respondent does not contest petitioner's contention that, if the annuity for life, beginning 10 years from the decedent's death, were the only interest involved, it would qualify for the marital deduction as no interest therein could pass to any person other than the surviving spouse. Cf. Regs. 105, sec. 81.47b (d). Therefore, the sole question is whether each policy, or the right to all of the payments under each policy, was one "property" within the purview1955 U.S. Tax Ct. LEXIS 38">44 of section 812 (e) (1) (B). If so, no part of the proceeds of the policies can qualify for the marital deduction as persons other than the surviving spouse may possess or enjoy some part of "such property" after the termination of the interest of the surviving spouse.There appear to be no prior cases construing the term "property" as used in section 812 (e). However, as this Court said in Kent Industrial Corporation, 25 T.C. 215, "In construing the language of a statute such as the one now before us, it is proper to consider the purpose which Congress had in mind when it was enacted. See Webster Corporation, 25 T.C. 55"; and, considerable light is shed on what Congress intended by the word "property" in passing the Revenue Act of 1948 by various statements made in the Report of the Senate Committee of Finance (S. Rept. No. 1013, part 2, 80th Cong., 2d Sess.), reprinted in 1948-1, C. B., 331, 333, 336, 337, 339-340:The terms "interest" and "property," as used in section 812 (e) have separate and distinct meanings. The term "property" is used in a comprehensive sense and includes all objects or rights which are susceptible1955 U.S. Tax Ct. LEXIS 38">45 of ownership. The term "interest" refers to the extent of ownership, that is, to the estate or the quality and quantum of ownership by the surviving spouse or other person, of particular property. For example, if the surviving spouse is specifically devised an estate for her life in a farm, the "interest" passing to her is the life estate, and the "property" in which such interest exists is the farm. Generally the property in which any person is considered as having an interest is the property out of which, or the proceeds of which, such interest may be satisfied. Thus, in case of a bequest, devise, or transfer of an interest which may be satisfied out of, or with the proceeds of, any property of the decedent's general estate or of a trust, the interest so bequeathed, devised, or transferred is an interest in any and all of such property. If the decedent's general estate or the trust consists of assets which are themselves interests in property (such as leases), the interest so bequeathed, devised, or transferred is an interest in such property.* * * On the other hand, an interest may be a terminable interest under subparagraph (B), section 812 (e), even though such interest1955 U.S. Tax Ct. LEXIS 38">46 is the entire property. Thus, if the property in which the surviving spouse has an interest, or all of the interest, is terminable, the interest of the surviving spouse is a terminable interest. Examples of such terminable interest are patents, copyrights, and annuity contracts.As previously stated, it is necessary for the purposes of section 812 (e) (1) to distinguish between an interest in property and the property in which such interest is an interest. Thus, if the decedent devises Blackacre to his wife 25 T.C. 366">370 for life with remainder to X, then X has an interest in the property (Blackacre) in which the surviving spouse has an interest. If the principal value of Blackacre was a coal mine which may be expected to be exhausted during the surviving spouse's life, nevertheless both the surviving spouse and X have an interest in the property, which is Blackacre. If the decedent devises Blackacre to his son in fee but subject to a charge on the rents of Blackacre in favor of his surviving spouse for her life, the surviving spouse and the son have an interest in the same property (Blackacre). In the case of a trust or fund, the income beneficiaries and the persons who may receive1955 U.S. Tax Ct. LEXIS 38">47 any part of the corpus have an interest in the property represented by the assets of the trust or fund as of the date of the decedent's death.* * * The term "possess or enjoy any part of such property" is intended to be broadly construed. * * EXAMPLE (2). The decedent during his lifetime purchased an annuity contract under which the annuity was payable during his life and then to his spouse during her life if she survived him. The value of the interest of the decedent's surviving spouse in such contract at the death of the decedent is included in determining the value of his gross estate. A marital deduction is allowed with respect to the value of such interest so passing to the decedent's surviving spouse inasmuch as no other person has an interest in the contract. If upon the death of the surviving spouse the annuity payments were to continue for a term to her estate, or the undistributed portion thereof was to be paid to her estate, the deduction is nevertheless allowable with respect to such entire interest. If, however, upon the death of the surviving spouse, the payments are to continue to another person (not through her estate) or the undistributed fund is to 1955 U.S. Tax Ct. LEXIS 38">48 be paid to such other person, no marital deduction is allowable inasmuch as an interest passed from the decedent to such other person.The application of the above principles, and particularly the example with respect to annuity payments which continue after the death of the surviving spouse, to the facts in the instant case requires, in our opinion, a holding that each policy or the right to all of the payments under each policy was one "property" within the purview of section 812 (e) (1) (B). Here, the interest received by the surviving spouse under each policy was an annuity for life which may be satisfied out of the entire proceeds of the policy. And, to quote again from the above Committee Report (1948-1 C. B., supra, at p. 333), "Generally the property in which any person is considered as having an interest is the property out of which, or the proceeds of which, such interest may be satisfied."While the insurance company may have computed separately the amounts required to provide the certain and contingent payments under each policy, nevertheless the right to all of the payments was acquired under one contract. Also, there was no segregation of the proceeds; and, as 1955 U.S. Tax Ct. LEXIS 38">49 is normally the case of fractional portions of the same property, each portion (here the sum required to provide the certain payments and the sum required to provide the contingent payments) was limited in amount by the size of the other portion, and 25 T.C. 366">371 both were limited in amount by the value of the property or, here, the total proceeds of the policy. While the property may have been divisible, it was nonetheless one property.Estate of Fredrick John Twogood, 15 T.C. 989, affd. 194 F.2d 627, cited by petitioner, is consistent with the above holding. In that case the decedent was entitled to an annuity for life upon retirement. He elected to take a reduced annuity in order that his wife might have an annuity for life if she survived him. We held that by the election "the decedent divided the property into two parts," and that he did not retain the right to possess or enjoy the income from that part which he transferred to his wife within the purview of section 811 (c) (1) (B). While the Twogood case presented an entirely different question from the one here under consideration, we think it is clear from the1955 U.S. Tax Ct. LEXIS 38">50 opinion in that case that the decedent's right to an annuity upon retirement was the underlying property or, to borrow the words of that opinion, "the property itself" out of which both the interest retained and the interest transferred were to be satisfied.Petitioner also relies upon the differentiation in the insurance policies between the certain payments and the contingent payments. Each policy provided that the certain payments, but not the contingent payments, were to be increased by any surplus additions, and, in five of the policies, the insured could have permitted the beneficiary to commute or anticipate only those payments payable for 10 years certain. However, this differentiation between the payments does not change the fact that the policy, or the proceeds of the policy, is the underlying property out of which all of the payments are to be satisfied. Therefore, we decide this issue for respondent. However, for the reasons previously stated,Decision will be entered under Rule 50. Footnotes1. SEC. 812. NET ESTATE.For the purpose of the tax the value of the net estate shall be determined, in the case of a citizen or resident of the United States by deducting from the value of the gross estate -- * * *(e) Bequests, Etc., to Surviving Spouse. -- (1) Allowance of marital deduction. -- (A) In General. -- 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.(B) Life Estate or Other Terminable Interest. -- Where, upon the lapse of time, upon the occurrence of an event or contingency, or upon the failure of an event or contingency to occur, such interest passing to the surviving spouse will terminate or fail, no deduction shall be allowed with respect to such interest --(i) if an interest in such property passes or has passed (for less than an adequate and full consideration in money or money's worth) from the decedent to any person other than such surviving spouse (or the estate of such spouse); and(ii) if by reason of such passing such person (or his heirs or assigns) may possess or enjoy any part of such property after such termination or failure of the interest so passing to the surviving spouse;↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621036/	SUNRISE CONSTRUCTION COMPANY, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSunrise Constr. Co. v. CommissionerDocket No. 39499-85.United States Tax CourtT.C. Memo 1987-21; 1987 Tax Ct. Memo LEXIS 21; 52 T.C.M. 1358; T.C.M. (RIA) 87021; 8 Employee Benefits Cas. (BNA) 1081; January 12, 1987. 1987 Tax Ct. Memo LEXIS 21">21 P deducted substantial amounts as payments to a voluntary employees' beneficiary association (VEBA), claiming exempt status under sec. 501(c)(9), I.R.C. Respondent determined that the plan did not qualify for exempt status because net earnings of the fund inured to benefit of P's sole shareholder. Held, the plan was not an exempt VEBA where (1) the amounts contributed far exceeded the amounts reasonable for the stated purposes of the contributions; (2) excess funds were invested at the direction of the shareholder in a nonfiduciary manner; and (3) terms of the organizing agreement were not honored upon termination of the plan. Contributions to the plan were therefore not deductible under sec. 162(a). William L. Lucas, for the petitioner. Gail K. Gibson, for the respondent. COHENMEMORANDUM OPINION COHEN, Judge: Respondent determined deficiencies in petitioner's Federal income taxes as follows: Tax Year EndedDeficiencyMarch 31, 1981$19,828March 31, 1982245,349March 31, 1983327After an agreement as to other adjustments, the issue for determination is whether petitioner is entitled to deduct $400,000 in the fiscal year ended March 31, 1982, and $221,000 in the fiscal year ended March 1987 Tax Ct. Memo LEXIS 21">22 31, 1983, as contributions to a voluntary employees' beneficiary association (VEBA) (hereinafter "the Plan"). Respondent determined that the amounts were not deductible as ordinary or necessary under section 162 1 because the Plan was not exempt under section 501(c)(9). All of the facts have been stipulated, and the stipulation is incorporated in our findings by this reference. At the time the petition was filed, petitioner was a corporation with its principal office located in Helena, Montana. Petitioner was incorporated on June 11, 1976, and thereafter engaged in the construction business, primarily in Montana. From August 28, 1978, through April 29, 1981, Thomas Battershell (Battershell) owned 500 percent of the stock of petitioner, and Terry Pipinich owned the other 50 percent of the stock of petitioner. On April 29, 1981, Terry Pipinich sold his stock in petitioner to Battershell for $200,000 plus other consideration. At all times material hereto, Battershell owned 100 percent of the stock of petitioner. At a meeting on March 31, 1987 Tax Ct. Memo LEXIS 21">23 1982, petitioner's Board of Directors, composed of Battershell, his wife, and Gary Duval, adopted a resolution to create a VEBA for the fiscal year ended March 31, 1982, and to contribute $400,000 to a VEBA trust. Petitioner executed documents entitled (1) Voluntary Employees' Beneficiary Association for Employees of Sunrise Construction, Inc. Helena, Montana, Specifications, (2) Voluntary Employees' Beneficiary Association for Employees of Sunrise Construction, Inc. Helena, Montana, Plan, and (3) Voluntary Employees' Beneficiary Association for Employees of Sunrise Construction, Inc. Helena, Montana, Trust. On July 23, 1982, the Plan created by the foregoing documents applied for an employer identification number. The Plan thereafter filed Forms 990, Return of Organization Exempt from Income Tax, for fiscal years ended March 31, 1982, and March 31, 1983. As originally executed, the Voluntary Employees' Beneficiary Association for Employees of Sunrise Construction, Inc. Helena, Montana, Plan, at section 3.02(a) provided as follows: Insurance Contracts - If the Specifications provide for the purchase of Contracts, the Committee shall direct the Trustee to invest contributions and 1987 Tax Ct. Memo LEXIS 21">24 accruals and earnings thereon in Contracts to the extent provided here at each Participant's entry and as necessary on any increase in his benefits. (a) If evidence of insurability is required, for Participants insurable at standard rates the Trustee shall purchase group of individual Contracts providing the benefit called for in the Specifications. (b) If evidence of insurability is required, the Participants found by the Insurer to be insurable only at substandard rates or with exclusions, the Contract may provide a graded benefit or contain exclusions. If the full benefit called for in the Specifications could be provided at additional cost and the Participant in writing agrees to pay that additional cost, the Contract shall provide the regular benefit. If the Participant does not wish substandard insurance, or if insurance is wholly unavailable from the Insurer, then the benefit shall be limited to an amount equal to the sum of premiums which would have been paid had the Participant been insurable at standard rates. On May 12, 1983, that section was amended to provide as follows: ADDENDUM TO VOLUNTARY EMPLOYEES' BENEFICIARY ASSOCIATION FOR EMPLOYEES OF SUNRISE CONSTRUCTION, 1987 Tax Ct. Memo LEXIS 21">25 INC. It is specifically agreed by the undersigned parties that Section 3.02(a) is to be amended to specifically include investment in commodities. It is further agreed that nothing in this Addendum shall be deemed to limit the original agreement. The addendum was signed by Battershell and his wife as trustees of the Plan and by Battershell as the President of petitioner. On August 5, 1983, at an annual meeting of petitioner's Board of Directors, a contribution of $221,000 to the Plan was approved by Battershell, his wife, and their daughter, as directors of the corporation. Those same three individuals were elected officers of the corporation. Form 1024, Application for Recognition of Exemption Under Section 501(a) or for Determination Under Section 120, was filed with the Internal Revenue Service on behalf of the Plan. After requesting additional information, the Internal Revenue Service notified the Plan on October 11, 1983, that it did not qualify for exemption. That determination was explained as follows: The information submitted indicates that you were organized pursuant to a trust agreement executed on March 31, 1982, to provide benefits effective April 1, 1981, for eligible 1987 Tax Ct. Memo LEXIS 21">26 employees of Sunrise Construction, Inc. (Company). Company-adopted specifications provide that full-time employees with one year of service as of your effective date or any plan anniversary date who are at least age 24, other than employees whose employment is governed by a collective bargaining agreement, are eligible for benefits. General organizational information is as follows: The Company appoints your trustee. The trustee has full investment management authority over your funds. The Company is also the Plan Administrator and appoints a committee to carry out its administrative duties. Your current trustees and committee members are Gary Duval, Thomas Battershell, and Louise W. Battershell. Mr. Battershell and his wife, Ms. Battershell, are the sole shareholders of the Company, each owning 50% of its stock. Mr. Battershell is also President of the Company, and Ms. Battershell, Secretary-Treasurer. The two are the directors of the Company. The Company has the right to amend or terminate the Plan and Trust at any time. On termination, the trust fund is to be distributed as directed by the Committee, in accordance with the Plan. The Plan provides that residual assets are 1987 Tax Ct. Memo LEXIS 21">27 to be applied in one or a combination of the following ways, as selected by the Company: (a) to provide life, sick, accident, or other benefits or (b) to provide cash to participants in proportion to their compensation. In accordance with the specifications and information subsequently submitted, you provide employer-funded life benefits equal to three times the employees' annual compensation and disability benefits equal to the employee's compensation. Benefits are provided through a combination of insurance and self-funding. For your first two fiscal years, you received employer contributions of $520,000. After expenditures of $46,515 for the purchase of term life insurance, and the receipt of investment income, reserves of $544,429 were available for the payment of benefits or distribution on termination. Based on your application and the employment data you submitted, the following employees are eligible for your benefits: EmployeeCompensationBattershell T.$450,000Battershell, L.58,300Duval, G.35,000Young, W.40,022Section 501(c)(9) of the Code provides for the exemption from federal income tax of voluntary employees' beneficiary associations providing for the payment of life, 1987 Tax Ct. Memo LEXIS 21">28 sick, accident, or other benefits to the members of the association or their dependents or designated beneficiaries, if no part of the net earnings of the association inures to the benefit of any private shareholder or individual. Section 1.501(c)(9)-4(a) of the Income Tax Regulations provides that no part of the new earnings of an employees' association may inure to the benefit of any private shareholder or individual other than through the payment of qualifying benefits. Whether prohibited inurement has occurred is a question to be determined with regard to all the facts and circumstances. Based on the information submitted, we have concluded that your net earnings inure to the benefit of Mr. Battershell. Due to the small number of participants and the large discrepancy between Mr. Battershell's compensation and that of the other participants, he is entitled to a dominant share of your benefits and on termination will receive a dominant share of your residual assets, whether in the form of continued benefits or a cash distribution. Based on the current salary and employment data you provided, his share is in excess of 75%. Further, through his ownership of 1/2 of the Company's 1987 Tax Ct. Memo LEXIS 21">29 outstanding stock, with the balance owned by his wife, Mr. Battershell has effective control over the company. The Company in turn controls your benefit plan and trust, including trust investments, plan administration, the timing of trust termination, and the manner of distribution of residual assets on termination. The trust is thus used to accumulate funds primarily for the benefit of Mr. Battershell. Under these circumstances, you function primarily as an investment fund for the direct personal and private benefit of Mr. Battershell rather than to provide qualifying benefits for a group of employees. The information submitted to the Internal Revenue Service that Louise W. Battershell, Battershell's wife, was a shareholder was erroneous. As now stipulated by the parties, Battershell owned 100 percent of the stock. Although at least one nonfamily employee was named as a trustee for a short period of time, there is no evidence of functions performed with respect to the trust fund by anyone unrelated to Battershell. As adopted, the Plan contained the following provision: Fund Recovery - It shall be impossible for any part of the contributions under this Plan to be used for, or diverted 1987 Tax Ct. Memo LEXIS 21">30 to, purposes other than the exclusive benefit of the Participants or their beneficiaries. (a) Any assets remaining in the Plan after satisfaction of all liabilities to existing beneficiaries shall be applied in one of the combination of the following, as selected by the Employer: (1) To provide, either directly or through the purchase of insurance, life, sick, accident or other benefits within the meaning of Section 4.02, pursuant to criteria which do not provide disproportionate benefits to officers, shareholders or highly compensated Employees, or (2) To provide cash to Employee-Participants in proportion to their Compensation. (b) Nothing herein shall be interpreted to prevent the return of excess insurance premiums, based on the mortality or morbidity experience of the Insurer to which the premiums were paid, to the Employer, Employee or other person or persons whose contributions were applied to such premiums. On December 31, 1983, after petitioner received notice of the Internal Revenue Service letter determining that the Plan did not qualify for exempt status, the Plan was terminated as of December 31, 1983. The remaining assets in the trust fund of the Plan were returned to 1987 Tax Ct. Memo LEXIS 21">31 petitioner and reported as income on petitioner's corporate income tax return for the fiscal year ended March 31, 1984. The receipts and expenditures of the trust fund of the Plan during the period of its existence are summarized as follows: Year Ended3/31/82Initial contributions$400,000 Insurance premiums and costs( 48,249)351,751 3/31/83Contribution221,000 Insurance premiums and costs( 16,493)Investment earnings (loss)63,045 619,303 3/31/84Investment earnings (loss) a(289,502)Value returned to Sunrise Construction$329,801 Petitioner has the burden of proving that respondent's determination in the statutory notice is incorrect. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure. Petitioner contends that the determination is inconsistent with respondent's regulations, sections 1.501(c)(9)-2 and (9)-4, Income Tax Regs., providing in pertinent part as follows: [Sec. 1.501(c)(9)-2(a)(2)(ii)] (ii) Generally permissible restrictions or conditions. In general, the following restrictions will not be considered to be inconsistent with 1.501(c)(9)-2(a)(2)(i) 1987 Tax Ct. Memo LEXIS 21">32 or 1.501(c)(9)-4(b): * * * (F) The provision of life benefits in amounts that are a uniform percentage of the compensation received by the individual whose life is covered. (G) The provision of benefits in the nature of wage replacement in the event of disability in amounts that are a uniform percentage of the compensation of the covered individuals (either before or after taking into account any disability benefits provided through social security or any similar plan providing for wage replacement in the event of disability). * * * [Sec. 1.501(c)(9)-2(c)(3)] (3) Of employees. To be described in this section [as a VEBA], an organization must be controlled -- (i) By its membership, (ii) By independent trustee(s) (such as a bank), or (iii) By trustees or other fiduciaries at least some of whom are designated by, or on behalf of, the membership. Whether control by or on behalf of the membership exists is a question to be determined with regard to all of the facts and circumstances, but generally such control will be deemed to be present when the membership (either directly or through its representative) elects, appoints or otherwise designates a person or persons to serve as chief operating 1987 Tax Ct. Memo LEXIS 21">33 officer(s), administrator(s), or trustee(s) of the organization. For purposes of this paragraph an organization will be considered to be controlled by independent trustees if it is an "employee welfare benefit plan", as defined in section 3(1) of the Employee Retirement Income Security Act of 1974 (ERISA), and, as such, is subject to the requirements of Parts 1 and 4 of Subtitle B, Title I of ERISA. 21987 Tax Ct. Memo LEXIS 21">35 * * * [Sec. 1.501(c)(9)-4] (a) General rule. No part of the net earnings of an employees' association may inure to the benefit of any private shareholder or individual other than through the payment of benefits permitted by sec. 1.501(c)(9)-3. * * * Whether prohibited inurement has occurred is a question to be determined with regard to all of the facts and circumstances, taking into account the guidelines set forth in this section. * * * (b) Disproportionate benefits. For purposes of subsection (a), the payment to any member of disproportionate benefits, where such payment is not pursuant to objective and nondiscriminatory standards, will not be considered a benefit within the meaning of sec. 1.501(c)(9)-3 even though the benefit otherwise is one of the type permitted by that section. 1987 Tax Ct. Memo LEXIS 21">34 For example, the payment to highly compensated personnel of benefits that are disproportionate in relation to benefits received by other members of the association will constitute prohibited inurement. Also, the payment to similarly situated employees of benefits that differ in kind or amount will constitute prohibited inurement unless the difference can be justified on the basis of objective and reasonable standards adopted by the association or on the basis of standards adopted pursuant to the terms of a collective bargaining agreement. In general, benefits paid pursuant to standards or subject to conditions that do not provide for disproportionate benefits to officers, shareholders, or highly compensated employees will not be considered disproportionate. See sec. 1.501(c)(9)-2(a)(2) and (3). Petitioner argues: Respondent is asking the Court to adopt new VEBA benefit limitations and control requirements which are beyond those of the Code and regulations and would deny Petitioner's VEBA exempt status even though it complied with Section 501(c)(9) and the regulations which respondent has adopted. The Court should decline to do so. * * Respondent argues that he is merely applying the express statutory language of section 501(c)(9), which exempts from taxation -- (9) Voluntary employees' beneficiary associations providing for the payment of 1987 Tax Ct. Memo LEXIS 21">36 life, sick, accident, or other benefits to the members of such association or their dependents or designated beneficiaries, if no part of the net earnings of such association inures (other than through such payments) to the benefit of any private shareholder or individual. Respondent contends that the overriding consideration is inurement to the benefit of Battershell. Respondent argues, in the alternative, that petitioner's VEBA arrangement, i.e., the Plan, was illusory. See Citrus Orthopedic Medical Group, Inc. v. Commissioner,72 T.C. 461">72 T.C. 461, 72 T.C. 461">464-467 (1979). Petitioner argues, in effect, that formalistic satisfaction of the criteria set forth in respondent's regulations is sufficient to secure exemption, i.e., is a "safe harbor." We do not accept this interpretation. The specific provisions of the regulations on which petitioner relies merely avoid any implication that participation by a shareholder-employee in a VEBA is a per se disqualification of the Plan from exemption. VEBA's were administered for many years without interpretive regulations. See Anesthesia Service Medical Group, Inc. v. Commissioner,85 T.C. 1031">85 T.C. 1031, 85 T.C. 1031">1049-1051 (1985), on appeal (9th Cir., May 14, 1986). The regulations 1987 Tax Ct. Memo LEXIS 21">37 do not narrow the requirements for eligibility for exempt status set forth in the statute. In any event, the deductions in question are limited by section 1.162-10(a), Income Tax Regs., as follows: (a) In general. Amounts paid or accrued by a taxpayer on account of injuries received by employees and lump-sum amounts paid or accrued as compensation for injuries are proper deductions as ordinary and necessary expenses. Such deductions are limited to the amount not compensated for by insurance or otherwise. Amounts paid or accrued within the taxable year for dismissal wages, unemployment benefits, guaranteed annual wages, vacations, or a sickness, accident, hospitalization, medical expense, recreational, welfare, or similar benefit plan, are deductible under section 162(a) if they are ordinary and necessary expenses of the trade or business. * * * The exempt status of petitioner's Plan, specifically in regard to whether prohibited inurement occurred, must be determined on the basis of the substance of the Plan and not its form. See Greensboro Pathology Associates v. United States,698 F.2d 1196">698 F.2d 1196, 698 F.2d 1196">1200-1201 (Fed. Cir. 1982); Grant-Jacoby, Inc. v. Commissioner,73 T.C. 700">73 T.C. 700, 73 T.C. 700">707-710 (1980), 1987 Tax Ct. Memo LEXIS 21">38 and cases cited therein. We conclude that, in substance, the Plan was not adopted or operated as an employee benefit plan but was merely a separate fund controlled by petitioner's sole shareholder for his own benefit.The incidental coverage of other employees of the corporation appears to be merely a cost of securing the anticipated tax-exempt status. Thus the contributions to the Plan are not ordinary and necessary business expenses. Our conclusion is based on three primary factors, among the facts and circumstances apparent from the limited record. See section 1.501(c)(9)-2(a)(2)(i) and (c)(3) and sec. 1.501(c)(9)-4(a), Income Tax Regs.First, the amounts contributed to the trust fund and deducted on petitioner's tax returns, $621,000, were almost 10 times the amounts actually paid out for insurance premiums and costs, $64,742. Responding to this point, petitioner merely states "apparently no consideration was given to any possible need for a reserve for future benefit costs." Petitioner, however, has presented no evidence as to the amount of a reasonable reserve. We have no evidence of the projected cost of obtaining insurance for participants in the Plan. One need not be 1987 Tax Ct. Memo LEXIS 21">39 an actuary, however, to recognize that the amount contributed to the Plan far exceeds the amount reasonable or necessary for the expressed purpose of the Plan. Second, Battershell invested the excess funds of the Plan in speculative investments, not an appropriate exercise of fiduciary duty over a trust for the benefit of others.See 29 U.S.C. sec. 1104(a); Montana Code Ann. sec. 72-21-104 (1985); and Bogert, Trusts & Trustees, sec. 612 (2d ed. 1980) (prudent man rule). 3 Petitioner has failed to prove any reason for the investments chosen other than to accommodate special interests of Battershell. Third, after the Internal Revenue Service ruled that the Plan was not exempt, the assets of the Plan were returned to petitioner without regard to the terms of the Plan documents or the requirements of the applicable regulation, section 1.501(c)(9)-4(d), Income Tax Regs.1987 Tax Ct. Memo LEXIS 21">40 41987 Tax Ct. Memo LEXIS 21">41 1987 Tax Ct. Memo LEXIS 21">42 Disregard of contractual documents is frequently cited as evidence that a transaction is without its intended effect for tax purposes. See, e.g., Falsetti v. Commissioner,85 T.C. 332">85 T.C. 332, 85 T.C. 332">351-355 (1985). Petitioner argues that the ultimate termination of the Plan cannot be considered as retroactively disqualifying the Plan from its inception. The conduct of petitioner and Battershell with respect to the Plan, however, is evidence of their original intention to maintain unlimited control over the Plan's assets and supports the conclusion that no bona fide transfer occurred for tax purposes. Compare Holman v. Commissioner,728 F.2d 462">728 F.2d 462 (10th Cir. 1984). See also 72 T.C. 461">Citrus Orthopedic Medical Group, Inc. v. Commissioner,supra at 466-467, where we held that the potential for return of funds to the employer upon termination of a plan negated deductibility of contributions as amounts "paid or incurred" under section 162(a).In summary, the simple rule applicable to this case is the one frequently cited from Gregory v. Helvering,293 U.S. 465">293 U.S. 465 (1935), in which the Supreme Court concluded that what was done there, although in accord with the literal language of the statute, was mere artifice. Adapting the language to substitute the circumstances in this case for those involved in 293 U.S. 465">Gregory v. Helvering,supra, the rule is as follows: No doubt, a new and valid * * [entity] was created. But that * * * [entity] was nothing more than a contrivance to the end * * * [of transferring property to the corporate shareholder]. It was brought into existence for no other purpose; it performed, as it was intended from the beginning it should perform, no other function. When that limited function had been exercised, it immediately was put to death. In these circumstances, 1987 Tax Ct. Memo LEXIS 21">43 the facts speak for themselves and are susceptible of but one interpretation. The whole undertaking, though conducted according to the terms of * * [the applicable statute], was in fact an elaborate and devious form of conveyance masquerading as a * * * [VEBA], and nothing else. The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose. [Gregory v. Helvering,293 U.S. 465">293 U.S. at 469-470.] The Supreme Court's opinion in 293 U.S. 465">Gregory v. Helvering,supra, has been relied on for a variety of purposes in a variety of transactions. See Moore v. Commissioner,85 T.C. 72">85 T.C. 72, 85 T.C. 72">103 (1985). The case before us, however, is one of those in which its application is directly analogous to its original context. The requirement of section 501(c)(9) that no part of the net earnings of a VEBA inure to the benefit of any private shareholder or individual is patently intended to prevent use of a VEBA as a private investment account for a person in Battershell's 1987 Tax Ct. Memo LEXIS 21">*44 position. Superficial compliance with the formalities cannot overcome the undisputed substantive facts. See also Knollwood Memorial Gardens v. Commissioner,46 T.C. 764">46 T.C. 764, 46 T.C. 764">791 (1966). Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue.↩a. Commodity losses and decline in market value upon liquidation of mutual fund investments.↩2. Sec. 3(1) of the Employment Retirement Income Security Act of 1974 (ERISA), codified as 29 U.S.C. sec. 1002(1) (1982), defines "employee welfare benefit plan" as follows: (1) The terms "employee welfare benefit plan" and "welfare plan" mean any plan, fund, or program which was heretofore or is hereafter established or maintained by an employer or by an employee organization, or by both, to the extent that such plan, fund, or program was established or is maintained for the purpose of providing for its participants or their beneficiaries, through the purchase of insurance or otherwise (A) medical, surgical, or hospital care or benefits, or benefits in the event of sickness, accident, disability, death or unemployment, or vacation benefits, apprenticeship or other training programs, or day care centers, scholarship funds, or prepaid legal services, or (B) any benefit described in section 302(c) of the Labor Management Relations Act, 1947 (other than pensions on retirement or death, and insurance to provide such pensions).3. The stipulation, and thus the record, is sparse as to actual compliance with various fiduciary responsibilities imposed on trustees of employee welfare benefit plans by the Employee Retirement Income Security Act of 1974 (ERISA). See generally 29 U.S.C. secs. 1101-1114 (1982)↩. Because the burden of proof is on petitioner, omissions must bear against it.4. Sec. 1.501(c)(9)-4(d), Income Tax Regs., provides as follows: (d) Termination of plan or dissolution of association. It will not constitute prohibited inurement if on termination of a plan established by an employer and funded through an association described in section 501(c)(9), any assets remaining in the association, after satisfaction of all liabilities to existing beneficiaries of the plan, are applied to provide, either directly or through the purchase of insurance, life, sick, accident or other benefits within the meaning of sec. 1.501(c)(9)-3 pursuant to criteria that do not provide for disproportionate benefits to officers, shareholders, or highly compensated employees of the employer. See sec. 1.501(c)(9)-2(a)(2). Similarly, a distribution to members upon the dissolution of the association will not constitute prohibited inurement if the amount distributed to members are [sic] determined pursuant to the terms of a collective bargaining agreement or on the basis of objective and reasonable standards which do not result in either unequal payments to similarly situated members or in disproportionate payments to officers, shareholders, or highly compensated employees of an employer contributing to or otherwise funding the employees' association. Except as otherwise provided in the first sentence of this paragraph, if the association's corporate charter, articles of association, trust instrument, or other written instrument by which the association was created, as amended from time to time, provides that on dissolution its assets will be distributed to its members' contributing employers, or if in the absence of such provision the law of the state in which the association was created provides for such distribution to the contributing employers, the association is not described in section 501(c)(9)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621037/	C. C. ALBRIGHT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Albright v. CommissionerDocket No. 47193.United States Board of Tax Appeals28 B.T.A. 82; 1933 BTA LEXIS 1191; May 11, 1933, Promulgated 1933 BTA LEXIS 1191">1191 SECTION 704(b), REVENUE ACT 1928 - TAXABILITY OF INCOME TO THE BENEFICIARY OF A TRUST FILING AN ELECTION TO BE TAXED THEREUNDER. - Where the trustee under a declaration of trust which was created and operated for the sole purpose of liquidating real property as a single venture, distributing the proceeds therefrom in due course to or for the benefit of the beneficiaries and discharging indebtedness secured by the trust property, elected to be taxed under section 704(b) of the Revenue Act of 1928, the net income of the trust is taxable within the year when such income is earned by the trust, to the beneficiaries of the trust who are entitled to its ultimate distribution, whether actually distributed or not; and this is true whether a beneficiary makes his income tax returns on an accrual basis or on the cash receipts and disbursements basis. George M. Thompson, C.P.A., for the petitioner. Albert C. Baird, Esq., and R. W. Wilson, Esq., for the respondent. BLACK 28 B.T.A. 82">83 In this proceeding respondent has determined against petitioner deficiencies as follows: 1924$4,535.04192525,920.69The petitioner, during the years 19241933 BTA LEXIS 1191">1192 and 1925, was a realtor, engaged in the business of subdividing and selling real estate and acting as sales agent for two real estate subdivision trusts designated as Trust No. 2 - 1569, Security Trust and Savings Bank, Trustee (sometimes hereinafter referred to as Trust No. 2 - 1569), and Trust No. S - 5925, Cahuena Park Title Insurance and Trust Company, Trustee (sometimes hereinafter referred to as Trust No. S - 5925). The trustee in each of these trusts filed notice of election to have the trust income taxed to the beneficiaries, for the taxable years involved in this proceeding, in accordance with the provisions of section 704(b) of the Revenue Act of 1928, which election was recognized by respondent and the income treated accordingly. The errors which petitioner claims the respondent has committed in his treatment of the distributable income of the trust in so far as it affects petitioner will be stated in the opinion. The parties have filed a stipulation of facts to which were attached certain exhibits designated as Exhibits A, B, and C. Reports of internal revenue agents, adopted by the respondent in his determination of the deficiencies and referred to in the deficiency1933 BTA LEXIS 1191">1193 notice, were introduced in evidence for the purpose of showing the details of respondent's determination of the deficiencies. From the stipulation filed, the exhibits attached thereto, and the internal revenue agents' reports we make the following findings of fact. FINDINGS OF FACT. The petitioner, C. C. Albright, resides in the city of Los Angeles, State of California. During the years 1924 and 1925 he owned a 26.425/150ths beneficial interest in Trust No. 2 - 1569. Respondent determined that petitioner owned a 28.125/150ths beneficial interest. Petitioner's distributive share of the net income of Trust No. 2 - 1569 for the year 1924 is $2,705.45 and not $2,879.50 as determined by respondent. Petitioner's distributive share on account of his beneficial interest in Trust No. 2 - 1569 for the year 1925 is $15,103.01 and not $16,074.64 as determined by respondent. Petitioner, in addition to being entitled to a pro rata share of the earnings of Trust No. 2 - 1569 based upon his beneficial ownership therein, was entitled, in accordance with an agreement entered into under date of November 1, 1923, between C. C. Albright (petitioner), 28 B.T.A. 82">84 Harry H. Culver, and1933 BTA LEXIS 1191">1194 the syndicate holders of the said Trust No. 2 - 1569 (which agreement was submitted as petitioner's Exhibit B of the stipulation), to the payment of a further sum of $75,000, said sum to be paid at the time and in the manner set forth in the November 1, 1923, agreement, paragraph eight of which agreement is hereinafter quoted. The proceeds of Trust No. 2 - 1569 were to be distributed in accordance with the agreement dated November 1, 1923, which is submitted as petitioner's Exhibit B of the stipulation. This agreement, which provides for the distribution of the trust proceeds, provides that all funds which are distributed to the sales agent and/or beneficiaries shall be distributed in the manner and with the order of priority listed in the agreement. Several of these priorities are not needed here and we think it is only necessary to quote paragraph eight thereof, which reads as follows: Eighth: After all of the foregoing payments have been made, the balance shall be called "The General Profit", which said General Profit shall be distributed as available for distribution as follows: (a) Forty per cent. (40%) thereof to the Syndicate Holders until Three Hundred Thousand ($300,000.00) 1933 BTA LEXIS 1191">1195 Dollars, plus interest thereon at the rate of seven per cent (7%) per annum from January 1, 1924, to respective dates of realization, the Three Hundred Thousand Dollars and interest being hereinafter called the "Syndicate Profit", thereof has been so distributed to the Syndicate Holders; (b) Twenty per cent (20%) thereof to Albright until Seventy-five Thousand [75,000.00) Dollars, plus interest thereon at the rate of seven per cent (7%) per annum from January 1, 1924, to respective dates of realization thereof, the Seventy-five Thousand Dollars and interest being hereinafter called "Albright's Profit," has been so distributed to said Albright. (c) Forty per cent (40%) thereof, hereinafter called "Culver's Profit" to Culver; (d) All, however, subject to the following conditions and limitations: (1) No distributions of "Culver's Profit" shall be made to Culver while taking the cash then distributable under Subdivision Eighth, plus the unpaid portions of the sales price on outstanding contracts of sale, upon which the buyers are not in default, does not equal an aggregate figure sufficient to pay the Syndicate Profit and Albright's Profit, as well as Culver's Profit. But while1933 BTA LEXIS 1191">1196 such aggregate is so sufficient, Culver shall participate in such division on the forty per cent (40%) basis, but while it is not sufficient the distribution under this subdivision Eighth shall be made, one-third (1/3) to Albright and two-thirds (2/3) to the Syndicate Holders to apply on the Syndicate Profit and Albright's Profit, respectively; but, while the condition permitting distribution hereunder to Culver does exist, than if Culver is short in his forty per cent (40%) due to such one-third and two-third distributions to the Syndicate and Albright, he shall get all distributions until his distributions equal forty per cent of the total amount distributed under this subdivision Eighth; (2) After the Syndicate Profit and Albright's Profit have been paid in full, then and thereafter all distributions under this Subdivision Eighth shall be made to Culver, even though they exceed the forty per cent. 28 B.T.A. 82">85 The sum of $75,000 to which the petitioner was entitled in accordance with the agreement dated November 1, 1923, marked "Petitioner's Exhibit B," from which above quotations are taken, was paid to him as soon as funds were available, said payments being made as follows: 1933 BTA LEXIS 1191">1197 1926$44,625192719,000192811,375Respondent has allocated the sum of $75,000 to which the petitioner was entitled in accordance with the agreement dated November 1, 1923, as follows: 1924$7,678.66192546,200.71192621,120.63During the years 1924 and 1925, petitioner was one of the beneficiaries designated as first beneficiaries in Trust No. S - 5925, and owned a 15/126ths beneficial interest therein. In addition to being designated as one of the first beneficiaries of Trust No. S - 5925, petitioner was also designated in said trust instrument as one of the second beneficiaries and entitled to one half of the profits, if any, remaining after all other payments had been made as provided for in the declaration of trust creating Trust No. S - 5925. The proceeds of Trust No. S - 5925 were to be distributed as provided in section 3 of said declaration of trust. This section provides for several priorities, but paragraph six seems to be the only one relevant to the issue to be decided here. It reads as follows: 6th: After payment in full of said debt secured hereunder, the surplus not required for either or any of the foregoing1933 BTA LEXIS 1191">1198 distributions - of the proceeds from such sale shall be disbursed by said trustee as follows: First: To the return of advances if any advanced by the First Beneficiaries together with interest thereon. Second: To the repayment of commissions. Third: "Then to the payment, to the First Beneficiaries hereunder as their interests under this Trust then appear, of the following: (a) Interest at the rate of six per cent (6%) per annum, payable quarterly, on the amount from time to time remaining unpaid of the $126,000.00 mentioned in the next paragraph as payable under this Trust to the First Beneficiaries hereunder; excepting such portion (if any) thereof as shall have been paid; Which said interest - but not the principal - the Second Beneficiaries hereunder, by their approval of this Declaration, do promise and agree to pay; (b) One Hundred Twenty-Six Thousand Dollars ($126,000.00) hereby declared payable solely under this Trust to the First Beneficiaries hereunder, as their interests appear. 28 B.T.A. 82">86 Fourth: After payment in full of all amounts mentioned in the foregoing distributions 'First,' 'Second,' and 'Third' then to the payment of another sum of One Hundred Twenty-six1933 BTA LEXIS 1191">1199 Thousand Dollars ($126,000.00) - without interest - also hereby declared payable solely under this Trust to the First Beneficiaries hereunder, as their interests under this Trust then appear. Fifth: And the surplus, if any, of the proceeds from such sale shall be paid to said Second Beneficiaries hereunder as their interests under this Trust then appear. IT IS EXPRESSLY UNDERSTOOD, that, upon payment in full to the First Beneficiaries hereunder of the hereinbefore mentioned two sums of One Hundred Twenty-six Thousand Dollars ($126,000.00) with said interest only upon the first thereof, all interest in and to this Trust of said First Beneficiaries - as such - thereupon immediately shall cease and determine." Respondent in determining petitioner's net income for the year 1925 has, pursuant to section 3 of the declaration of trust designated No. S - 5925 (just quoted above), included in income the sum of $59,828.54 as second beneficiary's profit. No distributions were made to the first beneficiaries, other than interest pursuant to the terms of section 3 of the declaration of trust designated No. S - 5925, by the trustee prior to December 31, 1925. The trustee did not pay, 1933 BTA LEXIS 1191">1200 and the petitioner did not receive during the years 1924 and 1925, any sum or sums representing amounts due second beneficiaries in accordance with section 3 of Trust No. S - 5925. Petitioner's books of account during the years 1924 and 1925 were kept on the cash receipts and disbursements basis and his income tax returns were filed on the same basis. OPINION. BLACK: Section 704(b) of the Revenue Act of 1928, which is involved in this proceeding, is printed in the margin. 11933 BTA LEXIS 1191">1201 The Commissioner in his determination of the deficiencies has determined the net income of the two trusts for each of the taxable years and has also determined the beneficiaries to whom it was distributable and in what amounts it was distributable to each. Petitioner does not contest the determination which the Commissioner has made of the net income of the trusts, but he does contest respondent's determination of the amount of such income which was distributable to petitioner in each of the taxable years. 28 B.T.A. 82">87 We think it will make for clarity if we discuss the trusts separately. Trust No. 2 - 1569.The Commissioner has determined the net income of this trust for the taxable years to be: 1924, $23,035.99; 1925, $146,932.11. Of the above amounts he has allocated, for the year 1924, to the petitioner the sum of $2,879.50 as his share of the profits distributable to the beneficiaries, and $7,678.66 designated as residuary profit. For the year 1925 the Commissioner has allocated to petitioner $16,074.64 as his share of the profits distributable to the beneficiaries, and $46,200.71 designated as residuary profit. Petitioner does not contest respondent's allocation1933 BTA LEXIS 1191">1202 to him of his distributable share of the income for each of the respective taxable years on account of his being one of the beneficiaries of the trust. It has been stipulated, however, that this part of petitioner's share for each of the taxable years was somewhat smaller than that which respondent determined and effect will be given to this stipulation in a recomputation under Rule 50. Petitioner does, however, contest the action of respondent in adding $7,678.66 to his income for 1924, and $46,200.71 to his income for 1925, under the designation of residuary profits from Trust No. 2 - 1569. Petitioner's assignment of error in this respect is stated in his petition as follows: Petitioner, in addition to owning a 26.425/150ths interest in Trust 2 - 1569, is also entitled, in the nature of a commission or bonus under the terms of said trust to the sum of $75,000. This sum is not received on account of his beneficial interest and is therefore not taxable in accordance with section 704(b), Revenue Act of 1928, whether distributed or not, but is taxable in the year received. We do not agree with this contention. Section 704(b) provides that the income of a trust coming within1933 BTA LEXIS 1191">1203 its provisions shall be taxable (whether distributed or not) to the beneficiaries. As we view it, the question we have to decide is not whether the two amounts in question, $7,678.66 for 1924 and $46,200.71 for 1925, were actually distributed to petitioner during the taxable years, but whether such amounts were distributable income to him as a beneficiary of the trust in those years. If such profits were distributable income to him as a beneficiary of the trust, they are taxable income to him whether actually distributed or not. H.R. 1, when it first passed the House of Representatives in 1928, did not contain any section 704(b). An amendment was added in the Senate as section 704(a) and (b). Section 704(b), as added by the Senate, gave these real estate trusts the option to file their election to be taxed as a trust and not as an association, but did not 28 B.T.A. 82">88 make clear that the income of the trust was to be taxed to the beneficiaries whether distributed or not. The bill was amended in conference as follows: "On page 41 of the Senate engrossed amendments, line 21, after 'taxable' insert 'whether distributed or not'." In the statement accompanying the conference1933 BTA LEXIS 1191">1204 report to the House of Representatives, the managers on the part of the House had the following to say regarding section 704(b) as amended by the conference report: Under existing law there is considerable confusion as to the proper distinction to be drawn between a trust and an association, particularly certain so-called real estate trusts. While it is not deemed advisable at this time to write into the statutes a more explicit definition of a trust and an association, it was desired by the Senate to make specific provision retroactively to make definite and certain the tax liability in the past of these organizations. The House recedes with a clarifying amendment making it certain that the amounts will be taxable to the beneficiaries whether or not such amounts are actually distributed. [Italics supplied.] Cf. ; . An examination of the agreement entered into November 1, 1923, will show that the profits designated as general profits were to be divided (a) 40 percent to the syndicate holders until they should receive $300,000; (b) 20 percent to Albright (petitioner) 1933 BTA LEXIS 1191">1205 until he should receive $75,000; (c) 40 percent to Culver. There was no agreement that the syndicate holders should receive their 40 percent of the profits to a limit of $300,000 ahead of petitioner's 20 percent of the profits to a limit of $75,000. It was Culver's profits which were to be postponed and the agreement specifically provided that, when the profits were insufficient to make distribution of profits to Culver, the division of the profits should be made on the basis of one third to Albright and two thirds to syndicate holders. This is what the respondent has done in his determination of the distributable income of the trust for the years 1924 and 1925, and we think it is in accordance with the agreement of the parties. It is true that in the agreement of November 1, 1923, petitioner was designated as agent for the sale of the property when subdivided into lots and of course any commissions which were paid for the sale of lots were deductions from the gross income of the trust and do not constitute a part of the net income of the trust which the Commissioner has determined for the two taxable years. There is no contention that the Commissioner has refused to allow, 1933 BTA LEXIS 1191">1206 as a deduction in determining the net income of the trust, any of the commissions paid for the sale of lots. 28 B.T.A. 82">89 In addition to the 20 percent commissions which were to be paid for the sale of each lot, Albright was to receive a division of what were designated general profits. This amount, as we have already stated, was to be 20 percent of said general profits not to exceed $75,000. These general profits were not deductible as a part of the expense of selling the lots. It seems to us that this part of the agreement constituted Albright a beneficiary of the trust within the meaning of section 704(b), Revenue Act of 1928, and the amounts of these general profits which were his distributable share during the two taxable years in question were taxable to him, although he did not receive them until a later date and although he filed his income tax return on the cash receipts and disbursements basis. Respondent's action in this respect is approved. Trust No. S - 5925.Respondent in his determination of the deficiencies increased the petitioner's distributable share of the trust income as one of the first beneficiaries for the year 1924, from $7,876, as reported1933 BTA LEXIS 1191">1207 by petitioner in his return, to $11,319.86. Respondent added nothing to petitioner's income for the year 1924 on account of his being one of the second beneficiaries of the trust. For 1925 respondent decreased petitioner's distributable share of income as one of the first beneficiaires of the trust from $6,999.16 to $3,680.15 and added to petitioner's income $59,828.54 as petitioner's share of the distributable income of the trust due the second beneficiaries. This latter item petitioner contests in his brief on the following ground: "Petitioner is not taxable upon any sums purporting to represent 'second beneficiary' profits from Title Insurance and Trust No. S - 5925, Cahuena Park, until such sums are actually received by the petitioner." An examination of the petition does not disclose any assignment of error corresponding to the above quotation from petitioner's brief. The Board has held that unless an issue is raised by the pleadings, it is too late to raise it for the first time in the brief. However, even if it be conceded that petitioner's allegations in the petition are sufficient to raise the question as presented by his brief, we think he must fail. As we have1933 BTA LEXIS 1191">1208 already pointed out in our discussion under Trust No. 2 - 1569, section 704(b) requires that the income of the trust described therein shall be taxable to the beneficiaries whether distributed or not. All that is required is to ascertain the beneficiaries to whom such income is distributable and what share each is entitled to receive. Upon the ascertainment of these facts, the income which 28 B.T.A. 82">90 each beneficiary is entitled to receive is taxable to him whether distributed or not and whether he files his income tax return on an accrual basis or on the cash receipts and disbursements basis. An examination of the revenue agent's report, which was approved by the Commissioner in his determination of the deficiencies, discloses that the revenue agent determined that the distributable net income of Trust No. S - 5925 for 1924 was $95,086.79, and for 1925, $150,570.31. The petition filed herein assailed this determination upon several grounds, but evidently these assignments of error have all been abandoned, because the stipulation contains no facts with reference to them and nothing is said about them in petitioner's brief. The only reason which petitioner urges as to why the1933 BTA LEXIS 1191">1209 $59,828.54, determined by respondent to be petitioner's distributable share for the year 1925 as one of the second beneficiaries of the trust, should not be added to his taxable income for that year, is that he did not receive that amount in 1925 and under the terms of the trust agreement could not possibly have received it in that year. It must be remembered that we are dealing here with income and not the corpus of the trust estate. It is true that section 3 of the trust agreement, quoted in full in our findings of fact, provided that the first beneficiaries should first recover their full principal; viz, $126,000, and interest thereon at 6 percent, and then the first $126,000 of profits should be distributed to them, after which all their interest in the trust should cease. Then the second beneficiaries, of whom petitioner is one, were entitled to receive the balance of earnings. It is plain that the above agreement, under the facts stipulated, postponed the actual receipt of petitioner's share in these surplus earnings beyond the taxable year 1925, but that fact does not affect petitioner's right to their ultimate distribution. The total profits of the trust in question1933 BTA LEXIS 1191">1210 for the years 1924 and 1925, as determined by respondent, were $245,657.10. Manifestly only $126,000 of this income belonged to the first beneficiaries under the terms of the agreement, and the balance was ultimately distributable to the two second beneficiaries, of whom petitioner was one. Because he was a second beneficiary of the trust makes him none the less a beneficiary. It is true that the payment to these second beneficiaries of their share of the profits had to be postponed until the first beneficiaries had not only received $126,000 in profits, but a return of their capital of $126,000, but this capital payment has nothing to do with the taxability of income - it simply affects the time of payment to the second beneficiaries of their share of the profits. The respondent has so treated it. The first $126,000 of the $245,657.10 income of the trust for 1924 and 1925 respondent has held to be distributable to the first beneficiaries. 28 B.T.A. 82">91 This resulted in none of the distributable income of the trust for 1924 being allocated to the second beneficiaries, but resulted in $119,657.07 of 1925 income being allocated to second beneficiaries. Of this, petitioner was held1933 BTA LEXIS 1191">1211 to be entitled to one-half, or $59,828.54, and it is this amount which respondent has added to petitioner's income for 1925 as income of second beneficiary. We think respondent's action in this respect is in accord with the contract agreement between the parties and the law which is applicable to the case. Cf. Trust No. 5522 and Trust No. 5654, , allegation (d) therein. Respondent's determination in this respect is approved. Reviewed by the Board. Decision will be entered under Rule 50.Footnotes1. (b) For the purpose of the Revenue Act of 1926 and prior Revenue Acts, a trust shall, at the option of the trustee exercised within one year after the enactment of this Act be considered as a trust the income of which is taxable (whether distributed or not) to the beneficiaries, and not as an association, if such trust (1) has a single trustee, and (2) was created and operated for the sole purpose of liquidating real property as a single venture (with such powers of administration as are incidental thereto, including the acquisition, improvement, conservation, division, and sale of such property), distributing the proceeds therefrom in due course to or for the benefit of the beneficiaries, and discharging indebtedness secured by the trust property, and (3) has not made a return for the taxable year as an association. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621039/	KENNETH H. and BONNIE S. SMITH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSmith v. CommissionerDocket No. 13935-78.United States Tax CourtT.C. Memo 1981-644; 1981 Tax Ct. Memo LEXIS 97; 42 T.C.M. 1621; T.C.M. (RIA) 81644; November 4, 1981. 1981 Tax Ct. Memo LEXIS 97">97 During a part of 1975, H was employed by SRC, which maintained a savings and profit-sharing plan for its employees. H's employment with SRC was terminated before he was eligible to receive employer contributions to such plan for 1975. After his employment with SRC was terminated, H made a contribution to an IRA. Held, it has not been shown that H may not subsequently receive credit for his prior participation in the SRC plan, and therefore, during 1975, H was an "active participant" in a qualified plan; accordingly, H may not deduct the contribution to the IRA. Foulkes v. Commissioner, 638 F.2d 1105 (7th Cir. 1981), revg. a Memorandum Opinion of this Court, distinguished. Kenneth H. Smith and Bonnie S. Smith, pro se. William P. Hardeman, for the respondent. SIMPSONMEMORANDUM FINDINGS OF FACT AND OPINION SIMPSON, Judge: The Commissioner determined a deficiency of $ 2,223.97 in the petitioners' Federal income tax for 1975. After concessions by the petitioners, the sole issue for decision is whether the petitioners are entitled to deduct a contribution made to an individual retirement account (IRA) in 1975. FINDINGS OF FACT Some of the facts have been stipulated, and those facts are so found. The petitioners, Kenneth H. and Bonnie S. Smith, husband and wife, maintained their legal residence in Lewisville, Tex., at the time they filed their petition in1981 Tax Ct. Memo LEXIS 97">98 this case. They timely filed their joint Federal income tax return for 1975 with the Internal Revenue Service Center, Austin, Tex.Mr. Smith commenced working for Sears, Roebuck & Co. (Sears) in 1969 and continued working there until September 1975, when Sears terminated his employment. During the years Mr. Smith was employed by Sears, it maintained for its employees the Savings and Profit Sharing Fund of Sears Employees (the plan). The plan provided for both employee and employer contributions. During 1975, employer contributions were only credited to the accounts of individuals who were employees as of November 15. During 1975, Mr. Smith made contributions of $ 750 to the plan. After he was terminated, such amount was withdrawn from the plan and returned to him without interest. Since Mr. Smith was not employed by Sears as of November 15, 1975, no employer contributions were credited to his account for that year. On December 15, 1975, Mr. Smith contributed $ 1,500 to an IRA. In his notice of deficiency, the Commissioner disallowed a deduction for such contribution on the ground that Mr. Smith was ineligible to contribute to an IRA. 11981 Tax Ct. Memo LEXIS 97">99 OPINION The petitioners contend that the intent of Congress in authorizing contributions to an IRA was to provide a tax benefit for the retirement savings of those taxpayers who did not receive benefits during the taxable year from an employer-sponsored pension or profit-sharing plan. Since Mr. Smith received no employer contributions to the plan during 1975, they argue that they should be allowed to deduct his contribution to an IRA. The Commissioner contends that during part of 1975, Mr. Smith was an active participant in a plan described in section 401(a) of the Internal Revenue Code of 19542 and was, therefore, ineligible to contribute to an IRA. 3Subject to certain limitations, section 219(a) allows taxpayers to deduct amounts paid in cash to an IRA during the taxable year. However, section 219(b)(2) provides that No deduction is allowed under subsection (a) for an individual for1981 Tax Ct. Memo LEXIS 97">100 the taxable year if for any part of such year-- (A) he was an active participant in-- (i) a plan described in section 401(a) which includes a trust exempt from tax under section 501(a) * * * [Emphasis added.] Section 219 does not define the term "active participant." See Orzechowski v. Commissioner, 69 T.C. 750">69 T.C. 750, 69 T.C. 750">753 (1978), affd. 592 F.2d 677 (2d Cir. 1979). However, the legislative history explains such term: An individual is to be considered an active participant in a plan if he is accruing beneits under the plan even if he only has forfeitable rights to those benefits. Otherwise, if an individual were able to, e.g., accrue benefits under a qualified plan and also make contributions to an individual retirement account, when he later becomes vested in the accrued benefits he would receive tax-supported retirement benefits for the same year both from the qualified plan and the retirement savings deduction. * * * [H. Rept. 93-807 (1974), 1974-3 Supp. C.B. 236, 364.] In Orzechowski, we relied upon that legislative history and held that a taxpayer who was covered by a qualified plan during the taxable year, even though his rights1981 Tax Ct. Memo LEXIS 97">101 thereunder were forfeitable, was not allowed to contribute to an IRA. Deductions are a matter of legislative grace ( New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435 (1934)), and we are required to follow the limitations established by the Congress. In a host of cases, we have held that taxpayers were not entitled to deduct contributions to IRAs because they were covered by a qualified plan during some part of the taxable year. See Johnson v. Commissioner, 620 F.2d 153 (7th Cir. 1980), affg. per curiam a Memorandum Opinion of this Court; Chapman v. Commissioner, 77 T.C. (Aug. 24, 1981). 41981 Tax Ct. Memo LEXIS 97">102 In Foulkes v. Commissioner, 638 F.2d 1105 (7th Cir. 1981), revg. a Memorandum Opinion of this Court, however, the Seventh Circuit held that a taxpayer who terminated his employment during 1975, thereby forfeiting his rights to benefits under his employer's noncontributory pension plan, could deduct his contribution to an IRA which he established during that year. In reaching such holding, the Seventh Circuit found that the congressional purpose in enacting the "active participant" limitation of section 219(b)(2)(A)(i) was to prevent the potential for a double tax benefit; that is, that if a taxpayer were able to accrue benefits under a qualified plan and also make contributions to an IRA, he would, when he later becomes vested in such accrued benefits, receive tax-supported retirement benefits for the same year from both the qualified plan and the IRA. 638 F. 2d at 1107 n. 10, 1109 n. 14; H. Rept. 93-807, supra. In making such determination, the Seventh Circuit held that the potential for a double benefit should be made as of year end and that, on the facts of that case, no potential for a double benefit existed. However, in Foulkes, the1981 Tax Ct. Memo LEXIS 97">103 Commissioner conceded that the break-in-service rules of section 411(a)(6) could not have applied to Mr. Foulkes. Since Foulkes, the issue has come before this Court again in Chapman v. Commissioner, supra. In that case, the taxpayer was covered by a qualified pension plan, although he had no vested right to his accrued benefits. The pension plan provided that an employee was entitled to previously accrued benefits if he ceased employment but was re-employed within the period provided by the break-in-service provision of the pension plan. In 1976, the year in which the taxpayer's employment was terminated, he made, and claimed a deduction for, a contribution to an IRA. In denying the taxpayer a deduction for such contribution, we found that unlike Foulkes, the potential for a double benefit did exist since Mr. Chapman would be entitled to a reinstatement of his previously accrued benefits if he were to be re-employed by his employer within the time provided by the break-in-service provision of the pension plan. Consequently, we held that the rationale adopted by the Court of Appeals in Foulkes was not applicable. 77 T.C. at . The parties assume that1981 Tax Ct. Memo LEXIS 97">104 the plan was a "qualified plan" 5 within the meaning of section 401(a); therefore, the break-in-service rules of section 411(a)(6) may have been included in it. See sec. 401(a)(7). Section 411(a)(6)(C) provides that for a participant in a defined contribution plan (such as Mr. Smith) who has had any 1-year break in service, years of service after such break shall not be required to be taken into account for purposes of determining the nonforfeitable percentage of his accrued benefit derived from employer contributions which accrued before such break. However, section 1.411(a)-6(c)(1)(ii), Income Tax Regs., provides, subject to certain exceptions (see sec. 1.411(a)-6(c)(1)(iii)), that although years of service completed after a 1-year break in service are not required to be taken into account for purposes of determining the nonforfeitable percentage of the participant's right to employer-derived benefits which accrued before such break, years of service before such break may not be disregarded in determining the nonforfeitable percentage of a participant's right to employer-derived benefits which accrue after such break. Thus, if Mr. Smith is re-employed by Sears after 1975, 1981 Tax Ct. Memo LEXIS 97">105 his pre-termination years of participation in the plan could result in an increase in the nonforfeitable percentage of his right to Sears' contributions to the plan which are made subsequent to his re-employment. Therefore, the potential for a double tax benefit did in fact exist, and consequently, the rationale adopted by the Seventh Circuit in Foulkes is not applicable. See Chapman v. Commissioner, supra.The petitioners have the burden of proof. Rule 142(a), Tax Court Rules of Practice and Procedure; Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). Based on the record before us, we are compelled to find and hold that in 1975 Mr. Smith was an "active participant" in a qualified plan. Accordingly, the petitioners are not entitled to a deduction under section 219 for the contribution to an IRA made during such year. 61981 Tax Ct. Memo LEXIS 97">106 Decision will be entered for the respondent. Footnotes1. In his notice of deficiency, the Commissioner did not assert an excise tax (see sec. 4973, I.R.C. 1954↩) for improperly depositing funds into an IRA, nor was such issue raised in the pleadings.2. All statutory references are to the Internal Revenue Code of 1954 as in effect during the year in issue. ↩3. The Commissioner concedes that after Sears terminated his employment, Mr. Smith was not employed by an employer who maintained a retirement plan.↩4. See also Goldman v. Commissioner, T.C. Memo. 1981-223; Ellor v. Commissioner, T.C. Memo. 1981-148; Hall v. Commissioner, T.C. Memo. 1980-576; Lightweis v. Commissioner, T.C. Memo. 1980-290; Andalman v. Commissioner, T.C. Memo. 1980-276; Alexander v. Commissioner, T.C. Memo. 1980-71; Toloczko v. Commissioner, T.C. Memo. 1979-424; Cooper v. Commissioner, T.C. Memo. 1979-256; Goldstein v. Commissioner, T.C. Memo. 1978-480; Pervier v. Commissioner, T.C. Memo. 1978-410↩.5. The petitioners did not introduce into evidence a copy of the plan.↩6. Sec. 311 of the Economic Recovery Tax Act of 1981, Pub. L. 97-34, 95 Stat. 274, 283, provides that an individual, whether or not he is an active participant in a qualified plan, can establish and deduct contributions to an IRA. However, Congress has restricted that privilege to tax years beginning after Dec. 31, 1981, and we have no authority to apply such liberalized provision to earlier years.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621042/	Helene Irwin Fagan v. Commissioner.Fagan v. CommissionerDocket Nos. 13361, 18320.United States Tax Court1950 Tax Ct. Memo LEXIS 290; 9 T.C.M. 44; T.C.M. (RIA) 50017; January 26, 19501950 Tax Ct. Memo LEXIS 290">290 The petitioner completed building a residence in 1929. In 1933 she decided never again to use the property as a residence. The property was listed with a real estate broker from 1933 to 1941 as being for sale and from 1941 to 1947 for sale or rent. The property was sold in 1947. Held, under the provisions of section 23 (a) (2) and section 23 (1) (2), the property was held for the production of income when it was offered for sale in 1933. The fair market value of the depreciable portion of the property is determined as of that date. In 1929 the petitioner purchased ten non-interest bearing notes of Monterey Hospital, Ltd., at face value of $1,000 each. The petitioner considered that the purchase of these notes was a proper gesture of interest in support of a community hospital then in the process of being built. The notes were sold in 1943 for a total consideration of $100. Held, this was not a transaction entered into for profit within the meaning of section 23 (e) (2), I.R.C.Theodore R. Meyer, Esq., and Robert H. Walker, Esq., 111 Sutter St., San Francisco, Calif., for the petitioner. C. W. Nyquist, Esq., for the respondent. VAN FOSSAN Memorandum Findings of Fact and Opinion The respondent determined deficiencies in the petitioner's tax liabilities as follows: DocketNo.YearTaxAmount133611943Income and VictoryTax$19,942.48183201944Income Tax8,866.98The year 1942 is involved in these proceedings due to the forgiveness provisions of the Current Tax Payment Act of 1943. Certain issues were not contested by the petitioner1950 Tax Ct. Memo LEXIS 290">292 or were settled by stipulation, leaving in controversy the following: 1. The fair market value of the depreciable portion of a residence at the time of its conversion to property held for the production of income, 2. Whether or not the loss realized on the sale of certain non-interest bearing notes was a loss incurred in a transaction entered into for profit within the meaning of section 23 (e) (2) of the Internal Revenue Code. The case was submitted upon a stipulation of facts, exhibits, oral testimony and a deposition. The facts stipulated are so found. Other facts are found from the evidence. Findings of Fact The petitioner, Helene Irwin Fagan, is an individual and is now, and has been since 1925, a resident of the town of Hillsborough, County of San Mateo, State of California. The property, the value of which is here in issue, is referred to hereinafter as the Pebble Beach house, or the house, and includes the adjacent garage. The petitioner commenced construction of the Pebble Beach house in 1926, with the intention of occupying it as a residence for a part of each year. Construction of the house was completed in December, 1929, at a total cost1950 Tax Ct. Memo LEXIS 290">293 to the petitioner of $700,911.97, exclusive of the cost of the land. The land upon which the house was located was 2.924 acres in area and was acquired by the petitioner in 1923 at a cost of $20,000. An adjoining parcel of 1.610 acres was purchased by petitioner in 1931 at a cost of $10,000, and is still owned by the petitioner. After the petitioner married Paul I. Fagan in 1929, her plans for the use of the Pebble Beach house changed. The petitioner and her husband decided to divide their time between Hillsborough and the Hawaiian Islands and abandoned her plans for using the Pebble Beach house as a part time residence. Petitioner built a new house in Hawaii in 1930 which cost her approximately $350,000. Neither the petitioner nor her husband ever occupied the Pebble Beach house as a residence, and, in fact, never used it at all except for a few weekends (from four to ten in number) in 1930 and 1931, and on one occasion in 1931 when the petitioner's husband spent about ten days in the house recuperating from a broken back. In 1933 the petitioner decided to sell the Pebble Beach house. This was in accordance with her decision at that time never to use the house again. The petitioner1950 Tax Ct. Memo LEXIS 290">294 listed the house for sale with a licensed real estate brokerage firm in 1933. This firm was told to submit to petitioner any reasonable offers. There were no offers made until the house was sold in 1947. The petitioner's original minimum price in 1933 was $250,000. By 1941 this price was reduced to $200,000. The house was continually listed for sale from 1933 to 1947. During this period the house was shown to numerous prospects by the real estate dealer with whom it was listed. One saleswoman showed it to approximately 100 prospects. Other real estate agents and firms who knew that the property was for sale and the petitioner's financial agents also attempted to sell it. The Pebble Beach house and the 2.924 acres of land upon which it was located was sold in 1947 for the sum of $160,000. This was an arms length transaction at the then market value. In 1941 the petitioner listed the house for rent at a rental of $1,000 per month for the summer months, or $750 per month for a three to six months' lease, or $500 per month for a lease for a year or longer. The Pebble Beach house continued to be so listed for rental from 1941 to 1947 when the house was sold. During those years, the1950 Tax Ct. Memo LEXIS 290">295 petitioner and her husband and various real estate agents made continual efforts to rent the house. The petitioner never succeeded in renting the house except for a period of three days in 1946 when it was rented in connection with the filming of a motion picture. The expenses of maintaining the Pebble Beach house paid by the petitioner and all of which were ordinary and necessary were $3,809.01, $4,083.27 and $4,189.52 in the years 1942, 1943, and 1944, respectively. The following table shows the assessed value of the Pebble Beach house (excluding the land upon which it was located), determined by the County Assessor of Monterey County, State of California, for real property tax purposes for each of the years 1929 to 1944, and the percentages of actual value stated by said Assessor to be represented by assessed values generally in the County: AssessedPer-YearValuecentage1929$175,00033 1/31930175,00033 1/31931175,000401932100,00040193370,00040193470,00040193591,00050193691,000501937100,000501938100,00050193990,00050194090,00050194190,00050194290,00050194360,00050194454,000501950 Tax Ct. Memo LEXIS 290">296 The Pebble Beach house was conceived of by the petitioner as a perfect example of Byzantieg style of architecture. The petitioner took an active interest in the building of the house. She consulted the architect and visited the site of the house on numerous occasions during the period of construction. She furnished the house largely with antiques brought from Europe. The house itself is located on Monterey Peninsula approximately 120 miles south of San Francisco on the coast of California. The area is famous for its even climate and scenic beauty. The Pebble Beach house is situated in the most desirable section of the peninsula overlooking Carmel Bay and the ocean in an area of large homes and estates. The house was built into the side of the hill amidst the trees and rocks. The house is 180 feet long and varying in width from 24 to 44 feet. It contains two floors above the ground and a basement. The first floor consists of an entrance hall, drawing room, dining room, and various service rooms and servants' dining and bedrooms. The second floor contains seven bedrooms and bathrooms. The house is of reinforced concrete and stone. The exterior walls are of French limestone. Many1950 Tax Ct. Memo LEXIS 290">297 of the interior walls are finished with this same French limestone. The floors of the principal rooms are of marble, mosaic or travertine with oak flooring in the servants' sections. The roof is wood construction overlaid with handmade terra cotta tiles. The cloister columns and the interior and exterior columns of the entrance hall are of imported Italian marble with carved marble caps. The windows of the main room are of metal with wide lead reinforcements. The main door is of hardwood with bronze outer covering. The heating system is partly direct and partly indirect. Most of the radiators are concealed behind carved stone grilles. The plumbing consists of brass piping and the bathroom fitting are of antique design. The floor in one of the bathrooms is inlaid with marble and gold leaf and covered with glass and the fixtures are of gold finish. The black marble tub is carved to resemble a sarcophagus. The garage is construted of the same material as the house. The first floor has a capacity for four automobiles. The second floor contains additional servants' living quarters. The house was appraised by a firm of appraisers in 1933 as having a cost of replacement at that time of1950 Tax Ct. Memo LEXIS 290">298 $300,997.45 and a sound value of $270,897.71 based on depreciation of 10 per cent. The size and character of the house decreased the number of potential buyers. The house was of such size that it required about 12 servants to staff it properly. The parties have stipulated that the rate of depreciation for each of the taxable years shall be two per cent per annum of the basis for depreciation as shall be determined by this Court. We find that the fair market value and the basis for depreciation of the house, including the garage but excluding the land on which it is situated, was $150,000 in 1933. In 1929 the petitioner purchased at a total cost of $10,000 ten non-interest bearing debenture notes of Monterey Hospital, Ltd., having a face value of $1,000 each. The petitioner sold all of the notes in 1943 for a total consideration of $100 to a doctor on the staff of the hospital. The petitioner purchased these notes in what she considered to be a proper gesture of interest in support of a community hospital then in the process of being built. The purchase of these notes by the petitioner was not intended to result in a profit to her. In the petitioner's tax returns filed for1950 Tax Ct. Memo LEXIS 290">299 1942, 1943, and 1944, the respondent disallowed deductions for depreciation and maintenance expenses of the Pebble Beach house for lack of evidence that the property was held for the production of income. In the petitioner's tax return filed for the year 1943 the respondent disallowed a deduction for a long-term capital loss of $4,950 (50% of $9,900) on the sale of the noninterest bearing notes of Monterey Hospital, Ltd. Opinion VAN FOSSAN, Judge: The first issue to be decided is the fair market value of the depreciable portion of a residence property at the time of its conversion to property held for the production of income. The pertinent sections of the Internal Revenue Code are as follows: "SEC. 23. DEDUCTIONS FROM GROSS INCOME. "In computing net income there shall be allowed as deductions: (a) Expenses. - * "(2) Non-Trade or Non-Business Expenses. - In the case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income. * "(1) Depreciation. - A reasonable allowance1950 Tax Ct. Memo LEXIS 290">300 for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) - * * "(2) of property held for the production of income. * The respondent in his letters of deficiency disallowed entirely deductions for depreciation and maintenance expenses of the Pebble Beach house in 1942, 1943, and 1944. In his brief the respondent abandoned this position and conceded that during the taxable years the house was held by the petitioner for the production of income in so far as deductions under section 23 (a) (2) and 23 (1) (2) are concerned and that at some time prior to the taxable years the property was converted to property held for the production of income. The property has been adequately described and its fair market value of $150,000 in 1933 determined in our findings of fact. The question of when the property was converted to property held for the production of income requires further consideration. The specific question is whether the property was held for the production of income in 1933 when it was first offered for sale or whether it was so held when it was offered for sale or rent in 1931. In Mary Laughlin Robinson, 2 T.C. 305">2 T.C. 305,1950 Tax Ct. Memo LEXIS 290">301 we held that the abandonment of property as a residence and the listing of it for rent or for sale with real estate firms was an appropriation of it to income producing purposes. In our opinion, a proper interpretation of the term "property held for the production of income" would lead to the conclusion that this property was so held in 1933 when it was permanently abandoned as a residence and offered for sale. Such would seem to be within our holding in the Robinson case. We so find. This view is supported by the respondent's Regulations 111, section 29.23 (a)-15, wherein he states, in part, as follows: "* * * Expenses incurred in managing, conserving, or maintaining property held for investment may be deductible under this provision even though the property is not currently productive and there is no likelihood that the property will be sold at a profit or will otherwise be productive of income and even though the property is held merely to minimize a loss with respect thereto." Our findings of fact that the fair market value of the house in 1933 was $150,000 is well supported by the evidence. The parties made greatly divergent claims as to its fair market value. The petitioner1950 Tax Ct. Memo LEXIS 290">302 introduced testimony of a real estate appraiser and two real estate sales people, all of whom had experience with property in that area and who testified that the house was worth from $300,000 to $350,000 in 1933. The respondent's one witness, a real estate appraiser, testified that the house had a fair market value of $35,000 in 1933. The respondent's witness had considerable experience in appraising real estate property but had not previously appraised nor participated in the sale of any property in the Pebble Beach area. These estimates offered by the parties are of the value of the house and garage and excluded the value of the land. The property was listed for sale with a real estate broker from 1933 until 1947. The property was shown to about 100 people by one saleswoman alone. The price asked in 1933 was $250,000. This price was reduced to $200,000 by 1941. There were no offers made for the purchase of the house which were reasonably close to these amounts. In point of fact, the record discloses no offer made prior to the consummation of the sale of the property in 1947 for $160,000, which figure included land and building. In arriving at the fair market value of the house1950 Tax Ct. Memo LEXIS 290">303 in 1933 we have considered, among other factors, its location and design, the original cost, the replacement cost, its appraised value for local taxes, the condition of the real estate market at the various times, the several opinions of real estate experts and the limited number of potential buyers of such a property. The petitioner should be allowed deductions in the taxable years for expenses of maintenance and for depreciation at the stipulated rate of two per cent per annum of the basis herein determined. The second issue is whether or not a loss realized on the sale of certain notes was deductible under the provisions of section 23 (e) (2) of the Internal Revenue Code: "SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: * * (e) Losses by Individuals. - In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise - * "(2) if incurred in any transaction entered into for profit, though not connected with the trade or business; or" * The notes were non-interest bearing, purchased at a total face value of $10,000. 1950 Tax Ct. Memo LEXIS 290">304 The petitioner considered that their purchase in 1929 was a proper gesture of interest in support of a community hospital then in the process of being built. The notes were sold in 1943 for a total amount of $100. These facts lead us to conclude that this was not a transaction entered into for profit and that the loss on the sale of the notes is not deductible within the meaning of the applicable provisions of the Code. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621043/	Irving Eisenberg and Edith Eisenberg v. Commissioner.Eisenberg v. CommissionerDocket No. 2810-65.United States Tax CourtT.C. Memo 1967-35; 1967 Tax Ct. Memo LEXIS 221; 26 T.C.M. 174; T.C.M. (RIA) 67035; February 28, 1967Irving Eisenberg, pro se, 411 W. Fullerton Pkwy., Chicago, Ill. James F. Hanley, for the respondent. TANNENWALDMemorandum Findings of Fact and Opinion TANNENWALD, Judge: Respondent determined deficiencies in the income tax of petitioners for 1961 and 1962 in the amounts of $486.47 and $199.18, respectively. Because of concessions by petitioners, the sole issue before us is whether certain postage and travel expenses incurred by petitioner husband were ordinary and necessary to his trade or business within the meaning of section 162. 1Findings of Fact Irving1967 Tax Ct. Memo LEXIS 221">222 and Edith Eisenberg are husband and wife residing in Chicago, Illinois, both at the time of filing their 1961 and 1962 returns and at the time of the filing of the petition herein. Their joint Federal income tax returns were filed timely for the years 1961 and 1962 with the district director of internal revenue at Chicago, Illinois. All references to "petitioner" shall be to Irving, Edith being a party to this proceeding solely by having joined in the returns. During the years 1961 and 1962 petitioner was an attorney engaged in the general practice of law in Chicago. His practice was domestic and local. In 1958 petitioner attended a lawyers' convention in Israel, where he met and became friendly with Israeli lawyers. Because of the lack of adequate libraries in Israel, petitioner was requested to acquire and donate law books or money for Israeli libraries. Upon his return to Chicago, he embarked on a program of obtaining and sending various public welfare and law books, as well as copies of statutes. As part of this program, he sent four or five thousand books to Israel, the majority of which were law books. During 1961 and 1962, petitioner forwarded various books and pamphlets1967 Tax Ct. Memo LEXIS 221">223 to the Supreme Court in Jerusalem, the bar association in Tel Aviv, Dr. M. Ishai, a professor of law, and the Department of Public Welfare in Jerusalem. The books and pamphlets relating to law were to be made available to law students for their use as well as for the use of the legal profession. Petitioner incurred expenses of $150 and $125, respectively, in 1961 and 1962 in forwarding these books and pamphlets to Israel. In the fall of 1961, petitioner took a three-week trip to Israel with his wife, two brothers, his sister, and a sister-in-law, who, while there, dedicated the planting of trees in the memory of petitioner's parents. Petitioner did not make the trip for clients. He did not receive any income directly or indirectly relating to his law practice nor were any clients ever referred to him as a result of the trip. Petitioner paid approximately $730 in 1961 for expenses relating to the trip to Israel, of which amount $633.77 is claimed to have been expended in connection with his business. All adjustments set forth in the statutory notice were conceded by the petitioners except the disallowance of the $633.77 relating to the trip to Israel, the disallowance of $1501967 Tax Ct. Memo LEXIS 221">224 of postage expense for 1961, and the disallowance of $125 for postage expense for 1962. Opinion Were the amounts expended by petitioner for postage on the shipment of books to Israel during 1961 and 1962 and a portion of the expenses of his trip to Israel in 1961 deductible as ordinary and necessary business expenses under section 162? Unquestionably, petitioner's motives in incurring the expenditures in question were stimulated by the deepest public spirit and concern for the development of the legal structure of a new nation. We have the utmost admiration for his efforts. But the record herein is utterly devoid of any evidence that he would ever, directly or indirectly, benefit in his law practice from such undertakings. Petitioner did testify, in vague and general terms, that his activities - particularly his trip - expanded his knowledge and would, as a consequence, enhance his ability and reputation as a lawyer. But, given the facts that his law practice was domestic and local in nature and that he never derived any business from his Israeli activities - or, for that matter, as far as this record goes, never had any realistic basis for expecting that he would do so - the1967 Tax Ct. Memo LEXIS 221">225 link to his business is too tenuous to satisfy the proximate relationship requirement which underpins section 162. The instant case does not even have as many supporting elements as those involved in Alexander P. Reed, 35 T.C. 199">35 T.C. 199 (1960), where we held that expenses incurred by a Pittsburgh lawyer, in attending a meeting of the International Law Association in Yugoslavia, were not deductible. On the authority of that case and others too numerous to warrant citation, we hold that the expenditures involved herein were personal expenses and, as such, nondeductible. 2Decision will be entered for the respondent. Footnotes1. All references are to the Internal Revenue Code of 1954.↩2. There is no question of a charitable deduction for the value of the books and the postage expenses incurred in connection therewith, since the contributions, if any, were to or for the use of foreign persons and therefore could not qualify under section 170.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621044/	EITINGON-SCHILD CO., INC., AND SUBSIDIARIES, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Eitingon-Schild Co. v. CommissionerDocket Nos. 34128, 36930, 47114.United States Board of Tax Appeals21 B.T.A. 1163; 1931 BTA LEXIS 2234; January 15, 1931, Promulgated 1931 BTA LEXIS 2234">2234 1. The turnover tax instituted by the law of the Republic of France of June 25, 1920, held to be an excise or sales tax and not an income or profit tax. The amounts so paid by the petitioners to France in the taxable years are, therefore, not allowable as credits against the income tax due the United States under section 238 of the Revenue Acts of 1921, 1924 and 1926. 2. On the facts, held, that the respondent erred in disallowing deductions as business expenses claimed by the petitioners (a) of the amount of $2,000 per month paid in lump sums to the petitioners' officers during the taxable years for entertainment and traveling expenses, an excess of that amount having been expended, and (b) of the amount of $37,500 paid in the same year to one Ahern in consideration of his covenant not to enter into competition with the petitioners, but did not err in disallowing a deduction of $25,750 contributed to the Charity Chest of the Fur Industry of the City of New York. Richard S. Holmes, Esq., for the petitioners Maxwell E. McDowell, Esq., for the respondent. TRAMMELL 21 B.T.A. 1163">1164 These are proceedings for the redetermination of deficiencies1931 BTA LEXIS 2234">2235 in income tax determined by the respondent as follows: Docket TaxpayerTax yearDeficiencyNo.34128Eitingon-Schild CoPeriod Jan. 1, 1922, to $26,835.49Nov. 30, 192236930doFiscal year ended 14,647.72Nov. 30, 1923doFiscal year ended 19,754.34Nov. 30, 1924Moscow Fur Trading Codo1,154.6847114Eitingon-Schild CoFiscal year ended 49,109.43Nov. 30, 1926Bach Fur Codo322.02Funston Brothers Co. do2,950.66(Delaware)Laclede Real Estate & do1,175.86Investment Co.The following issues are raised by the pleadings: (1) Whether or not the respondent erred in allowing as deductions in computing net income, under section 234 of the Revenue Acts of 1921, 1924, and 1926, instead of allowing as credits against the tax, under section 238 of said acts, the amount of certain French and British income taxes paid by the petitioners in the taxable years; (2) whether or not the respondent erred in allowing as deductions in computing net income, under said section 234, instead of allowing as credits against the tax, under section 238, the amounts of certain French turnover taxes paid by the1931 BTA LEXIS 2234">2236 petitioner, Moscow Fur Trading Co., in the taxable years; (3) whether or not the respondent erred in disallowing deductions as business expenses of $2,000 per month paid during the taxable years by the petitioner, Eitingon-Schild Co., to its president and senior vice president for entertainment and traveling purposes; (4) whether or not the respondent erred in disallowing the deduction as a business expense of the amount of $25,750 paid by the petitioner, Eitingon-Schild Co., to the "Charity Chest of the Fur Industry" in the fiscal year 1926; (5) whether or not respondent erred in disallowing a deduction claimed as a business expense of the amount of $37,500 paid in the fiscal year 1926 by the petitioner's subsidiary, the United States Fur Exchange, Inc., to one Ahern in consideration of his refraining from entering into competition with the petitioners in the fur business; and (6) whether or not the petitioner failed to 21 B.T.A. 1163">1165 allow reasonable deductions for depreciation to the petitioner, Laclede Real Estate & Investment Co., for the fiscal year 1926. The first issue above set out has been settled by stipulation of the parties, and issue (6) was abandoned and no evidence1931 BTA LEXIS 2234">2237 offered thereon. The proceedings were duly consolidated for hearing and decision. FINDINGS OF FACT. The petitioner Eitingon-Schild Co. is a corporation organized under the laws of the State of New York, with its principal office in New York City. The other petitioners are subsidiary corporations of the Eitingon-Schild Co., with principal offices as follows: Moscow Fur Trading Co., New York, N.Y.Bach Fur Co., Chicago, Ill.Funston Brothers & Co. (Delaware), St. Louis, Mo. Laclede Real Estate & Investment Co., St. Louis, Mo. The petitioner Eitingon-Schild Co. was organized in 1914, and together with its subsidiaries, is engaged in the business of importing and exporting fur skins. Its business is world-wide, with buying and selling branches in the United States, France, England, Germany, Italy, Belgium, and Poland, and buying branches in China, South America, and Canada. The petitioners were affiliated and filed consolidated income-tax returns for the fiscal period and years here involved. For the purpose of these proceedings, certain French and British income taxes were properly accrued by the petitioners as follows: Taxable periodFrenchBritishPeriod Jan. 1 to Nov. 30, 1922$2,387.21$2,843.82Fiscal year ended Nov. 30, 19238,868.3115,176.78Fiscal year ended Nov. 30, 192410,040.7517,616.32Fiscal year ended Nov. 30, 19262,035.6813,711.231931 BTA LEXIS 2234">2238 The petitioner Moscow Fur Trading Co. paid French turnover taxes as follows: For the period January 1 to November 30, 1922$399.96For the fiscal year ended - November 30, 192310,847.09November 30, 192414,316.96November 30, 192619,883.41Said turnover taxes were imposed by and paid pursuant to articles 59 to 73, inclusive, of the law of the French Republic of June 25, 1920, and subsequent laws amendatory thereof and supplementary thereto, which read, in parts material here, as follows: Art. 59. - From the first day of the month which follows the promulgation of this present law, a turn-over tax is instituted on the amount of business 21 B.T.A. 1163">1166 done in France by persons who, habitually or occasionally, purchase for resale, or who accomplish such professional acts, which are subject to taxation on industrial and commercial profits, instituted by chapter 1 of the law of July 31, 1917, as also on exploits of enterprizes subject to proportional payments as provided for by article 33 of the law of April 21, 1810. * * * Article 62. - For the liquidation of the tax instituted by article 59, the turnover is established as follows: 1) For1931 BTA LEXIS 2234">2239 persons selling merchandise, groceries, furniture, or any objects, by the amount of actual sales that are definitely realized. 2) For intermediary persons: Proxies, Designers, Hirers of things, Contractors, or Hirers of services, Bankers, Discounters, Changers, by the amount of the brokerage, commissions, remittances, salaries, rentals, interests, discounts, premiums and other profits definitely acquired. If a person effects operations which partly belong to the first category and partly to the second category, the turn over is determined by applying to each of the operations the above definitions. If taxes have been collected on sales or services which are subsequently cancelled, or which remain unpaid, they will be deducted in the manner fixed by the regulation of the Public Administration as per article 67, from the taxes due on business done subsequently; or they will be refunded if the person who has paid them, has ceased to be subject to them. Article 63. - The rate of the tax is fixed at one percent (1%) with a tenth for the benefit of the Departments and Communities, of the turn-over as defined in the preceding article. It is however, increased to: 1) Three1931 BTA LEXIS 2234">2240 percent (3%), without the tenth, on business done relating to lodgings, consumption on the premises of drinks and victuals of any kind, sold in establishments classed as belonging to the second category. 2) To Ten per cent (10%), without the tenth, on expenses relating to lodgings and to consumption on the premises of alimentary articles of any kind, sold in establishments classed as belonging to the first category. 3) To Ten percent (10%), without the tenth, on retail sales or consumption of merchandise, victuals, Supplies, or any objects classed as being de luxe. The sums collected for the Departments (Counties) and Communities are distributed according to the rules established by the Financial law of 1921, at the rate of 2/3 for the Communities and 1/3 for the Departments. * * * Article 66. - Any person subject to the turn-over tax, if he has not habitually a bookkeeping system showing the amount of turn-over as defined in article 62 and the following ones, must have a book with numbered pages in which he enters day by day, without blanks or erasures: a) if he sells merchandise, groceries, supplies or objects, each sale effected. b) if he sells services, each1931 BTA LEXIS 2234">2241 amount of brokerage, commissions, remittances, salaries, rentals, interests, discounts, premiums, and other profits, constituting the remuneration for his services. Each item must indicate the date, a summary description of the objects sold, or of the services rendered, as also the sales price or the amount of brokerage, commissions, remittances, salaries, the amount of rental, interests, discounts, premiums, and other profits. However, cash-transactions for amounts of less than 100 fcs. and not applying to objects "de luxe" may be entered in a total sum at the end of each day. 21 B.T.A. 1163">1167 If the sale had been closed with another merchant and if the amount exceeds 500 frcs. the entry must, moreover, show the name and address of that merchant. The amounts of the transactions made will be added up at the end of each month. The book prescribed in the first paragraph of this article, or the bookkeeping system used instead, as well as all vouchers relating to transactions made by the persons liable to the tax, especially invoices for purchases made, must be kept intact for the space of 3 years from the 1st of January of the year in which the book has been started or during1931 BTA LEXIS 2234">2242 which the vouchers were established. * * Article 71. - If a public sale comprises merchandise, Groceries, supplies or objects of any kind, belonging to a person who is liable to the turn-over tax and classed as "de luxe" in accordance with article 64 of the present law, the tax of 10% will be collected at the time of the registration of the sale on the price of said objects. July 11, 1925. Article 39. - There will be considered as a Merchant & subject to the turnover tax and to the tax on industrial & commercial profits, any person or Company, acting as an intermediary for the purchase or sale of Real Estate, or negotiable securities, or who, habitually, buys the same in his name, thus becoming the owner of them with a view of reselling them. * * * They are subject to the tariff imposed by the fiscal law. However, for any person, who has declared in the bill of Sales, that such Real Estate is bought for resale, the tax will be brought up to 12% (plus the tenth). But in this case, the act of resale pays only half the ordinary tax if the resale takes place within one year. Moreover, the first acquirer, who shall have paid the tax of 12% (plus the tenth), 1931 BTA LEXIS 2234">2243 shall have recourse against the second Purchaser to have one half of the tax reimbursed to him. * * Article 84. - Article 12 of the law of July 31, 1920 is repealed. Article 60 of the law of June 25, 1920 is supplemented as follows: * * * For those persons operating in France as agents or employees of persons not established in France, the amount of business serving as a basis for the tax instituted by article 59 of the law of June 25, 1920 is constituted by the amount of sales actually and definitely realized. If the operations effected by Intermediaries or Proxies, concern merchandise presented at importation and which they introduce into France, the tax will be collected on the amount of purchase or sale thus realized, except as concerns products aimed at in paragraph 3 preceding, and under reservation of the proofs mentioned in the said paragraph. If the merchandise presented for importation from abroad or from the colonies, are not introduced in France through the care of an agent or employee of persons who are not established in France, or through the care of an intermediary or Proxy, the tax will be due by the purchaser under the conditions 21 B.T.A. 1163">1168 1931 BTA LEXIS 2234">2244 provided for by the law of June 25, 1920 on the amount of the purchases actually and definitely realized, except if it is a matter of products aimed at in the preceding paragraph No. 3. This disposition concerns only the Buyer receiving goods from abroad or from the Colonies destined to his own use or for his own consumption and not for resale. * * * Article 142. - From the first day of the quarter which follows the promulgation of the present law, the collection of taxes instituted by the articles 59 and 72 of the law of June 25, 1920, will exclusively be carried forward so far as mineral coal is concerned, Lignites, coke and mixtures of gas-coke, in the business of sales effected by exploiters of coal mines, or manufacturers of coke, as also on the importation of such products, to the exclusion of all other business. The rate of the tax is fixed at 1.80%. This rate includes the part collected for the benefit of the Departments (Provinces) and Communities, which part is fixed at 0.15%. Excepted from the tax are the coals used for the consumption of the Mine and Miners, as also coal sold amongst (between) those subjected to the tax, or for the manufacture of coke, or for1931 BTA LEXIS 2234">2245 direct exportation. In the case of a Cokery, belonging to a metallurgic factory, the tax is due on the value of production supplied by the Cokery to the said factory. Article 143. - From the 1st of October 1925 are exempt from the taxes instituted by articles 59 and 72 of the law of June 25, 1920 the business relating to the Commerce with Cattle, Oxen, calves, lambs, hogs, and horses, destined to be butchered, as also the commerce with fresh meats from those animals. From the same date there is instituted at the slaughter house of animals designated above, a tax the amount of which is fixed as follows: Veal and mutton, 0.15 fr. per kilo of the live-weight of the animal. Hogs, Oxen and Horses, 0.10 fr. per kilo of the live-weight of the animal. The importation of fresh meats, refrigerated or frozen, originating from the same animals, the tax is as follows: Veal and mutton 0.30 fr. per kilo of the net weight of the imported meat. Hogs, oxen and horses, 0.20 fr. per kilo of the net weight of the imported meat. A decree of the Public Administration will fix the manner of application of the tax at the Slaughter house. Contraventions will be ascertained and1931 BTA LEXIS 2234">2246 pursued under the same conditions as those relating to the turn-over tax. The tax on importations will be liquidated and collected in conformity with the dispositions of article 72 of the law of June 25, 1920. Article 57. - The transactions actually taxed at the rate of 1.30% by application of articles 59 and 72 of the law of June 25, 1920 and article 3 of the law of March 22, 1924, will from the first of April 1926 and until December 31, 1926, be taxed at the rate of 2%, of which 0.10% go to the benefit of the Departments and Communities. However, the rate of 1.30% remains applicable to the business of retail sales, or consumption on the spot. During the taxable periods here involved the petitioner Eitingon-Schild Co. paid to its president and senior vice president the sum of $1,000 each per month, to cover entertainment and traveling expenses on business trips to Europe made in behalf of the corporation. 21 B.T.A. 1163">1169 Beginning prior to the taxable years and continuing to the present time, it has been the custom of said officers to make frequent trips to visit the European branches and there transact business for the company. The president of the corporation usually1931 BTA LEXIS 2234">2247 spent from five to seven months of each year in Europe. In January, 1920, the president, senior vice president, and secretary of the corporation discussed and considered the matter of adopting some convenient and proper method of handling expenses of the trips to Europe. It was finally agreed that the president and senior vice president should each receive from the corporations $1,000 per month in addition to their salaries to cover all European traveling and entertainment expenses, and that no charge for any such items should thereafter be made by either officer against the companies. They were not to be required to account to the corporations for the money spent. The payments were not charged as salaries of the officers receiving them, but were charged to a separate account designated "Entertainment Account." This arrangement has never been made the subject of a formal resolution by the board of directors, and has never been embodied in a formal contract between the company and the officers. However, this practice has continued for approximately 10 years and is still in effect, without any objection thereto having been made by any director or stockholder. During the1931 BTA LEXIS 2234">2248 years 1922, 1923, and 1924 the president and senior vice president were each paid a salary of $36,000 per year, which was increased in 1925 to $48,000. Subsequently, the president of the corporation declined an offer of the board of directors to increase his salary to $150,000 per year. No detailed record of the expenditures was kept by the officers, but the amounts actually expended by them for entertainment and traveling expenses on European trips exceeded the amounts paid to them by the corporation. The amount of common stock in the corporation held by the president varied from a minimum of 30 per cent to a maximum of 60 per cent of the total outstanding, while the amount of the common stock held by the senior vice president never at any time exceeded 10 per cent and went down to 6 per cent. The balance of the common stock was held by some 20 or 30 other stockholders. It was the custom in the fur business to entertain customers, and this practice was regarded as a business necessity. During the year 1926 the petitioner Eitingon-Schild Co. contributed the sum of $25,000 to a corporation organized in 1925 under the name of the "Charity Chest of the Fur Industry of the1931 BTA LEXIS 2234">2249 City of New York." Prior to 1925 the petitioner was frequently solicited 21 B.T.A. 1163">1170 by its customers to make contributions to various charities in which they, the customers, were interested and the petitioner felt obliged to comply with these requests in order to maintain friendly business relations. In 1922 the petitioner contributed in this way some $4,000 to $6,000; in 1923, approximately $10,000; and in 1924, approximately $17,000. In 1925 certain members of the fur industry in New York, who were customers of the petitioner, started a movement to organize a central fund through which all charitable contributions of the industry were to be made. The result was the organization of a membership corporation known as the "Charity Chest of the Fur Industry of the City of New York." The petitioner was one of the 1,100 concerns engaged in the fur industry in New York City which subscribed to and became members of the charity chest corporation. The petitioner's president in 1926 served as a vice president of this corporation. The other officers and directors were prominent in the fur trade, and some of them were large customers of the petitioner. All of the leading concerns of1931 BTA LEXIS 2234">2250 the fur trade in New York City having a capital of $5,000 or over were subscribers to the charity chest. The charity chest corporation undertook to secure subscriptions by establishing a rating committee of three to five members, all in the trade, who decided what amount each firm should give. Each concern was thus given a quota which it was expected to subscribe, and if it failed or refused to subscribe such amount, when solicited to do so, the matter was reported to the rating committee and further efforts to secure the subscription were made. As the largest concern in the fur industry, the petitioner was given the highest rating. Originally, the subscription of the petitioner was fixed at $40,000, but the petitioner's president thought this amount was too high, whereupon it was determined that the corporation should contribute $25,000 and the president personally contributed the balance of $15,000. This was the only case in which an officer of a corporation contributed personally to the charity fund. The petitioner was the largest contributor to this fund. Direct business benefits flowed to the petitioner as a result of meeting its contribution quota to the charity chest, 1931 BTA LEXIS 2234">2251 in that it was enabled to maintain cordial relations with the directors who were representatives of big concerns which were customers of the petitioner. The contribution also possessed a definite advertising value. The amount of the petitioner's contribution was advertised in the papers by the charity chest corporation, and was made well known to the trade. It aided the petitioner in becoming known as a large and prosperous concern among present and prospective customers. 21 B.T.A. 1163">1171 After the organization of the charity chest, all solicitors of charities were referred to the Chest, and the petitioner discontinued making individual contributions. The charity chest corporation contributed to the Fur Foundation, which takes care of employees in the fur industry who become sick or disabled or are otherwise in distress. The petitioner employed about 95 persons in New York City who were entitled to these benefits. Under date of July 23, 1923, the petitioner's subsidiary, the United Fur Exchange, Inc., entered into a written contract with one Albert M. Ahern, which contract provided in the first, second, and third paragraphs for the sale by Ahern to said subsidiary of the stock1931 BTA LEXIS 2234">2252 of certain corporations owned or controlled by him, with numerous representations and warranties by him as to the properties and assets of said corporations. Paragraph third of said contract is concluded as follows: "All the foregoing provisions in Paragraphs First to Third, both inclusive, are entirely distinct from Paragraph Fourth following." Paragraph fourth reads in part as follows: You agree with the Purchaser that you will neither directly nor indirectly, within the period of ten years beginning at date hereof and ending July 23rd, 1933, engage, or be directly or indirectly interested in or connected with any firm, person or corporation which engages, in any part of North America, in the "Fur Receiving Business", as "Fur Receiving Business" is hereinafter defined, or, in St. Louis, Missouri, in the "Fur Auction Business", as "Fur Auction Business" is hereinafter defined, nor are you during said period to advertise or mention (except by word of mouth or in written or typewritten non-circular individual letters in the course of regular correspondence in some line of business other than the Fur Receiving Business in North America and other than, in St. Louis, Missouri, the1931 BTA LEXIS 2234">2253 Fur Auction Business, (as hereinafter defined) your former connection with either of the Affiliated Companies; * * * Paragraph fifth provides, among other things not here material, for the payment by the purchaser to Ahern of the sum of $403,484.42 for and in consideration of the sale and delivery by Ahern to the purchaser of the stocks of the corporations specified, "and the agreements, representations and gurantees (other than the agreements set forth in Paragraph Fourth hereof) by you entered into in this letter * * ." Paragraph sixth reads as follows: For and in consideration of your agreements set forth in Paragraph Fourth hereof, the Purchaser agrees to cause to be paid to MississippiValley Trust Company of St. Louis for you or your legal representatives (but if your wife Eulalie F. Ahern survive you, then for her or for her legal representatives, but she shall also have the power of disposition by will of any unpaid installments), the sum of $375,000.00, of which $18,750.00 shall be payable on the 3rd day of January, 1924, $18,750.00 on the 3rd day of July, 1924, $18,750.00 on the 3rd 21 B.T.A. 1163">1172 day of January, 1925, $18,750.00 on the 3rd day of July, 1925, and $37,500.001931 BTA LEXIS 2234">2254 on the 3rd day of July of each year from 1926 to 1933, both inclusive. Each installment not paid when due shall bear interest at 6% per annum from maturity until paid. During the year 1926 the United Fur Exchange, Inc., paid to the said Ahern the sum of $37,500 under paragraph sixth of the contract above referred to, and this amount was claimed by the petitioners in the consolidated return for said year as a deduction from gross income for a business expense. The deduction claimed was disallowed by the respondent. OPINION. TRAMMELL: Section 234(a)(3) of the Revenue Acts of 1921, 1924, and 1926 provides that in computing the net income of a corporation there shall be allowed as a deduction taxes paid or accrued within the taxable year, except (a) income, war-profits and excess-profits taxes imposed by the authority of the United States, (b) so much of the income, war-profits and excess-profits taxes imposed by the authority of any foreign country or possession of the United States as is allowed as a credit under section 238, and (c) taxes assessed against local benefits of a kind tending to increase the value of the property assessed. Section 238(a) of said acts provides1931 BTA LEXIS 2234">2255 as follows: In the case of a domestic corporation the tax imposed by this title shall be credited with the amount of any income, war-profits, and excess-profits taxes paid or accrued during the same taxable year to any foreign country, or to any possession of the United States: Provided, That the amount of such credit shall in no case exceed the same proportion of the tax (computed on the basis of the taxpayer's net income without the deduction of any income, war-profits, or excess-profits taxes imposed by any foreign country or possession of the United States), against which such credit is taken, which the taxpayer's net income (computed without the deduction of any such income, war-profits, or excess-profits tax) from sources without the United States bears to its entire net income (computed without such deductions) for the same taxable year. * * * The first issue raised by the pleadings and set out in our preliminary statement involves the action of the respondent in allowing as deductions in computing net income, under section 234(a)(3) of the statutes above quoted, instead of allowing as credits against the tax, under section 238(a) of the same statutes the amounts of1931 BTA LEXIS 2234">2256 certain French and British income taxes accrued by the petitioners in the taxable years. The parties stipulated at the hearing that the amounts of such taxes were properly accrued as set forth in our findings of fact, above. Accordingly, the amounts so stipulated and found should, subject to the limiting provisions of section 238(a), 21 B.T.A. 1163">1173 supra, be allowed as credits against the tax in recomputing the deficiencies herein under Rule 50. The second issue raises the question of the correctness of the respondent's action in allowing as deductions in computing net income, under section 234, instead of allowing as credits against the tax, under section 238, the amounts of certain French "turnover" taxes paid by the petitioner Moscow Fur Trading Co. in the taxable years. The amounts so paid were stipulated by the parties at the hearing, and are set out in our findings of fact, above. The parties agree also that if the said taxes are in fact in the nature of income or profits taxes, the petitioners are entitled to have said amounts applied as credits against the tax for each of the years here involved, instead of allowed as deductions in computing net income. The precise1931 BTA LEXIS 2234">2257 question presented for decision, therefore, is whether or not the French "turnover" tax is an income or profits tax. The French law of June 25, 1920, instituting the tax here in controversy, designates it in article 59 as "a turnover tax." The phrase "turnover tax" at once suggests the idea of a tax based on the amount of the turnover or business transacted, or in other words, a tax computed upon the amount of the gross sales. That such is the meaning of the term as used in the French law is indicated by the language of article 59, as follows: " * * a turnover tax is instituted on the amount of business done in France by persons who, habitually or otherwise, purchase for resale, or who accomplish such professional acts, which are subject to taxation on industrial and commercial profits * * ." The turnover tax, then, is in the first place instituted on the amount of business done in France by persons who purchase for resale, and is limited to professional acts which are subject to taxation on industrial and commercial profits, thus indicating that the turnover tax itself is not a profits tax. That the turnover tax is a sales tax and not a tax on income or profits is further1931 BTA LEXIS 2234">2258 indicated by article 62, which provides that: For the liquidation of the tax instituted by article 59, the turnover is established as follows: (1) For persons selling merchandise, * * * by the amount of actual sales that are definitely realized. (2) For intermediary persons: Proxies, designers, hirers of things, contractors, or hirers of services, bankers, discounters, changers, by the amount of the brokerage, commissions, remittances, salaries, rentals, interests, discounts, premiums and other profits definitely acquired. While paragraph (2) of article 62 refers, among other things, to "salaries, rentals, interests, discounts, premiums and other profits," it seems clear that the intermediary persons mentioned are regarded as being in the business of selling services and it is on the basis of the gross sales of such services that the tax is determined. This is none 21 B.T.A. 1163">1174 the less true because of the fact that gross sales of services may be equivalent to gross income or profits. The tax in effect is not laid upon but is merely measured by the amount of the gross sales. Such interpretation is supported by the further provisions of article 62, as follows: If a person1931 BTA LEXIS 2234">2259 effects operations which partly belong to the first category (sales of merchandise) and partly to the second category (sales of services), the turnover is determined by applying to each of the operations the above definitions. If taxes have been collected on sales or services which are subsequently cancelled, or which remain unpaid, they will be deducted in the manner fixed by the regulation of the Public Administration * * . (Italics supplied.) Article 63 provides that: "The rate of the tax is fixed at one per cent * * of the turnover as defined in the preceding article." And since the "turnover" is defined in the preceding article 62 as the "amount of actual sales," either of merchandise or services, "definitely realized," the statute thus imposes a tax equal to one per cent of the actual or gross sales "definitely realized." Article 63 further provides that the tax of one per cent is increased to "Three per cent (3%) * * * on business done relating to lodgings," etc., and "To Ten per cent (10%) * * * on retail sales or consumption of merchandise, victuals, supplies, or any objects classed as being de luxe." (Italics supplied.) Article 66 provides that: 1931 BTA LEXIS 2234">2260 Any person subject to the turnover tax, if he has not habitually a bookkeeping system showing the amount of turnover as defined in article 62 and the following ones, must have a book with numbered pages in which he enters day by day, without blanks or erasures: (a) If he sells merchandise, groceries, supplies or objects, each sale effected;(b) If he sells services, each amount of brokerage, commissions, remittances, salaries, rentals, interests, discounts, premiums, and other profits, constituting the remuneration for his services. (Italics supplied.) We deem it unnecessary to make further detailed references to the provisions of the French law. The provisions above pointed out clearly establish, we think, that the law in question imposes an excise tax on the privilege of carrying on in France businesses of the kinds enumerated, which tax is measured by the amount of the gross sales "definitely realized." The tax essentially and fundamentally is an excise tax as distinguished from a tax laid upon income and profits. We find no provision in the French statute in question which we are able to construe as imposing a tax on income or profits, either gross or net. 1931 BTA LEXIS 2234">2261 In ; ; ; and , we had before us the question whether the French law of July 15, 1914, imposed an income tax. In each of the 21 B.T.A. 1163">1175 cases cited, we held that the tax imposed by the said law was in effect an income tax, notwithstanding the fact that, in the case of persons not domiciled in France, but who possessed one or more residences there, the tax was computed on the basis of a taxable income arbitrarily fixed at a sum equal to seven times the rental value of the residences. With respect to whether the tax so imposed was in its nature an income tax, we said in , supra:The statute imposing the French tax states that "The taxable income is fixed at a sum equal to seven times the rental value of this or these residences * ." Whatever may be the nature of the tax, it is imposed upon what the French Government determines to be income. It is in no sense of the word imposed upon the ownership of property. It is a1931 BTA LEXIS 2234">2262 part of a statute which imposes income taxes upon citizens and residents of France. In view of this situation, we think that the tax was an income tax * * . The fact that under the law the taxable income is determined in a manner different from the taxable income under the Revenue Act of 1921 does not change the nature of the tax. In the instant case a wholly different situation is presented. The law here involved is not part of a statute which imposes an income tax upon citizens and residents of France, or any one else. The tax is not laid upon income or profits, either actual or fictitious, nor is the determination of the amount of the tax in any wise dependent upon the amount of income derived or profits earned. Having reached the conclusion that the tax here in question is not an income or profits tax, the action of the respondent on the second issue is approved. The third issue brings into question the correctness of the respondent's action in disallowing deductions claimed by the petitioners for entertainment and traveling expenses of its officers on business trips to Europe. The petitioners maintained a number of buying and selling agencies in Europe and apparently1931 BTA LEXIS 2234">2263 transacted a large amount of business there. At any rate, the evidence shows that the business of the foreign branches required the principal executive officers to spend a considerable portion of their time in the countries where such branches were located. The president was in Europe on an average of five to seven months in each year. On such trips, the officers entertained customers, which is a recognized and common practice in the fur trade, and a necessity from a business standpoint. Beginning prior to the taxable years, the petitioners adopted the plan of paying to its president and senior vice president $1,000 each per month, in addition to their salaries, to reimburse them for traveling and entertainment expenses on the European trips made in connection with the business affairs of the corporations. This practice was originally instituted by the said officers in conference with 21 B.T.A. 1163">1176 the secretary, and while it was never formally authorized by the board of directors nor embodied in a formal contract, the arrangement has been continued down to the present time, extending over a period of approximately 10 years, without objection from any stockholder or director. 1931 BTA LEXIS 2234">2264 After adoption of the lump-sum allowance plan, the officers paid their own expenses for travel and entertainment, making no charges for such items against the corporations, and they were not required to account for the money so spent. There is nothing in the records before us to suggest that the amounts in question represent in any degree a distribution of profits under the guise of expenditures for expenses. Each officer received a salary of $36,000 per year until 1925, when the salary of each was increased to $48,000. The president owned from 30 to 60 per cent of the outstanding common stock, while the senior vice president held from 6 to 10 per cent. Yet each received the same allowance for entertainment and traveling expenses, and the amounts actually expended for such purposes exceeded the aggregate amount of the allowances. We are of the opinion that the amounts paid by the petitioners to the president and senior vice president during the respective taxable years, under the circumstances here shown, constituted ordinary and necessary expenses paid or incurred during those years in carrying on the business of the petitioners, and are proper deductions in computing net1931 BTA LEXIS 2234">2265 income. In , where we considered the same question under substantially similar facts, we allowed the deductions, saying: The fact that the president and vice president were not required to keep itemized expense accounts is not material, as the evidence shows that the sums were authorized by the petitioner; were expended by the officers in carrying on the business and were, in fact, less than the amounts actually expended by said officers. . Apparently, the respondent disallowed the deductions here claimed because of lack of satisfactory proof as to the nature of the expenditures. Having so explained his position, counsel for the respondent stated at the hearing: "We frankly approach that question in anticipation of proof on the point." The evidence now presented in the record, we think, is sufficient to establish the deductibility of the amounts in controversy. On the third issue, the action of the respondent is reversed. The fourth issue concerns the action of the respondent in disallowing a deduction claimed by the petitioners as a business expense in the amount of $25,7501931 BTA LEXIS 2234">2266 representing a payment made in 1926 to the Charity Chest of the Fur Industry of the City of New York, under the circumstances set out in our findings of fact. 21 B.T.A. 1163">1177 Individuals are permitted by the statute to deduct the amount of contributions or gifts made to religious, charitable, scientific, literary or educational organizations within certain limitations (sec. 214(a)(10)), but such deductions concededly are not allowable in the case of corporations, nor is the deduction here in controversy claimed as such. However, corporations as well as individuals are permitted to deduct "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business (sec. 234(a)(1)), and it is under this provision of the statute that the petitioners claims the deduction, contending that the amount was an ordinary and necessary expense paid or incurred in carrying on their business in the taxable year. We have consistently adhered to the rule that a donation or contribution made by a corporation, of the kind here in controversy, is deductible as a business expense when, and only when, it bears some reasonable relation to the conduct of the1931 BTA LEXIS 2234">2267 corporation's business. ; ; ; ; ; ; ; ; . In , we said: In our opinion, neither the deduction of an item by a corporation nor its disallowance depends upon whether it is a donation. The Board has frequently held that the deductibility of items such as this depends in each case upon the particular evidence to prove its relation to the proper conduct of petitioner's business. Items which may colloquially be called donations, because perhaps the recipient is a charity or the occasion is beneficent or the transaction is not approached in a formal manner with express legal consideration, may still have such a business significance as to justify their outlay and1931 BTA LEXIS 2234">2268 their recognition as business expenses. When by adequate evidence they are shown to be such, they are deductible as any other ordinary and necessary expense; and when the evidence fails to establish this or shows in fact that the donations are not reasonably motivated by or related to the proper conduct of the business, the deduction must fail. There is no substantial disagreement respecting the correct rule of law, nor is there conflict of authorities. The difficulty arises in applying the rule to the facts of a given case in determining whether the donation bears such reasonable relation to the business of the corporation that it constitutes an allowable deduction as a business expense. In , the corporation made a contribution to a church maintained in its mill village, 90 per cent of the congregation of which was composed of employees of the corporation. We 21 B.T.A. 1163">1178 held that the donation was made for purposes reasonably connected with the operation of the petitioner's business, that it represented a consideration for benefits flowing directly to the corporation, and was deductible as a business expense. See also 1931 BTA LEXIS 2234">2269 In , the corporation contributed $3,430 to a fund to be used to purchase a tract of land to be given to the Government for the establishment of an Army Post. The business success of the corporation depended upon the demand for lots and acreage which it was offering for sale. The establishment of the Army post stimulated such demand, and thus increased sales of the petitioners property, which in turn resulted in increased profits for the company. We held that the contribution had in a direct sense a reasonable relation to the petitioner's business and allowed the deduction as a business expense. In , the question was whether a contribution of $25,000 to the building fund of a hospital, made by the corporation in part to avoid enlarging the dispensary facilities at its factory, was deductible as a business expense. The court held that the contribution was reasonably incidental to the carrying on of the company's business for the company's benefit, and therefore allowable as a deduction. 1931 BTA LEXIS 2234">2270 In , the president of the petitioner corporation in the latter part of 1919 presented to the chamber of commerce of the city a plan to raise the sum of $1,000,000 for civic betterment. The underlying purposes of the plan were to make the city more desirable to live in and to encourage the employees of the petitioner to purchase homes. It was determined that $600,000 of the fund should be allocated to the industries of the city, and that each industry should contribute to the fund upon the basis of its invested capital, the number of employees, and the volume of sales. All of the industries of the city except two joined in the plan, and upon the basis indicated, $360,000 of the $600,000 was allocated to the petitioner. The question was whether the amount so contributed by the petitioner was deductible as a business expense. The petitioner in that case employed about one-half of the wageearning population of the city, and contributed 36 per cent of the total fund, which was to be distributed among the following beneficiaries: American Legion, board of education, Boy Scouts, city commission, community1931 BTA LEXIS 2234">2271 building, Girl Scouts, hospital, girls' club, public library, park commission, Road of Remembrance, recreation association, Y.M.C.A., contingent. With the exception of the amount distributed to the city commission, and that allocated to the contingent 21 B.T.A. 1163">1179 fund, the court held that the contribution of the petitioner was deductible as a business expense. The court pointed out that the business of the petitioner had been successfully operated for twenty years under a policy looking to the contentment, and well-being of its employees, and that it was in pursuance of that policy that the petitioner determined to make the contribution in question. In its opinion, the court further observed: The question always is whether balancing the outlay against the benefits to be reasonably expected, the business interest of the taxpayer will be advanced. The answer must depend, among other things, upon the nature and size of the industry, its location, the number of its employees as compared to the entire community, the type of its employees, and what other employers similarly situated are doing. * * * We can not accept the contention that to permit the petitioner to make this contribution1931 BTA LEXIS 2234">2272 would give to a corporation the right to make donations which is given exclusively to individuals. * * The contention overlooks the fact that the contribution was not a philanthropy, but was a business expenditure to be reflected in increased earnings. The right to make such expenditures is not confined to corporations, but is also given to individuals. The individual has the additional right, under the statutes, to make gifts to charity that have no relation to business expenses. From the foregoing decisions, it appears that a correct application of the rule requires that the deduction be allowed where the evidence shows that the contribution was not a matter of charity or philanthropy, but was made as a necessary incident to the business. The instant case, in our opinion, does not come within the rule. The relation of the payments to the proper conduct of the petitioner's business was too remote and incidental. The fund to which the contribution was made was to be distributed among various charities, including the Fur Foundation. The evidence does not disclose what proportion of the contribution went to that organization, or what ratio the number of petitioner's employees1931 BTA LEXIS 2234">2273 has to the total number which might possibly be beneficiaries of that foundation. There does not appear any direct benefit, so far as the petitioner is concerned, from the contribution. The petitioner's employees were entitled to benefits through the Fur Foundation in case of sickness or for other reasons, but other charities gave assistance to people generally and apparently would not exclude employees of the fur industry merely because they were or had been such. In the American Rolling Mill Co. case and the Corning Glass case the employees of the taxpayers there involved contributed a substantial proportion of the total number of persons who were direct beneficiaries and the so-called contributions in those cases were very substantially and directly for the benefit of the corporations themselves, but here the petitioner's place of business was in New York, where the number of employees of the petitioner was inconsequential 21 B.T.A. 1163">1180 in comparison to the population or number of people to be benefited. The petitioner's employees were benefited so slightly and the corporation so indirectly and remotely that we do not think the situation comes within the principle of1931 BTA LEXIS 2234">2274 the American Rolling Mills case and other cases cited. Nor do we think that the situation here presented comes within the principle of the Anniston City Land Co. case, supra, where the contribution was made with the reasonable expectation of increasing sales and profits. It may well be true that the contribution was made for the purpose of maintaining good will on the part of purchasers, but this may well be true in the case of many unquestioned contributions to charity. It may also be true that the failure to make the contributions would have been bad business on the part of the petitioner, but this might be said in connection with other contributions to charities. The failure to make a contribution to a needed charity when competitors make such contributions might arouse some criticism on the part of a portion of the public or even some customers, but we do not think that this fact changes a charitable contribution into a business expense. We must keep in mind the fact that the statute does not authorize a deduction of such a contribution by a corporation. Doubtless Congress had a purpose in denying such deductions on the part of corporations while allowing them1931 BTA LEXIS 2234">2275 when the contribution is made by an individual. The fact that some pressure is brought to bear upon corporations to make charitable gifts is not, in our opinion, enough to change their character to business expenses. We do not think, under the circumstances, that the contribution in question was so incidental to or connected with the carrying on of the petitioner's business as to be considered an ordinary and necessary business expense. The action of the respondent on this issue is affirmed. The fifth issue raises the question whether the respondent erred in disallowing the deduction claimed as a business expense of the amount of $37,500 paid in the fiscal year 1926 by the petitioner's subsidiary, the United Fur Exchange, Inc., to Albert M. Ahern in consideration of his refraining from entering into competition with said subsidiary in certain restricted territory and for a specified period of time. By written contract dated July 23, 1923, the subsidiary purchased from Ahern the stock of certain corporations owned or controlled by him, for the sum of $403,484.42. By entirely separate and distinct provisions of the contract, unrelated to the sale and purchase of the stock1931 BTA LEXIS 2234">2276 of the corporations, Ahern agreed that he would not directly or indirectly engage or be interested in or connected with any firm, person or corporation which might engage, in any part of North 21 B.T.A. 1163">1181 America in the "fur receiving business," or in St. Louis, Mo., in the "fur auction business," within a period of ten years beginning with the date of the contract and ending July 23, 1933. In consideration of Ahern's covenant not to compete, the subsidiary agreed "to cause to be paid to Mississippi Valley Trust Co. of St. Louis for you (Ahern) or your legal representatives (but if your wife Eulalie F. Ahern survive you, then for her or her legal representatives, but she shall also have the power of disposition by will of any unpaid installments), the sum of $375,000, of which $18,750 shall be payable on the 3rd day of January, 1924, $18,750 on the 3rd day of July, 1924, $18,750 on the 3rd day of January, 1925, $18,750 on the 3rd day of July, 1925, and $37,500 on the 3rd day of July of each year from 1926 to 1933, both inclusive." During the year 1926 the petitioner's subsidiary paid to Ahern the sum of $37,500 pursuant to the terms of said contract, and this amount was claimed1931 BTA LEXIS 2234">2277 as a deduction from income in the consolidated return filed by the petitioners for said year. The deduction so claimed was disallowed by the respondent on the theory that the payments to Ahern constituted expenditures "strictly of a capital nature, the benefit derived being a business untrammelled and free from interference by Ahern's good will or competing activities in the trade." In support of his position, the respondent cites ; ; ; . The decisions cited are not in point, and on the facts are readily distinguishable from these proceedings. Only the case of Market Supply Co., involved a contract to refrain from entering into competition, and the deduction in that instance was disallowed for lack of proof of the amount paid as consideration for such covenant. We can not agree with the respondent's contention that the payments to Ahern represent part of the cost of the businesses acquired by the petitioner through the purchase of the stock of the corporations. The1931 BTA LEXIS 2234">2278 petitioner, through its subsidiary, paid a definitely stated amount for the stock, and agreed to pay in addition a definitely specified consideration for Ahern's covenant not to enter into competition. The fact that provisions constituting in effect two separate contracts were embodied in one written instrument is not material. The provisions of the contract are clear on this point, and specifically indicate that the consideration paid for the stock was "entirely distinct" from the consideration paid for the covenant. In , the petitioner acquired or entered into several contracts with corporations and individuals for the purchase of assets, including good will and 21 B.T.A. 1163">1182 covenants not to engage in a competing business in specified territory and for a specified time. The question was whether the respondent erred in failing to make a reasonable allowance for the exhaustion of the contracts, based upon the cost to the petitioner of said covenants. In our opinion, we said: The record shows very clearly that the motivating cause for the acquisition of all of the contracts hereinbefore discussed, either by the1931 BTA LEXIS 2234">2279 petitioner or its predecessor, was not to acquire additional tangible assets or to broaden the field of its manufacturing activities, but to stifle and render impossible the recurrence of competition in the manufacture of feed from brewers' grain, and it shows further that, notwithstanding that the amounts paid as consideration for those various contracts were written off to profit and loss, the values remained the same as when they were entered into. That they were of immense value to the petitioner can not be doubted. * * * * * * The petitioner's business was protected by the various contracts and agreements which it entered into for the periods of years specified therein. As each year passed the protection afforded by those contracts was diminished, and as the expiring date drew nearer the value became less because then, and only then, could the covenantors to the contracts proceed safely into the field of competition with the petitioner again. * * * These contracts are made for specified periods of time and we can attach no value to them beyond the period so specified and we, therefore, see no reason why they should not be exhausted in the normally accepted manner. The1931 BTA LEXIS 2234">2280 foregoing case differs from the facts here in that the consideration for each covenant was paid in a lump sum when the contract was entered into or acquired. In , after holding that the respondent erred in disallowing a deduction of the amount paid for certain services rendered, we said: Nor do we see any reason why the deduction of the amount paid Gallup for his covenant to refrain from competition should not be allowed. * * We have held in , that the taxpayer there was entitled to amortize the cost of contracts similar to the one here. In that case the cost was paid upon the acquisition of the contracts. In this proceeding payment was made ratably over the life of the contract and, therefore, the annual payment equals the amount of yearly exhaustion on the cost of the contract. In the instant case, the petitioner's subsidiary acquired valuable rights under its contract with Ahern, at a total cost of $375,000, payable at the rate of $37,500 annually for the period of ten years. The contract has a life of ten years, upon the expiration of which its value will1931 BTA LEXIS 2234">2281 be exhausted. Hence its value was and is being exhausted ratably by the passage of time. The provisions of the contract relating to the payment to other persons of any remaining installments in the event of Ahern's death prior to 1933, we think, are immaterial. This in no wise affects the total cost of the contract to the petitioner, which is the basis for computing the exhaustion 21 B.T.A. 1163">1183 allowance. A somewhat similar situation existed in the Black River Sand Corporation case, supra. But if the payment of the amount be held to be an ordinary and necessary expense instead of a capital expenditure to be amortized, the same result would be reached, the same amount would be allowable as a deduction in each year. In our opinion, the respondent erred in disallowing the deduction claimed, and his action on the fifth issue is, therefore, reversed. Issue six was abandoned and no evidence offered in respect thereto. Accordingly, the action of the respondent on this issue is affirmed. Reviewed by the Board. Judgment will be entered under Rule 50.MURDOCK concurs in the result only.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621047/	MORRIS JOE DIMSDALE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentDimsdale v. CommissionerDocket No. 7605-86.United States Tax CourtT.C. Memo 1987-53; 1987 Tax Ct. Memo LEXIS 214; 52 T.C.M. 1506; T.C.M. (RIA) 87053; January 22, 1987. 1987 Tax Ct. Memo LEXIS 214">214 Held, the affirmative allegations in R's answer were deemed admitted under Rule 37(c), Tax Court Rules of Practice and Procedure. Such allegations deemed admitted are sufficient to sustain deficiencies for the taxable years 1976 and 1977 against petitioner. Heldfurther, the allegations deemed admitted are sufficient to satisfy R's burden of proving fraud under sec. 6653(b) with respect to the taxable years 1976 and 1977. Doncaster v. Commissioner,77 T.C. 334">77 T.C. 334 (1981), followed. Morris Joe Dimsdale, pro se. Richard Goldman and Helen C. T. Smith, for the respondent. FEATHERSTONMEMORANDUM FINDINGS OF FACT AND OPINION FEATHERSTON, Judge: This case was assigned to Special Trial Judge Peter J. Panuthos for the purpose of hearing, consideration, and ruling on respondent's Motion for Judgment on the Pleadings, filed herein. 11987 Tax Ct. Memo LEXIS 214">215 After a review of the record, we agree with and adopt his opinion which is set forth below. OPINION OF SPECIAL TRIAL JUDGE PANUTHOS, Special Trial Judge: This case is before the Court on respondent's Motion for Judgment on the Pleadings filed on October 14, 1986, pursuant to Rule 120, Tax Court Rules of Practice and Procedure.In his notice of deficiency, respondent determined deficiencies and additions to tax for the taxable years 1976 and 1977 as follows: Additions to taxYearIncome Taxunder section 6653(b)1976$4,936.69$2,468.351977$9,160.38$4,580.19The adjustments in the notice of deficiency are as follows: Adjustments to Income19761977Interest$ 2.58 $ 3.58 Rental Income1,200.00 1,620.00 Rental Depreciation Expense(666.66)(666.66)Net Profit from Business21,889.72 28,673.17 Deduction of IRA(401.28)IRA Recovery1,775.58 Total Adjustments$22,024.36 $31,405.67 The basis for respondent's determination of net profit from business for 1976 was by use of the bank deposits method. For 1977, respondent utilized third party sources to reconstruct income. At the time of filing his petition herein, petitioner resided at Laurel, Mississippi. PROCEDURAL BACKGROUND After issuance of the notice of deficiency on December 17, 1985, a timely petition 1987 Tax Ct. Memo LEXIS 214">216 was filed on March 20, 1986. 2 In his Answer, filed May 27, 1986, respondent makes affirmative allegations with respect to the addition to tax under section 6653(b) for the taxable years 1976 and 1977. No reply having been filed, respondent's Motion for Entry of Order that Undenied Allegations in Answer Be Deemed Admitted was filed on August 12, 1986. 31987 Tax Ct. Memo LEXIS 214">217 On August 14, 1986, petitioner was served with a Notice of Filing Motion for Order Under Rule 37 and petitioner was given until September 4, 1986 to file a reply. The notice further indicated that "If petitioner does not file a reply as directed herein, the Court will grant respondent's motion and deem admitted for purposes of this case the affirmative allegations in the answer." No reply was filed and, accordingly, the Court on September 12, 1986 ordered that the affirmative allegations of fact set forth in paragraphs 6(a) through 6(an) of respondent's Answer were deemed admitted for purposes of this case. On October 14, 1986, respondent's Motion for Judgment on the Pleadings was filed. 4 By notice dated October 27, 1986, petitioner was advised that a hearing on respondent's motion was scheduled for December 10, 1986 at the Motions Session of the Court in Washington, D.C. Petitioner was further advised of the provisions of Rule 50(c) allowing for the submission of a written statement in lieu of, or in addition to attendance at the hearing. This matter was called for hearing at the Motions Session of the Court held in Washington, D.C. on December 10, 1986. Counsel for respondent appeared and presented argument in support of his motion. No appearance was made by or on behalf of petitioner, nor were any documents submitted pursuant to the provisions of Rule 50(c). The following findings of fact are based upon the record including allegations in respondent's Answer, which have been deemed admitted by our September 12, 1986 Order. FINDINGS OF FACT 1987 Tax Ct. Memo LEXIS 214">218 Petitioner is a Doctor of Chiropractic Medicine. During the taxable years 1976 and 1977, petitioner practiced medicine in Columbus, North Carolina and in Spindale, North Carolina. During the taxable years in issue, petitioner earned taxable income from his chiropractic practice and from rental properties. Petitioner failed to maintain or submit for examination by respondent, complete and adequate books of account and records of his income-producing activities. As a result of petitioner's failure to keep adequate books of account and records, and the refusal to furnish respondent such records, respondent determined petitioner's correct adjusted gross income for the taxable year 1976 on the basis of the bank deposits method of reconstructing income. During the taxable year 1976, petitioner's deposits into his bank accounts were as follows: Independence National Bank$10,370.00Northwestern Bank4,260.00North Carolina National Bank43,868.35Universal Church of Freedom1,000.00Total Bank Deposits$59,498.35Less: Reduction forNontaxable Sources28,365.30Net Taxable Deposits$31,133.05During the taxable year 1977, petitioner conducted most of his financial transactions in cash. On financial 1987 Tax Ct. Memo LEXIS 214">219 statements submitted to the Northwestern Bank of North Carolina and to the North Carolina National Bank, petitioner stated that he earned $44,000 in 1977. Petitioner's adjusted gross income and adjustments thereto for the taxable year 1977 is set forth as follows: Total earnings from chiropractic medicine$44,000.00Less: Business expenses15,326.83Net profit$28,673.17Plus: Interest income3.58Rental income1,620.00Individual Retirement Accountwithdrawal1,775.58Less: Rental depreciation expense666.66Unreported adjusted gross income$31,405.67During the taxable years 1976 and 1977, petitioner did not receive any nontaxable or excludable income, receipts, cash or other assets, inheritances, gifts, legacies or devises other than that accounted for in the aforementioned schedules. For the taxable year 1970 through 1975, petitioner filed with respondent valid Federal income tax returns reporting taxable income. In 1977, petitioner filed with respondent a 28 page document purporting to be a Federal income tax return for the taxable year 1976. In 1978, petitioner filed with respondent a 15 page document purporting to be a Federal income tax return for the taxable year 1977. In both of the documents, 1987 Tax Ct. Memo LEXIS 214">220 petitioner reported that he earned no taxable income and that he owed no Federal income tax for the taxable years in issue. Attached to the purported tax returns were numerous pages of "protester type" materials. On March 1, 1982, petitioner was convicted of willfully and knowingly failing to make and file Federal income tax returns for the taxable years 1976 and 1977 under the provisions of section 7203. The conviction was affirmed by the United States Court of Appeals for the Fourth Circuit. Petitioner's failure to maintain complete and accurate records of his income-producing activities and his failure to produce complete and accurate records to respondent in connection with the examination of his income tax returns for the taxable years 1976 and 1977 was fraudulent with the intent to evade tax. Petitioner's practice of conducting financial transactions in cash during 1977 was fraudulent with the intent to evade tax. Petitioner's refusal to cooperate with agents of respondent with respect to the examination of his 1976 and 1977 Federal income tax returns was fraudulent with the intent to evade tax. Petitioner's failure to have withholding or make estimated tax payments from his 1987 Tax Ct. Memo LEXIS 214">221 earnings for the years in issue was fraudulent with the intent to evade tax. Petitioner's filing of fraudulent "protester type" documents for the years in issue was with the intent to evade tax. Petitioner, fraudulently and with the intent to evade tax, failed to report income in the amounts of $22,024.36 and $31,405.67 for the taxable years 1976 and 1977, respectively. Petitioner's correct tax liability, the tax shown on his purported returns and understatement of tax are as follows: 19761977Corrected tax liability$3,727.99$7,679.32Add: Self-employment tax1,208.701,303.50Penalty for IRA distribution177.56Total corrected liability4,936.699,160.38Less: Tax shown on purported returnUnderstatement of tax$4,936.69$9,160.38A part of the underpayment of tax required to be shown on petitioner's Federal income tax returns for the taxable years 1976 and 1977 is due to fraud. OPINION Rule 120 provides that after the pleadings are closed, and within such time as not to delay the trial, any party may move for a judgment on the pleadings. A motion for judgment on the pleadings is appropriate only where the pleadings do not raise a genuine issue of material fact, but rather involve issues of law. 1987 Tax Ct. Memo LEXIS 214">222 Thus, respondent's motion is to be granted, only if, on the admitted facts, the moving party is entitled to a decision as a matter of law. Anthony v. Commissioner,66 T.C. 367">66 T.C. 367 (1976). The factual allegations in the answer respecting respondent's determination of a deficiency in income tax for the taxable years 1976 and 1977 have been deemed admitted by our Order dated September 12, 1986. Accordingly, we conclude that there is no genuine issue of material fact with respect to the deficiency determination. Respondent is entitled to a judgment respecting that determination as a matter of law. 5With respect to the additions to tax under section 6653(b) the burden of proof is on respondent to prove by clear and convincing evidence that an underpayment exists and that a part of the underpayment of tax is due to fraud with the intent to evade tax. Section 7454(a); Rule 142(b); Grosshandler v. Commissioner,75 T.C. 1">75 T.C. 1 (1980); Stratton v. Commissioner,54 T.C. 255">54 T.C. 255 (1970). We have previously determined that respondent's burden can be 1987 Tax Ct. Memo LEXIS 214">223 satisfied through the undenied facts deemed admitted under Rule 37(c). Doncaster v. Commissioner,77 T.C. 334">77 T.C. 334 (1981) (a Court reviewed opinion).6 The material factual allegations in the answer with respect to fraud which have been deemed admitted clearly and convincingly establish that for the taxable years 1976 and 1977 an underpayment of tax exists and part of the underpayment is due to fraud with the intent to evade tax. Since there is no genuine issue as to any material fact present in the record, respondent is entitled to a decision as a matter of law. Respondent's Motion for Judgment on the Pleadings will be granted. An appropriate order and decision will be entered.Footnotes1. This case was assigned pursuant to section 7456(d) (redesignated as section 7443A by the Tax Reform Act of 1986, Pub. L. 99-514, section 1556) and Rule 180. All section references are to the Internal Revenue Code of 1954, as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.2. The envelope in which the petition was contained reflects a mailing date of March 17, 1986. ↩3. According to the certificate of service attached to the motion, counsel for respondent certified that a copy of the motion was served on petitioner at P.O. Box 4268, Laurel, Mississippi 39441 on August 8, 1986.4. According to the certificate of service attached to the motion, counsel for respondent certified that a copy of the motion was served on petitioner on October 10, 1986.↩5. There is ample support for use of a reconstruction of income. Holland v. United States,348 U.S. 121">348 U.S. 121 (1954); Bedeian v. Commissioner,54 T.C. 295">54 T.C. 295↩ (1970).6. See also Marshall v. Commissioner,85 T.C. 267">85 T.C. 267 (1985); Ricotta v. Commissioner,T.C. Memo. 1986-508; Twist v. Commissioner,T.C. Memo. 1986-497; Siravo v. Commissioner,T.C. Memo. 1986-482; Jackson v. Commissioner,T.C. Memo. 1986-15↩ (see especially cases cited at n. 8 therein).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621049/	Clara M. Schneider v. Commissioner.Schneider v. CommissionerDocket No. 30785.United States Tax Court1952 Tax Ct. Memo LEXIS 3; 11 T.C.M. 1232; T.C.M. (RIA) 53005; December 31, 1952C. W. H. Bangs, Esq., for the petitioner. Elmer E. Lyon, Esq., for the respondent. TURNER Memorandum Findings of Fact and Opinion TURNER, Judge: Respondent determined against petitioner deficiencies in income tax and additions for fraud under section 293 (b) as follows: Taxable YearIncome TaxPenalty1944$1,093.57$ 546.7919451,630.78817.7119461,699.77849.8919485,367.822,683.91 By amended answer respondent seeks1952 Tax Ct. Memo LEXIS 3">4 an increase in taxes and penalty for the taxable year 1948 in the respective amounts of $961.44 and $480.72. Petitioner contests both the income tax deficiencies and the penalties. Findings of Fact Petitioner is an individual and resides at Fort Wayne, Indiana. She filed her income tax returns for the years involved with the collector of internal revenue for the district of Indiana. Petitioner was a masseuse and during the period between 1944 and 1949 was known as a naturopath-physician. She also maintained offices in the Stevens Building in Chicago, Illinois, from 1945 until sometime in 1950, making one trip each week to Chicago to treat patients referred to her from doctors in Chicago. In her application for rental of the offices she showed the business to be conducted as "osteopath" which word appeared on the front door of the offices. Petitioner was married to Ross Arnold and they resided in Fort Wayne, Indiana. They had three children, Nelson, Hubert and Elizabeth. On or about November 14, 1928, petitioner and Arnold were divorced and petitioner was awarded the custody of Elizabeth who at that time was twelve years of age. The court ordered Arnold to pay petitioner $25 per1952 Tax Ct. Memo LEXIS 3">5 month for the support of Elizabeth. After the divorce petitioner returned to her former husband's home and kept house for him and the children for a number of months. Petitioner then became the housekeeper for Dr. Adam L. Schneider of Fort Wayne sometime in 1929. Dr. Schneider permitted petitioner to bring her daughter Elizabeth with her and he paid petitioner $10 per week for her work as housekeeper. In addition, Dr. Schneider gave petitioner money with which to buy groceries. He paid the utilities and other bills. She was permitted to charge certain items to Dr. Schneider's account. In 1933 or 1934 she bought ten shares of Lincoln Life Insurance Company stock at $40 a share. This was paid for out of her savings. About May 1935, Dr. Schneider deposited $2,000 in the Peoples Trust & Savings Company of Fort Wayne to the joint account of petitioner, whose name at that time was Clara Arnold, and her daughter, Elizabeth Arnold. On August 8, 1935, petitioner and Dr. Schneider were married, after having executed an antenuptial agreement. The agreement provided inter alia that the doctor's residence at 1205 E. Lewis Street, Fort Wayne, would be conveyed by Dr. Schneider to petitioner, reserving1952 Tax Ct. Memo LEXIS 3">6 unto himself a life estate, and that Dr. Schneider would convey unto petitioner, after the solemnization of the intended marriage, fifty-five shares of common stock of the Fort Wayne Corrugated Paper Company of the approximate value of $5,000. The following provision also appears in the agreement: "In consideration of the conveyance and transfer to her of said real and personal property the party of the second part agrees that she will accept the same in lieu of any and all rights and claims of dower, inheritance, and descent in and to the real property of the first party now owned, or hereafter acquired or in lieu of any and all rights or claims to a distributive share of his personal estate now owned, or hereafter acquired and in lieu of any and all other claims which may arise and accrue to her by reason of said marriage; the party of the second part hereby releases, remises, and relinquishes to the party of the first part, her heirs, successors, administrators and assigns forever, all the interest, title and claim therein set out." Concurrently with the execution of the antenuptial agreement and in accordance with its provisions, the Lewis Street property was conveyed to petitioner. 1952 Tax Ct. Memo LEXIS 3">7 Before conveying to petitioner the fifty-five shares of the Fort Wayne Corrugated Paper Company stock Dr. Schneider was killed in an automobile accident, November 5, 1935. The executor of the estate of Dr. Schneider, by order of the court dated August 26, 1936, delivered to petitioner the fifty-five shares of the stock. At that time, the stock was appraised at $5,500. Dr. Schneider left an estate of approximately $72,000 and at the date of his death he had $184 cash in a safe and on his person, a checking account in Peoples Trust & Savings Company in the amount of $1,550.20 and a savings account in the same bank in the amount of $23,532.42. His heirs consisted of an adult daughter, Ruth I. Schneider, and four granddaughters, children of Lawrence B. Schneider, deceased son. After the doctor's death petitioner began to give massages and baths, and also did some sewing. During the summer of 1936 petitioner took a four-months course in physiotherapy in Chicago, Illinois. In 1937 she took a course of training at Battle Creek College, Battle Creek, Michigan. She took the summer course starting in June and enrolled for the fall term but in November she dropped out of the college. Elizabeth1952 Tax Ct. Memo LEXIS 3">8 also attended the college and lived with her mother. During the same year, 1937, petitioner sold the Lewis Street property to Tressie High for $4,250 on contract, receiving $750 as a down payment together with an agreement from the purchaser to make payments of $35 per month with interest at the rate of six per cent. She also sold her Fort Wayne Corrugated Paper Company stock for about $170 per share. Subsequent to the sale of the stock and in the same year, 1937, she bought property on Englewood Court for $6,800 cash. Petitioner also bought a house in Battle Creek, Michigan, in 1937, for $4,500 on a contract basis. Subsequently she sold this property on contract for the same price and the contract was paid out four or five years later. While in Battle Creek she had not done much outside work and spent more than she earned. Petitioner returned to Fort Wayne the latter part of 1937 and attended a chiropractic school there. Shortly after her return, in 1937, she sold the Englewood Court property for $7,500 on a contract, receiving a down payment of $1,500 with an agreement from the purchaser to make payments of $60 per month. The purchaser, in 1940, obtained a mortgage on that property1952 Tax Ct. Memo LEXIS 3">9 and paid petitioner the balance on the contract of $4,000. At approximately the same time petitioner bought property on Buell Drive for $5,000 cash. This was immediately sold on contract for $5,000, petitioner receiving a down payment of $500 and an agreement from the purchaser to make payments of $45 per month. Buying and selling this property was a financial transaction in which her only concern was the six per cent per annum interest she would receive. Late in 1940 or early in 1941 she sold her ten shares of Lincoln Life Insurance Company stock for about $450. During the periods petitioner was not taking the summer courses, or while attending school at night, she worked by giving massages and baths. Sometime after 1937 petitioner took a course in beginner's college chemistry at the Extension Department of the University of Indiana, which department was located in Fort Wayne. In 1943, petitioner bought a residence located at 4633 Tacoma Avenue, in South Wood Park Addition, for $10,500. This property was purchased on contract with a down payment of $2,000 cash. In 1945 petitioner paid the purchase price down to where she was able to obtain a mortgage loan on this property from1952 Tax Ct. Memo LEXIS 3">10 the Indianapolis Life Insurance Company in the principal amount of $5,600. In 1945 petitioner sold her Tacoma Avenue property for approximately $13,000 and paid off the mortgage on it. On February 16, 1945, petitioner purchased a farm of about 69 acres near Fort Wayne, for her son, taking title in her own name. The purchase price was $8,500. The deed was recorded July 6, 1945. On February 28, 1945, petitioner purchased from the same grantors a tract of land of approximately 86 acres, adjoining the farm previously purchased, taking the title in her name. The purchase price was $6,500. The deed was recorded April 15, 1946. Petitioner's son, Nelson Arnold, furnished petitioner with a down payment of $1,000 and the following week gave her approximately $1,700. Petitioner furnished enough of her money to obtain a mortgage loan on the first farm purchased, from the John Hancock Life Insurance Company in the original amount of $3,850. The second farm tract was purchased on contract with petitioner making a down payment of $500. Monthly payments of $50 were paid to Churubusco Bank. During 1946 petitioner borrowed $2,500 from her mother, Elizabeth Sprinkle, which petitioner applied toward1952 Tax Ct. Memo LEXIS 3">11 the payment on the contract of purchase of the second farm. She also paid the monthly installments for a year and a half. During 1947 Nelson Arnold borrowed $2,500 from his father and paid his mother for some of the money she had put into the two farms. He lived on the farm, made some improvements and kept up the repairs. He also paid the taxes and insurance and retained what crops that were produced. From July 1941 to September 1946, petitioner rented offices at 206 E. Jefferson Street. During 1946 she purchased an old residence located at 225 E. Jefferson Street, to which she moved her offices, converting the two front rooms into a joint reception and waiting room. This property was purchased on a contract basis of $14,200, petitioner agreeing to make payments of $100 per month. No other business was conducted in the building. Petitioner prior to 1944, charged her patients $2 a treatment. This was raised to $3 and then to $5. After raising her charge to $5 per treatment she charged for repeat calls $2, which was later raised to $3. She charged for her treatments in Chicago $10 per treatment and $5 for repeat calls by children. Subsequently, she made straight charges of $10 for1952 Tax Ct. Memo LEXIS 3">12 adults and $5 for children. On February 26, 1948, petitioner purchased her present residence located at 1125 Illsley Drive, Fort Wayne, on a contract basis, the purchase price being $19,500. She made a down payment of $5,000 cash and agreed to pay the balance in monthly payments of $125. During the year 1948 petitioner obtained a mortgage loan on her Illsley Drive residence from the Home Loan & Savings Association at Fort Wayne and with the proceeds of this loan paid off the contract balance then owing on her home. Also during 1948 petitioner advanced a total sum of $14,400 to her daughter, Elizabeth, who was living in Middlesex County, Massachusetts, and a residence located at 40 Westland Avenue, Winchester, Massachusetts, was purchased with Elizabeth and her husband and petitioner as joint tenants. On October 18, 1945, petitioner made application with Columbus Venetian Stevens Buildings, Inc., Chicago, Illinois, for rental of office space in the Stevens Building. Among the statements made in the application which was signed by petitioner are the following: "Business to be conducted: Osteopath References: Bank - checking - Anthony Wayne Bank, Fort Wayne, Indiana." With the1952 Tax Ct. Memo LEXIS 3">13 application petitioner gave a statement of her financial condition as follows: "Real EstateLocation: Farm located two mileseast of Churubusco, Indiana, onRoad 205Value$15,000Mortgage3,600Net Value$11,400MerchandiseNoneFixturesNoneBills ReceivableNoneCash1,000Other AssetsNoneOther AssetsNoneTotal Assets$12,400Total LiabilitiesNoneNet Assets$12,400The above is a correct statement."The above statement was followed by petitioner's signature and Fort Wayne address. During 1948 the Indiana Board of Medical Registration conducted an investigation of the professional activities of petitioner. One of the investigators observed the office hours and people coming in and out of the petitioner's office several times during the year. The people appeared to be from all walks of life. On February 10, 1948, from 7:30 A.M. to 9:48 A.M., forty-two individuals were observed entering petitioner's premises and during the same period eighteen people left the premises. On May 18, thirty-four persons were observed entering the premises between the hours of 8:03 A.M., and 9:58 A.M. About May, 1948, petitioner1952 Tax Ct. Memo LEXIS 3">14 was served with an injunction notice, instigated by the Indiana Board of Medical Registration, which action is still pending. The investigation and legal action led to publicity in the local newspapers. Although her number of patients decreased because of the publicity she found she did not have so many to talk with and have to turn them away, which really permitted her to treat more patients than she had been able to treat before and this in effect increased her income. Petitioner kept no books or records of her business receipts and expenditures during the period in question. During this period she had a checking account at the Peoples Trust & Savings Company and she had a savings account in the amount of $100 from 1943 to 1946, inclusive, at the Anthony Wayne Bank. Petitioner made no regular deposits in her checking account as it was not convenient for her to do so and she did not want people to find out about her business. Petitioner's assets, liabilities and net worth for the years involved were as follows: ASSETS194319441945194619471948CASHChecking account$ 196.35$ 1,398.35$ 2,957.80$ 2,017.80$ 108.32$ 378.53Savings account100.00100.00100.00100.00nonenoneCONTRACT RECEIVABLELewis Street property650.00350.00noneREAL ESTATETacoma Avenue property10,500.0010,500.00noneIllsley Drive propertynone19,500.0019,500.0019,500.0019,500.00East Jefferson Street propertynone14,200.0014,700.0014,700.00First farm tractnone5,800.005,800.003,300.003,300.00Second farm tract6,500.006,500.006,500.006,500.00Winchester, Mass., propertynone14,400.00Totals$11,446.35$12,348.35$34,857.80$48,117.80$44,108.3258,778.53LIABILITIESPERSONAL LOANS PAYABLEElizabeth Sprinklenone2,500.002,500.002,500.00CONTRACTS PAYABLESecond farm tractnone5,500.00Illsley Drive propertynone14,370.8413,579.6212,748.34noneEast Jefferson Street property14,973.0012,870.0011,875.00MORTGAGES PAYABLETacoma Street property5,525.723,648.52Illsley Drive property9,588.97First farm tract3,650.003,550.003,450.003,350.00Reserve for depreciation142.00588.001,034.00Totals$ 5,525.72$ 3,648.52$23,520.84$34,744.62$32,156.34$28,347.97Net Worth5,920.638,699.8311,336.9613,373.1811,951.9830,430.56Totals$11,446.35$12,348.45$34,857.80$48,117.80$44,108.32$58,778.531952 Tax Ct. Memo LEXIS 3">15 Petitioner's increased net worth, personal expenses, taxable income, deductions, income reported and additional income not reported for the years involved were as follows: 194319441945194619471948Net Worth$5,920.63$8,699.83$11,336.96$13,373.18$11,951.98$30,430.56Increase in Net Worth2,779.202,637.132,036.2218,478.58Personal Expenses2,795.683,955.656,764.424,205.94Taxable Income$5,574.88$ 6,592.78$ 8,800.64$22,684.52Less 50% capital gain on sale of residence964.75$ 5,628.03Less deductions as on returns334.83360.52975.09Net Income$5,240.05$ 5,267.51$7,825.55$22,684.52Net Income as reported on returns852.192,190.721,908.98Adjusted Gross Income as reported on return4,260.09Additional Income not reported$4,387.86$ 3,076.79$ 5,916.57$18,424.43Part of the deficiency for each of the taxable years is due to fraud with intent to evade tax. Opinion Respondent determined petitioner's taxable income for the years involved by the use of the increase in net worth, plus personal living expenses, method. This is permissible1952 Tax Ct. Memo LEXIS 3">16 where the taxpayer has failed to keep books and records that properly reflect his true income. Section 41, Internal Revenue Code1; Regulations 111, Section 29.41-1 2 ; Harris v. Commissioner, 174 Fed. (2d) 70. 1952 Tax Ct. Memo LEXIS 3">17 In computing petitioner's net worth for the taxable years respondent has determined for each year petitioner's assets and liabilities, based primarily on real estate holdings and outstanding indebtedness owing on them, and to the net worth determined he has added an amount for the respective years to cover the living expenses of petitioner. Petitioner has not challenged respondent's determination of living expenses and has agreed to the majority of assets and liabilities as found by respondent. The items upon which the parties disagree are (1) the amount of cash that petitioner claims was left with her by her husband, which she states was on hand at the time of his death and which, she maintains, she kept practically intact through the years extending from 1935 to 1948; and (2) the value of petitioner's interest, if any, in the farm tracts she purchased for her son. 1. Respondent has not found that petitioner had an asset of $10,000 or $12,000 cash in her home at any time during the years involved. Petitioner maintains that at the time her husband was killed he had brought home cash amounts totaling over $12,000, that she had kept that amount in her home from that date through1952 Tax Ct. Memo LEXIS 3">18 1943, that she had $11,000 of it in 1944, $10,000 in 1945, $12,000 in 1946 and 1947 and none of it in 1948. She testified that when the banks closed in 1933, Dr. Schneider brought home $3,000, which he had kept in a safe at his office, and requested petitioner to take care of it, explaining that he had been unable to get any money from his bank account and did not want to be caught in that condition again; that between that date and his death in November 1935, he had brought home other amounts which brought the total in her possession to over $12,000; that he was scared of the banks and that he wanted to have money with which he could give assistance to four grandchildren, whose father, the doctor's son, had died two years previously. There is no evidence to substantiate such statements, but there are facts and circumstances that negate them. It is not explained why petitioner could keep money more safely at home than the doctor could in a safe at his office. If he had been keeping money in his safe before the banks closed, there is no reason given for not continuing to do so after the bank closures. It is not shown that the doctor had suffered any loss because of the closing of1952 Tax Ct. Memo LEXIS 3">19 a bank or any other reason why he would not risk his money in a bank. To the contrary, the evidence shows that at his death he had cash on his person and in his safe in the comparatively small amount of $184, but a checking account of $1,500 and a savings account of over $23,000. Furthermore, in May 1935, for a reason not explained, the doctor turned over to petitioner and her daughter $2,000. This he did not do by delivering the cash to her for safe-keeping but by making a deposit to the joint account of petitioner and her daughter in the same bank where his checking and savings accounts were maintained, and this was done at a time when she, and he, are alleged to have had $12,000 cash in their home. The execution of the antenuptial agreement concurrently with the marriage of the doctor and petitioner was intended to limit petitioner, in lieu of dower rights, to the possession of his home and 55 shares of certain stock. At that time the home was valued at approximately $4,250, the amount for which the property was later sold and the stock was stated in the agreement to be of the value of approximately $5,000, and which was appraised in the doctor's estate at $5,500. Since the doctor1952 Tax Ct. Memo LEXIS 3">20 had an estate, exclusive of the home and the aforementioned stock, of about $72,000, of which about $25,000 was in cash, none of which estate petitioner claimed, it would appear, under the conditions, that the doctor would not fail to take into consideration in the agreement an asset in cash of approximately half the amount he had in his savings account, and which also was as much as, and $3,000 more, than the value of property he agreed to give her. Rather, it would seem from the business judgment he showed in making investments, of having most of his cash in a savings account and the execution of the agreement in settlement of the property rights of his wife-to-be in his estate he would have preferred to have had such an amount as $12,000 in his savings account or invested in some manner. Petitioner was very vague on the amount of cash she had on hand from the death of her husband until she had none of it in 1948; in fact, she admitted she never knew the exact amount at any time, nor did she know how much of it she had spent in those years when the cash was alleged to have been reduced to approximately $11,000 and $10,000; nor did she state clearly how much was spent, where and1952 Tax Ct. Memo LEXIS 3">21 when, in 1948, the year in which the entire amount of $12,000 is alleged to have been expended. During the course of time after petitioner sold her home and stock, she made investments; also, found it necessary to borrow money but despite her apparent desire to make money from her investments and to save interest on money she owed, she never used any of the cash that was available over a period of at least ten years. Her testimony on the above matters appears to lack the substance of reality. There is no need to prolong this discussion further. We think the evidence strongly supports respondent in his elimination from petitioner's assets the cash items claimed by petitioner to have been in her possession prior to and since the death of her husband. 2. The parties disagree with respect to petitioner's interest in the farm tracts purchased by petitioner for her son, Nelson Arnold, but title to which was taken in her name and has so remained until the present time, as far as the record shows. Respondent has given petitioner credit of $2,700 as having been paid to her by her son, which was presumably paid on the purchase price of the first farm tract in 1945 and also he has given her1952 Tax Ct. Memo LEXIS 3">22 credit of $2,500 as having been paid by the son to his mother in 1947 for money she had expended in purchasing the farm, and which $2,500 he had borrowed, on his note, from his father. Presumably, the credit was based on the testimony adduced by the mother and son and the $2,500 note in evidence, although it is not clear that the entire amount borrowed from his father was paid to petitioner. The evidence is not clear and convincing that petitioner had no financial interest in the property in 1948 and not more than the amount of $3,050 she claimed as her interest in the farm during 1945, 1946 and 1947. Petitioner and her son testified that the property was bought for him, that while petitioner helped financially she had been reimbursed by him, and that title was taken in her name in order to protect him from his wife, and particularly his mother-in-law, who had at one time caused him and his wife to be separated for a year and one-half. For this reason it is argued, if she caused any further trouble between him and his wife, they would not be able to reach his property. The record reveals, however, that the separation between Arnold and his wife occurred prior to 1937, that they were1952 Tax Ct. Memo LEXIS 3">23 reunited in that year, that the farm was purchased eight years later, in 1945, that at that time the mother-in-law was living with them and that the wife, who kept the books and records relating to the farm knew, at least, sometime after 1945 how the farm was acquired and paid for. It is argued that petitioner was merely holding the property in trust for her son, Nelson, that she was secured for the money advanced by the deed, that he was in possession of the property, that he had paid taxes and insurance, made repairs and improvements and his mother did not share in any crops or produce from the farm. Again, this does not convince us that she had no interest in the property. There is nothing in the two deeds that shows any interest of Nelson Arnold in the property; it was petitioner who signed the original contracts of purchase; it was through her that the balance due on the first contract was paid in 1946; it was she who made the down payment of $500 on the second piece of property; it was through her that the balance on the contract was reduced to where an insurance loan could be obtained; and, it was she who signed the mortgage in securing the loan. Except for the oral statement1952 Tax Ct. Memo LEXIS 3">24 of petitioner and her son, both being parties of interest, there is no evidence of any other payments being made to petitioner or to anyone else by Nelson on the contracts of purchase or on the outstanding mortgage. It is difficult to understand, too, how Nelson and his wife, knowing all the circumstances relating to the acquisition of the farm, are willing to leave title in another, when, as claimed, he had paid for it; when there is nothing to show his ownership; and when, if his mother should predecease him, there would be other children to share in the mother's estate, including the farm property. Nor, can we understand that Nelson could maintain a position that his wife should not have at least her dower interest in the farm, should he predecease his mother, particularly after the wife had been of such help to him in operating the farm as he testified. Again, the realities of the situation are contrary to the testimony of petitioner and her son. Considering all the circumstances, we conclude that petitioner had an interest in the farm to the financial extent we have found, in our findings of fact, for the years as respectively shown. Petitioner, on brief, in computing her net1952 Tax Ct. Memo LEXIS 3">25 worth included in her liabilities a reserve for depreciation on her respective homes and the Winchester, Massachusetts, property and also on a furnace and stoker in her office building. As she offered no proof, there is no evidence on which to base findings of fact on these items and consequently they are not included in our findings of fact. The parties are in agreement on the items of depreciation relating to petitioner's office building. In so far as the deficiencies in tax are concerned, petitioner, in our judgment, has failed to meet her burden of proof and the tax liability will, therefore, be determined in accordance with our findings of fact. Our final question is whether petitioner should be charged with a fraud penalty, as provided by section 293 (b) of the Internal Revenue Code. 31952 Tax Ct. Memo LEXIS 3">26 It is respondent's burden to prove by clear and convincing evidence that some part of the deficiencies is due to fraud, with intent to evade tax. Section 1112, Internal Revenue Code. In our opinion respondent has met his burden. "To establish fraud by direct proof of intention is seldom possible. Usually it must be gleaned from the several transactions in question and the conduct of the taxpayer relative thereto." M. Rea Gano, 19 B.T.A., 518, 532; Arlette Coat Co., 14 T.C. 751">14 T.C. 751, 14 T.C. 751">756. Petitioner claims that she reported all her income for the respective years in question on her income tax returns. It appears, however, that she did not. Petitioner appears to have been successful both in her business and in her investments. She has received income in substantial amounts, and has failed to report substantial amounts. She kept no books or records. In fact, she appears to have deliberately refrained from doing so, in order to prevent the Indiana Medical Board of Registration from knowing what her business was or how much income she was receiving, which operations, to say the least, prevented her from reporting her true income1952 Tax Ct. Memo LEXIS 3">27 or to permit respondent to obtain the facts relating thereto. Petitioner reported income on her returns for the taxable years as follows: Net income for 1944, 1945 and 1946 in the respective amounts of $852.19, $2,190.72 and $1,908.98, and adjusted gross income for 1948 in the amount of $4,260.09. As we have found in our findings of fact, her total net income for the first three taxable years amounted to $5,240.05, $5,267.51 and $7,825.55, respectively, and her adjusted gross income for 1948 was $22,684.52. She, thus, understated her income for the four years in the respective amounts of $4,387.86, $3,076.69, $5,916.57 and $18,424.43. It is obvious that she did not report a large percentage of her return in each year. As stated by the Sixth Circuit Court of Appeals in Rogers v. Commissioner, 111 Fed. (2d) 987, affirming 38 B.T.A. 16">38 B.T.A. 16: "* * * Discrepancies of 100% and more between the real net income and the reported income for three successive years strongly evidence an intent to defraud the Government. The Board did not err in deciding that 50% penalties should be assessed." 14 T.C. 751">Arlette Coat Co., supra, p. 756; Victor A. Dorsey, 33 B.T.A. 295">33 B.T.A. 295,1952 Tax Ct. Memo LEXIS 3">28 Frank A. Weinstein, 33 B.T.A. 105">33 B.T.A. 105. The repeated omission from the returns of such large percentages of the total taxable income, under circumstances indicating that petitioner, at the time the returns were made, knew that the omitted amounts constituted taxable income, cannot be ascribed to oversight or error but compels the conclusion that at least a part of the deficiency for each taxable year is due to fraud with intent to evade tax. Rogers v. Commissioner, supra.Her explanation that the returns reflect her income is evasive and unsatisfactory. Under our revenue laws the taxpayer is, in the first instance, his own assessor and, therefore, has the responsibility to deal fairly and honestly with his Government - he must turn square corners in reporting his income. Charles E. Mitchell, 32 B.T.A. 1093">32 B.T.A. 1093. Under the circumstances, and the record before us, we cannot conclude that petitioner has dealt fairly and honestly with the Government. Respondent has met his burden and his action in assessing the fraud penalties is sustained. Decision will be entered under Rule 50. Footnotes1. SEC. 41. GENERAL RULE. The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer's annual accounting period is other than a fiscal year as defined in section 48 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year. ↩2. SEC. 29.41-1. COMPUTATION OF NET INCOME. - Net income must be computed with respect to a fixed period. Usually that period is 12 months and is known as the taxable year. Items of income and of expenditure which as gross income and deductions are elements in the computation of net income need not be in the form of cash. It is sufficient that such times, if otherwise properly included in the computation, can be valued in terms of money. The time as of which any item of gross income or any deduction is to be accounted for must be determined in the light of the fundamental rule that the computation shall be made in such a manner as clearly reflects the taxpayer's income. If the method of accounting regularly employed by him in keeping his books clearly reflects his income, it is to be followed with respect to the time as of which items of gross income and deductions are to be accounted for. (See sections 29.42-1 to 29.42-3, inclusive.) If the taxpayer does not regularly employ a method of accounting which clearly reflects his income, the computation shall be made in such manner as in the opinion of the Commissioner clearly reflects it.↩3. 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).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621091/	RONALD H. AND ISABELLE DONEFF, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentDoneff v. CommissionerDocket No. 12496-89United States Tax CourtT.C. Memo 1991-253; 1991 Tax Ct. Memo LEXIS 296; 61 T.C.M. (CCH) 2822; T.C.M. (RIA) 91253; June 5, 1991, Filed 296 Decision will be entered for the respondent. James L. Stan and Herbert K. Douglas, for the petitioners. James R. McCann, for the respondent. HAMBLEN, Judge. HAMBLENMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined deficiencies in Ronald H. Doneff's (hereinafter petitioner) and Isabelle Doneff's (together hereinafter referred to as petitioners) Federal income tax for the taxable years 1981 and 1984 in the amounts of $ 22,714.39 and $ 10,745.11, respectively. The issues presented are: (1) Whether petitioners' consent to extend the statute of limitations, executed by their agent, was valid; (2) whether petitioners are entitled to a bad debt business deduction under section 166; 1 (3) alternatively, whether petitioners are entitled to a deduction under section 165(c)(1) for a loss incurred in a trade or business; (4) alternatively, whether petitioners are entitled to a deduction under section 165(c)(2) for a loss incurred in any transaction entered into for profit; (5) alternatively, whether petitioners are entitled to a deduction under section 165(c)(3) for a loss of property arising from theft; (6) alternatively, whether petitioners are entitled297 to a deduction under section 212 for expenses arising from the production of income; and (7) alternatively, whether petitioners are entitled to a deduction under section 1244 for a loss on small business stock. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners resided at 1270 W. 4th Street, Hobart, Indiana, at the time the petition in this case was filed. Petitioners timely filed joint Federal individual income tax returns (Forms 1040) for their taxable years 1981, 1982, 1983, and 1984. Petitioners executed Form 2848 appointing Nick Thomas, CPA, (hereinafter Mr. Thomas) as their attorney-in-fact for the taxable years 1981 through 1986 on September 9, 1987. 298 The power of attorney authorized Mr. Thomas to "receive confidential information and to perform any and all acts that the principal(s) can perform." On November 6, 1987, petitioners executed Form 872 extending the period of limitations in which to assess tax for the period ended December 31, 1984, until December 31, 1988. On October 19, 1988, Mr. Thomas, designated in petitioners' above power of attorney, executed Form 872 on behalf of petitioners, consenting to extend the period of limitations for the period ended December 31, 1984, until December 31, 1989. Petitioners executed Form 2848 appointing James L. Stan as an attorney-in-fact for the taxable year 1984 on December 31, 1988. The Form 2848 appointing Mr. Stan did not revoke the power of attorney of Mr. Thomas. In 1980, petitioners' son, Gregory Doneff (hereinafter Greg), was an unemployed twenty-five year old living in Palm Beach, Florida. During 1980, Greg met John Wesley Moore (hereinafter Moore) at a retail men's clothing shop named "John Wesley Moore" (hereinafter the Store), owned by John Wesley, Inc. (sometimes hereinafter referred to as the corporation). Greg began working at the Store and after a short period299 was made manager. He was active in the management and day-to-day operations of the Store. During the period at issue, the Store was in poor financial condition. For the fiscal year ending August 31, 1981, the Store cleared only $ 2,047 in profits. In 1981, Greg loaned $ 10,000 to John Wesley, Inc., and $ 65,000 jointly to John Wesley, Inc., and Moore. These loans were evidenced by promissory notes executed by Moore, as president of John Wesley, Inc., and Moore, individually. Greg thought that, in exchange for his loans totaling $ 75,000, he would receive an ownership interest in the entity running the Store. At a special meeting of the officers, directors, and shareholders of John Wesley, Inc., the corporation and Greg agreed that Greg would exchange his two notes evidencing the $ 75,000 loans for an equivalent amount of stock in the corporation. The precise number of shares was to be determined based upon corporate financial statements which had not been prepared at that time and were to be issued at a later date. Further, Moore told Greg that the shares would have to be repurchased by the corporation from three shareholders before they could be transferred to Greg. Therefore, 300 the exact number of shares involved in the exchange was undetermined at the time of the agreement. Greg was elected vice president of John Wesley, Inc., at a special meeting of its board of directors, officers, and shareholders on December 7, 1981. Greg was also appointed to be an additional director of the corporation at that meeting. In 1982, the Store needed cash in order to continue in business. Greg and Moore contacted petitioner hoping to obtain funds that could be used in the operation and expansion of the Store. Greg asked petitioners if there was any way they could put money into the corporation. Petitioner did not want to invest in the corporation. Petitioner had reviewed some of the financial statements and paperwork from the Store. He knew that the Store was not handling money in an efficient way, had a negative net worth, was in financial distress, probably would not be able to stay afloat, and did not warrant an investment. Petitioners nevertheless agreed to advance funds to the corporation. Petitioners' motivation in making the loans was to protect their son's equity interest in the corporation. The loans were predicated on the assumption that petitioners' 301 son would receive the stock once the company was better organized and running more efficiently. Petitioner has never been involved in entrepreneurial endeavors and has practiced medicine all his professional life. Petitioner was not engaged in the business of lending money as of the time he made the loans. The only business acumen he had was that of someone who is in a profession, hoping to find a separate nonbusiness-related sideline. However, at the request of their son, petitioners agreed to make loans to the corporation. Petitioners wrote several checks for large sums of money payable to their son, Greg, during 1981 and 1982. These checks included check number 116, dated November 25, 1981, in the amount of $ 50,000; check number 229, dated September 16, 1982, in the amount of $ 20,000; 2 and check number 5242, dated July 18, 1981, in the amount of $ 10,000. These funds, advanced by petitioners, were loaned by their son to John Wesley, Inc. In addition, petitioners wrote check number 5249, dated August 1, 1981, in the amount of $ 50,000, payable to the order of Moore. Check number 5249 did, however, include a notation, "G.S.D", for Gregory S. Doneff. 302 Petitioner drew up two separate promissory notes to evidence the loans made by him to his son and Moore. Petitioner made the notes payable from John Wesley Moore of Palm Beach, a figment partnership, because in his mind his son and Moore were a partnership. On January 3, 1983, Moore executed and delivered a promissory note to petitioners in the amount of $ 100,000 with a stated interest rate of 13.5 percent. Petitioners also received a promissory note, dated January 3, 1983, in the amount of $ 30,000 with a stated interest rate of 12.5 percent. Moore and Greg, purportedly as partners of John Wesley Moore of Palm Beach, signed the promissory note for $ 100,000 in favor of Ronald H. Doneff and the other promissory note for $ 30,000 in favor of his wife Isabelle Doneff. Both Moore and Greg were coguarantors and jointly and severally liable on each of the two promissory notes. As of January 3, 1983, John Wesley Moore of Palm Beach did not exist. In fact, the purported partnership John Wesley Moore of Palm Beach has never existed. At the time of the loan, it was the intention of the parties that the money be lent to the party or entity owning and operating the Store. It was the303 further intention of all parties that the promise to repay the money loaned, as evidenced by the notes, would be backed by the assets, financial standing, and credit worthiness of the party or entity owning and operating the Store. The Store was, in fact, owned and operated by John Wesley, Inc., rather than the purported partnership John Wesley Moore of Palm Beach. The funds loaned by petitioners were in fact received and used by the corporation. These funds were used by the corporation to expand the Store, to pay off prior debts, to acquire new merchandise, and for general operating expenses and salaries. The funds also enabled the corporation to pay off outstanding loans, realize a substantial savings on the cost of these loans, and reach a more stable financial situation. Petitioner agreed that the funds forwarded to the corporation were used for their intended purposes. Petitioner admits that the loans forwarded to the corporation allowed the corporation to stay afloat and meet its payables as they were becoming due. Three payments, each in the amount of $ 3,304.58, were made on the promissory notes. All three checks were paid to the order of petitioner and signed by his304 son, Greg. Neither John Wesley, Inc., nor the purported partnership John Wesley Moore of Palm Beach paid the installment due on June 3, 1983, and petitioners elected to accelerate payment of the balance. Petitioners sent a letter to John Wesley Moore of Palm Beach on June 29, 1983, advising Moore that he was in default of payments on the promissory notes. Petitioners never attempted to collect on the promissory notes from their son who was a co-guarantor. John Wesley, Inc., doing business as John Wesley Moore, filed a petition in bankruptcy in the U.S. Bankruptcy Court for the Southern District of Florida on April 10, 1984. The list of creditors attached to the bankruptcy petition confirms that the corporation had significant debts which it was unable to pay. In an amendment to the list of creditors, the debtor disputed the amount of debt owed to petitioners and disputed any debt that it owed to petitioner's son. Moore, individually, filed a petition in bankruptcy in the U.S. Bankruptcy Court for the Southern District of Florida on April 17, 1984. In an amendment to the list of creditors in his individual case, Moore disputed the amount owed to petitioners and disputed the305 debt owed to petitioner's son. Petitioners voluntarily agreed to cease pursuing any complaint in the Bankruptcy Court to block the discharge of Mr. Moore on the basis that the loans were fraudulently obtained. On April 18, 1985, Moore was discharged of debts nunc pro tunc as of January 22, 1985, by the U.S. Bankruptcy Court of the Southern District of Florida. In a letter to the president of the Florida State Bar Association on October 3, 1983, petitioner alleged that his son was defrauded and unjustly uprooted from his chosen livelihood and area of residence. No mention is made in the letter that petitioner himself was defrauded. Based on their losses on the promissory notes in question, petitioners took a worthless business loan deduction in the amount of $ 151,488.89 on their 1984 Federal income tax return. On May 6, 1985, petitioners also filed a joint application for tentative refund (Form 1045) for Federal net operating losses of $ 105,767.82 generated in the taxable year 1984, with a carryback first to the taxable year 1981, and with the remainder to the taxable years 1982 and 1983, respectively. Respondent sent a notice of deficiency to petitioners, dated March 7, 1989, 306 determining deficiencies of $ 22,714.39 and $ 10,745.11 for the taxable years 1981 and 1984, respectively. Petitioners timely filed their petition to this Court contesting respondent's determined deficiencies for the taxable years 1981 and 1984, on June 7, 1989. OPINION Respondent determined that petitioners were not entitled to their claimed business bad debt deduction in the amount of $ 151,488.89 for the taxable year 1984 and consequential net operating losses of $ 105,767.82 for the taxable year 1984 and the taxable year 1981 via the carryback provisions of the Internal Revenue Code. Petitioners contend that the consent to extend the statute of limitations to December 31, 1989, executed by Nick Thomas, is invalid. Petitioners argue that, because Mr. Thomas did not have "specific authority" to execute the consent on behalf of petitioners, the consent is invalid. Based upon their assertion that the consent is invalid, petitioners contend that respondent's deficiency determination is barred since it came after the expiration of the three-year period of limitations in which respondent could have assessed the tax at issue. If the Court finds that the consent was valid, petitioners307 argue that they are entitled to report the total amount in controversy as a business bad debt deduction under section 166(a). Alternatively, petitioners claim that they are entitled to report the amount in controversy as a loss incurred in a trade or business under section 165(c)(1), or a loss incurred in any transaction entered into for profit under section 165(c)(2), or a loss of property arising from theft under section 165(c)(3), or an expense incurred in the production of income under section 212, or a loss on small business stock under section 1244. Respondent determined that the consent, executed by Mr. Thomas on behalf of petitioners, was valid. In doing so, respondent asserts that the "specific authority" needed for Mr. Thomas to execute the consent on behalf of petitioners was granted by petitioners when they executed a power of attorney in favor of Mr. Thomas. Respondent contends that petitioners have not substantiated their claim that the amount at issue herein should be treated as a business bad debt deduction. Instead, respondent, in the notice of deficiency, determined that petitioners were entitled to a nonbusiness bad debt deduction under section 166(d)(1), subject308 to tax treatment as a short-term capital loss. Respondent further asserts that petitioners have failed to meet their burden of proof in substantiating their claim for deductions under the various cited Code sections. The Notice of DeficiencyPetitioners contend that respondent's notice of deficiency is barred by the three-year period of limitations in which respondent can assess tax. In support of their position, petitioners argue that the consent to extend the time to assess tax (Form 872) executed by their agent, Mr. Thomas, on October 18, 1988, is invalid because they never specifically authorized Mr. Thomas to sign the consent on their behalf. Respondent asserts that the consent in question was properly executed by petitioners' agent, Mr. Thomas. Respondent points to the power of attorney (Form 2848), executed by petitioners, which authorizes Mr. Thomas "to receive confidential information and to perform any and all acts that the principal(s) can perform with respect to the above specified tax matters (excluding the power to receive refund checks, and the power to sign the return (see regulations section 1.6012-1(a)(5)), Returns made by agents), unless specifically309 granted below)." In executing the Form 2848 power of attorney, petitioners granted Mr. Thomas all powers necessary to act on their behalf except to receive refund checks or to sign returns. Respondent asserts that neither of these two restrictions is at issue in these proceedings. Respondent further points out that the power of attorney covers the taxable years in question. Section 6501(a) declares that, except as otherwise provided, "the amount of any tax imposed * * * shall be assessed within 3 years after the return was filed * * * and no proceeding in court * * * shall be begun after the expiration of such period." The Secretary and the taxpayer may extend this time period upon the written consent of both parties. Sec. 6501(c)(4). The tax may then be assessed at any time prior to the expiration of the agreed-to time period. Further, within the extension period, the extension itself can again be extended by subsequent written agreement of the parties. Sec. 6501(c)(4). The bar to the period of limitations in which to assess tax is an affirmative defense and the party raising it must specifically plead it and carry the burden of proof with respect thereto. Adler v. Commissioner, 85 T.C. 535">85 T.C. 535, 540 (1985);310 Rule 142(a). Petitioners make a prima facie case by proving the filing date of the return, Miami Purchasing Service Corp. v. Commissioner, 76 T.C. 818">76 T.C. 818, 823 (1981); Robinson v. Commissioner, 57 T.C. 735">57 T.C. 735, 737 (1972), and showing that the notice of deficiency was issued beyond the normally applicable limitations period. Adler v. Commissioner, 85 T.C. at 540. The burden of going forward then shifts to respondent to introduce evidence showing that the bar of the period of limitations is inapplicable. Miami Purchasing Service Corp. v. Commissioner, 76 T.C. at 823. Pursuant to section 6501(c)(4), respondent can meet his burden by showing that the statutory notice of deficiency was mailed prior to the expiration of the agreed limitations period, pursuant to a consent which is valid on its face. Adler v. Commissioner, 85 T.C. at 541. A consent is valid on its face if it identifies the taxpayers, bears their signature, identifies the year, and was dated prior to the expiration of the then existing limitation period.3 A consent is valid on its face even if the underlying documentation311 that relates to it, such as a power of attorney (Form 2848), is invalid.4 Once the consent is determined to be valid on its face, the burden of going forward then shifts back to petitioners to show that the underlying documents are invalid or the alleged exception is not applicable. Adler v. Commissioner, 85 T.C. at 540. The ultimate burden of proof always rests with the party raising the issue of the period of limitations as an affirmative defense. Adler v. Commissioner, 85 T.C. at 540. In the case before us, respondent produced an initial consent to extend the period of limitations in which to assess tax to December 31, 1988, that appears valid on its face. Next, respondent meets his burden of going forward by producing a second consent to extend the period 312 of limitations in which to assess tax to December 31, 1989, executed within the first extension period. The second consent is valid on its face as it was signed by petitioners' duly authorized attorney-in-fact, Mr. Thomas. The ultimate burden of proof rests with petitioners. Petitioners simply have not met this ultimate burden as the consents are valid on their face, and the burden is upon petitioners to bring in evidence of the invalidity of the consents. Petitioners could have very easily called Mr. Thomas to testify at trial as to the actual scope of his authority with respect to petitioners' 1981 through 1986 taxable years. The failure of a party to introduce evidence within his possession which, if true, would be favorable to him, gives rise to a 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). This principle is particularly pertinent when the party failing to produce the evidence has the burden of proof or the other party to the proceeding has established a prima facie case. Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. at 1165.313 Petitioners did not call Mr. Thomas and gave this Court no reasons why they did not do so. This raises the presumption that, had Mr. Thomas been called, his testimony would have been unfavorable to petitioners' position. Instead of calling Mr. Thomas, petitioners attempt to argue that they did not grant Mr. Thomas specific authority to execute the consent to extend time on their behalf. This argument fails to overcome the patent provisions of the documents and the presumption that Mr. Thomas would have testified contrary to petitioners' position. See Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. at 1165. 5 Consequently, petitioners have not carried their ultimate burden of proof. See Adler v. Commissioner, 85 T.C. at 540. We find that the two consents at issue are valid and that respondent issued the notice of deficiency within the extended period in which respondent must assess tax. Bad Debt314 Business DeductionPetitioners claim that the losses they incurred on the loans made to their son and Moore qualify as a business bad debt deduction under section 166(a)(1). Respondent determined that the losses were deductible as a nonbusiness bad debt deduction under section 166(d)(1). Respondent further contends that petitioners conceded this issue in the opening statement of petitioners' counsel. Before addressing the propriety of petitioner's claimed section 166 business bad debt deduction, we must first consider respondent's contention that petitioners' counsel conceded this and other issues in his opening statement. In making this assertion, respondent relies on the opening statement of petitioners' counsel, in which he stated: Your Honor, I simply want to say that, while a lot of issues are contained in the contentions, essentially we're taking the position that this write-off is a result of fraud. And, we are going to be concentrating on that. And, I think that will simplify the trial of this case. So, I don't think that we have to get into a lot of these issues that are in there. And, I think -- I'm reluctant to concede much -- but, I think the Respondent is 315 correct in his contentions in a lot of the -- as far as the defense of this thing, and I think that, basically, we're on a fraud case. Period. We find that these statements do not rise to the level of a concession on the part of petitioners to all issues other than the issue of fraud. We interpret these statements as petitioners' counsel's way of directing the Court's attention to the issues he views most favorable to his clients. Respondent was ill-advised to assume away several issues that were raised in the petition, mentioned in petitioners' brief, and maintained in petitioners' reply brief. It would have been more appropriate for respondent to have tested this matter by motion at trial, or thereafter, prior to submission of briefs. It is the function of this Court, not respondent, to determine if a concession has been made. However, notwithstanding respondent's briefing tactics, deductions are a matter of legislative grace, and petitioners bear the burden of proof to show that they are entitled to any deductions greater than those allowed by respondent. 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). This burden of proof includes establishing316 both the right to and the amount of the deduction. Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U.S. 134">417 U.S. 134, 40 L. Ed. 2d 717">40 L. Ed. 2d 717, 94 S. Ct. 2129">94 S. Ct. 2129 (1974); New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 78 L. Ed. 1348">78 L. Ed. 1348, 54 S. Ct. 788">54 S. Ct. 788 (1934). Section 166(a) provides that a deduction shall be allowed for any debt which becomes worthless within the taxable year. Section 166(d)(1)(A) restricts the benefits of section 166(a) for nonbusiness bad debts. In this respect, section 166(d)(1)(B) allows a deduction for nonbusiness bad debts but treats nonbusiness bad debts as a short term capital loss. Nonbusiness bad debts is defined in section 166(d)(2) as "a debt other than - (A) a debt created or acquired * * in connection with a trade or business of the taxpayer; or (B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business." The question whether a debt is a business debt or a nonbusiness debt is a question of fact in each particular case. Sec. 1.166-5(b), Income Tax Regs.Section 166(d), by defining a nonbusiness debt, establishes that a business debt is a debt created or acquired in connection with the trade or business of the taxpayer or a debt the loss317 from the worthlessness of which is incurred in the taxpayer's trade or business. In order for a debt to be considered a business debt, it must have a proximate relation to the taxpayer's trade or business. United States v. Generes, 405 U.S. 93">405 U.S. 93, 31 L. Ed. 2d 62">31 L. Ed. 2d 62, 92 S. Ct. 827">92 S. Ct. 827 (1972). In determining whether a proximate relationship exists, the proper measure is the taxpayer's dominant motivation for incurring the debt. A significant motivation in not sufficient. United States v. Generes, 405 U.S. at 103. In the case at hand, petitioners argue that the debt was incurred in petitioners' trade or business. The facts do not bear this out. The facts indicate that petitioner was a physician, not a person in the trade or business of making business loans, who loaned money to his son's venture, knowing that the investment was ill-advised. Petitioner knew the Store was not handling money efficiently. Petitioner knew that the Store was in financial distress and would probably not be able to stay afloat. The facts further indicate that petitioner's dominant motivation for making the loans was to protect his son's interests. Petitioners have presented scant evidence to support318 their contention that the loans in question were made by petitioner within his trade or business. We find that petitioners have failed to meet their burden of proof with regard to their claimed business bad debt deduction under section 166(a). Therefore, we find that petitioners are not entitled to section 166(a) business bad debt treatment for the loans at issue. Alternate Methods of DeductibilityPetitioners claim various alternate methods to deduct their losses on the loans at issue. Petitioners assert that the loans qualify under section 165(c)(1) for a loss incurred in a trade or business, section 165(c)(2) for a loss incurred in any transaction entered into for profit, section 165(c)(3) for a loss of property arising from theft, section 212 for an expense incurred in the production of income, or section 1244 for a loss on a small business stock. Respondent again contends that petitioners have conceded all of the above issues, except the section 165(c)(3) deduction for loss of property arising from theft. Respondent bases his contention on the previously noted excerpt from petitioners' counsel's opening statement, supra. As before, we do not find that these statements319 rise to the level of a concession. However, petitioners still must carry their burden of proof in establishing their right to and the amount of any claimed deductions in excess of those allowed by respondent. Welch v. Helvering, supra; Rule 142(a). Section 165(c)(1) allows a deduction for individuals for losses incurred in a trade or business. As we have previously found based on the entire record before us, petitioners were not in the trade or business of making business loans. Further, petitioner was engaged in no other business that we know of, based on the record before us, which would in any way relate to the advances in question. Petitioner was a physician who loaned money to his son's venture in hopes of helping his son maintain his interest. Further, petitioners, on brief, produced no credible evidence to support their argument for deductibility under section 165(c)(1). Petitioners have failed to demonstrate their right to the claimed deductions. See Commissioner v. National Alfalfa Dehydrating & Milling Co., supra.Therefore, petitioners fail to meet their burden of proof. Based on the above, we find that petitioners320 do not meet the requirements that would allow them a deduction under section 165(c)(1). Section 165(c)(2) allows a deduction for individuals for losses incurred in any transaction entered into for profit, regardless of whether the loss was incurred in the taxpayer's trade or business. The facts in the present case demonstrate that petitioners did not enter into the transaction in hopes of making a profit. Petitioners admit that their dominant motivation in making the loans at issue was to protect their son's interests. Petitioner further admits that he knew the Store was not a very good investment and that the Store would probably not be able to continue operations due to its poor money management. We find that petitioners' motive in making the loans was love for their son, not profit. Further, petitioners bring forth no credible evidence to support their theory of deductibility under section 165(c)(2). Instead, petitioners rely on a mere recitation of the Code sections they think might afford them relief. This mere recitation certainly does not provide petitioners' proof. Therefore, petitioners are not entitled to a deduction under section 165(c)(2) for losses incurred in321 a transaction entered into for profit. Section 212, in pertinent part, allows a deduction 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. Petitioners bring forth no evidence to support their claim that they qualify for a deduction under section 212. Instead, petitioners merely cite section 212, evidently in hopes that it may apply to their situation. We find that it does not. We further find that petitioners have failed to meet their burden of proof with regard to this issue. Therefore, petitioners are not entitled to a deduction under section 212 for the losses they incurred on the promissory notes in question. Section 1244(a) allows an ordinary deduction, subject to the limitations of section 1244(b), for losses on certain kinds of stock, defined in section 1244(c), issued to an individual or a partnership which would otherwise be treated as a loss from the sale or exchange on a capital asset. Petitioners again produced no evidence to support their contention that they qualify for section 1244 treatment. 322 Further, the facts demonstrate that section 1244 is inapplicable to petitioners' situation. Petitioners owned no stock in the venture in which Moore and his son were engaged. Petitioners made loans, evidenced by promissory notes. The record contains no evidence that petitioners held anything other than debt instruments and the record is unclear as to who issued the notes, i.e., Moore, petitioners' son, or some entity in which Moore and petitioners' son were involved. No equity interest, i.e., stock ownership, as contemplated by section 1244, exists under the circumstances extant. We, therefore, find that petitioners are not entitled to the deductions for losses on stock as set forth by section 1244. Section 165(c)(3) allows an individual a deduction for a loss that is a result of fire, storm, shipwreck, or other casualty, or from theft. The losses under section 165(c)(3) are allowable notwithstanding the fact that they were not incurred either in the taxpayer's trade or business or in an activity entered into for profit. Petitioners' main argument is that they are entitled to a deduction under section 165(c)(3) for a loss of property arising from theft. Theft is broadly 323 construed and is not limited to larceny, embezzlement, and robbery. Sec. 1.165-8(d), Income Tax Regs. In order to prove a theft occurred, petitioners must establish criminal intent and an illegal act under the law of the jurisdiction where the alleged theft occurred. Johnson v. United States, 291 F.2d 908">291 F.2d 908, 909 (8th Cir. 1961). 6We find that the facts in the instant case demonstrate that no theft actually took place. Petitioners loaned money to a business that they knew was in a precarious financial condition at the time of the loan. Petitioners admit that the funds were used exactly as they had intended them to be used. No evidence was brought forward that Moore secreted these funds to himself, away from their intended use. Petitioners argue that they were defrauded when Moore represented their son, Greg, to be his partner. The facts demonstrate that Greg had some management interest and some ownership interest 324 in the Store. The exact interest was never set forth. Petitioners knew that their son's ownership interest was unsettled at best. This knowledge was corroborated in petitioner's letter to Moore, on behalf of Greg, asking that Greg receive stock for his efforts rather than for an additional contribution, as previously agreed. Further, petitioners had the opportunity to oppose Moore's discharge in his bankruptcy proceedings specifically on the grounds of fraud. They chose not to. Another indication to the Court that no theft occurred was petitioner's letter to the Florida State Bar Association on October 3, 1983. In that letter, petitioner submitted that his son was defrauded by Moore. However, petitioner never contended that he or his wife were defrauded by Moore. Finally, petitioners received three payments, each in the amount of $ 3,304.58, on the promissory notes. We find that these payments indicate there was no intent on behalf of Moore and Greg to defraud petitioners. Based on all of the above facts, we find that petitioners have not carried their burden of proof in establishing their right to a deduction under section 165(c)(3). Consequently, petitioners are not entitled*325 to a deduction for theft under section 165(c)(3). CONCLUSION We find that petitioners have not met their burden of proof in establishing their right to deductions under any of the Code sections they listed. Further, we find that the entire record herein supports respondent's position that petitioners are entitled to a nonbusiness bad debt deduction under section 166(d)(1), subject to treatment as such. We have reviewed petitioners' other arguments and find them wholly unpersuasive and without merit. To reflect the foregoing, Decision will be entered for the respondent. Footnotes1. Unless otherwise indicated, section references are to the Internal Revenue Code of 1954 as amended and in effect for the taxable years at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Check number 229 was made payable to: Gregory S. Doneff/John Wesley Moore of Palm Beach.↩3. Lefebvre v. Commissioner, T.C. Memo 1984-202">T.C. Memo 1984-202, affd. per curiam 758 F.2d 1340">758 F.2d 1340↩ (9th Cir. 1985).4. See Griffith v. Commissioner, T.C. Memo 1988-445↩.5. See also Griffith v. Commissioner, supra↩.6. See also Huey v. Commissioner, T.C. Memo 1985-348">T.C. Memo 1985-348↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621092/	DAVIS YARN CO., INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Davis Yarn Co. v. CommissionerDocket No. 6885.United States Board of Tax Appeals8 B.T.A. 299; 1927 BTA LEXIS 2906; September 27, 1927, Promulgated 2906 Where a corporation, organized on March 1, 1921, filed its returns on a calendar year basis and the return included the income from organization to December 31, 1921, held that such return is a return for a full taxable year of 12 months and it is entitled as an excess-profits credit to the entire specific exemption of $3,000, plus an amount equal to 8 per cent of its invested capital, averaged over the full taxable year of 12 months. Milton M. Wecht, Esq., for the petitioner. D. D. Shepard, Esq., for the respondent. VAN FOSSAN 300 In this proceeding the petitioner appeals from the determination of a deficiency of income and profits taxes for 1921 in the amount of $1,001.88. The alleged deficiency arises from the action of the respondent in treating the return of the petitioner as a return for a fractional part of a year instead of a return for a full taxable year, and in prorating the specific exemption and excess-profit credit of 8 per cent of invested capital on the basis of such fractional part. FINDINGS OF FACT. The petitioner is a New York corporation, organized on March 1, 1921. Its business is trading in silk and woolen2907 yarn and its principal office is located at Brooklyn, N.Y.The petitioner began business on March 1, 1921. It kept and closed its books on a calendar year basis, the books being closed for the first time on December 31, 1921. The outstanding capital stock at both March 1, 1921, and December 31, 1921, amounted to $100,000, and the invested capital covering this 10-month period likewise amounted to $100,000. On or before March 15, 1922, the petitioner filed a return which is styled "Corporation income and profits tax return for the calendar year 1921, or for the period begun March 1, 1921, and ended December 31, 1921." In determining its excess-profits credit under Schedule C in the return so filed, the petitioner claimed the specific exemption of $3,000, plus 8 per cent of its invested capital of $100,000, ($8,000) or a total excess-profits credit of $11,000. The respondent in determining the excess-profits credit, prorated both the specific exemption of $3,000 and the invested capital of $100,000 on the basis of a return for ten-twelfths of a year, thereby arriving at a total excess-profits credit of $9,166.67. OPINION. VAN FOSSAN: The question in this case is the2908 amount of the excess-profits credit to which the petitioner, a corporation organized March 1, 1921, and filing a return covering its operations to and including December 31, 1921, is entitled under section 312 of the 1921 Act. This section provides: 301 That the excess-profits credit shall consist of a specific exemption of $3,000 plus an amount equal to 8 per centum of the invested capital for the taxable year. The questions arising in the instant proceeding are substantially the same as those involved in the . That case arose under the Revenue Act of 1918, but we find no material difference in the pertinent sections of Act involved in the two proceedings. In that case, the question of what is a return for a fractional part of a year and what is a return for a year was discussed at length and decided in accordance with principles laid down in the case of . The Board has further had occasion in other instances wherein similar questions were involved, to apply the principles laid down in the Bankers' Trust Co. case; 2909 ; . See also , and . Following the reasoning used in the above cited cases, we are of the opinion that the petitioner's return in which was included the income for the period from March 1, 1921, the date of organization to December 31, 1921, was not a return for a "fractional part of a year" but was a return for a full taxable year of 12 months and that it is entitled to the full specific exemption of $3,000. The remaining question is the proper basis to be applied in arriving at the invested capital for computing the additionall deduction of 8 per cent allowed as an excess-profits credit under section 312. On this point also the decision is governed by the principles announced by the Board in Judgment will be entered on 15 days' notice, under Rule 50.Considered by MARQUETTE, MILLIKEN, and PHILLIPS.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/1820083/	991 So. 2d 938 (2008) Joseph STANLEY and Elaine Stanley, Appellants, v. Rebecca MARCEAUX, Appellee. No. 4D07-3523. District Court of Appeal of Florida, Fourth District. August 20, 2008. Rehearing Denied October 27, 2008. Cayla B. Tenebaum and Roberta G. Mandel of Stephens, Lynn, Klein, Lacava, Hoffman & Puya, Miami, for appellants. Julie H. Littky-Rubin of Lytal, Reiter, Clark, Fountain & Williams, LLP, West Palm Beach, and Steven B. Phillips of Littky, Smith, Phipps, Casas & Phillips, P.A., West Palm Beach, for appellee. TAYLOR, J. Rebecca Marceaux sued the owners of her duplex, Joseph and Elaine Stanley, after a portion of her kitchen ceiling collapsed and fell on her head and shoulder. She tried her case before a jury on the sole claim that Mr. Stanley negligently 939 repaired the roof above the adjacent apartment and that his negligent repair caused the ceiling in her apartment to erode and ultimately collapse. The jury returned a verdict for the plaintiff and awarded her $194,782.47 in damages. The defendants appeal, contending that the trial court erred in failing to direct a verdict in their favor. Defendants assert that the plaintiff did not present any evidence to support her allegations of negligent repair of the roof or show a causal connection between the roof repair and her alleged injuries. They argue that the jury could have found liability only by impermissible stacking of inferences. We agree and reverse the judgment. In September 2004, the plaintiff was a tenant in a single-story duplex residence owned and maintained by the defendants, Joseph and Elaine Stanley, in Palm Beach County. The plaintiff occupied the east duplex unit. On September 5, 2004, Hurricane Frances came ashore in Palm Beach County. About three weeks later, Hurricane Jeanne hit the area. Shortly thereafter, a tree fell and struck the edge of the roof of the west duplex unit, causing the interior ceiling of that unit to completely collapse. Plaintiff testified that Joseph Stanley removed the tree approximately a week later and repaired the damage to the roof and interior ceiling of the residence adjoining plaintiff's unit. According to plaintiff, the ceiling of the west unit then collapsed again. She testified that it was wet. On November 4, 2004, while plaintiff was cooking breakfast, the drywall ceiling of her kitchen fell down on top of her, striking her head and shoulder. Plaintiff testified that water came into her apartment. She said that the drywall that fell was wet and that there was water on the ceiling beams, the floor, and on the drywall. Plaintiff sued the Stanleys in a two-count amended complaint, alleging premises liability and negligence. However, the parties agreed to try only plaintiff's claim for negligent roof repair. Plaintiff's theory was that Mr. Stanley negligently repaired the damaged portion of the roof above the adjacent apartment, thereby permitting moisture to enter through that area and then migrate to and accumulate over the portion of her kitchen ceiling that eroded and collapsed. At trial, however, plaintiff did not call any expert witnesses or present any direct evidence to support these claims. At the close of the plaintiff's case, the defendants moved for a directed verdict. They argued that plaintiff presented no evidence that the manner in which Mr. Stanley performed the roof repair constituted a failure to use due care. Defendants also argued that there was no evidence showing a causal connection between the repair of the hole in the roof and the collapse of the plaintiff's kitchen ceiling. Defendants argued that plaintiff presented only circumstantial evidence and relied upon impermissible inferences stacked upon inferences. The trial court denied the defendants' motion for directed verdict. After denial of the motion, Joseph Stanley testified that he fixed the roof by nailing down a new 4 foot by 4 foot section of plywood. He then tarred the plywood, installed Rubberoid, and spread tar all the way around the Rubberoid. That, according to Mr. Stanley, sealed it. He testified that the section of the ceiling in the west unit came down just as a result of the tree impacting the roof. He denied that there was ever any evidence of water in either unit. He offered no explanation for the collapse of the kitchen ceiling in plaintiff's apartment. 940 On May 30, 2007, the jury returned a verdict finding Joseph Stanley negligent and awarding the plaintiff $194,782.47 in damages. The verdict form presented only negligence as a potential ground of recovery. This verdict was reduced to final judgment against the defendants on that same date. The defendants timely moved for judgment notwithstanding the verdict, arguing the same grounds that were asserted in the motion for directed verdict. The trial court denied the motion. In reviewing the denial of a motion for directed verdict, we must view the evidence in a light most favorable to the non-moving party. Allen v. Stephan Co., 784 So. 2d 456, 457 (Fla. 4th DCA 2000). If there is any evidence to support a verdict for the non-moving party, it is improper to enter a directed verdict. Liggett Group, Inc. v. Davis, 973 So. 2d 467, 475 (Fla. 4th DCA 2007). The rules governing the use of circumstantial evidence in a civil case were set forth in Nielsen v. City of Sarasota, 117 So. 2d 731, 733 (Fla.1960): The sum of all of these opinions is that in a civil case, a fact may be established by circumstantial evidence as effectively and as conclusively as it may be proved by direct positive evidence. The limitation on the rule simply is that if a party to a civil action depends upon the inferences to be drawn from circumstantial evidence as proof of one fact, it cannot construct a further inference upon the initial inference in order to establish a further fact unless it can be found that the original, basic inference was established to the exclusion of all other reasonable inferences. The rule that an inference may not be stacked on another inference is designed to protect litigants from verdicts based upon conjecture and speculation. Voelker v. Combined Ins. Co. of Am., 73 So. 2d 403, 407 (Fla.1954). An example of this rule in action is found in McCormick Shipping Corp. v. Warner, 129 So. 2d 448, 449-50 (Fla. 3d DCA 1961). There, a passenger brought suit against a cruise ship owner for injuries she sustained in a fall while descending the ladder from an upper bunk. The plaintiff alleged that the defendant was negligent in failing to inspect the ladder properly and warn of its defective condition. The third district reversed the denial of the directed verdict in that case, stating: The jury was required under the circumstances to infer that there was negligence on the part of the appellant in providing a defective or inadequate ladder and upon that inference, to infer further that such negligence was the proximate cause of the fall. Clearly the record does not support the conclusion that the initial inference was justified to the exclusion of any other reasonable inferences and therefore, the rule prohibiting the finding of an ultimate fact on an inference based upon an inference controls. Id. at 449-50. The defendants argue that, as in McCormick, the jury in this case was invited to infer that the landlord's attempted repair of the roof was negligently performed and then stack upon that inference the further inference that the defective roof repair caused the ceiling in the plaintiff's unit to collapse weeks later. Defendants argue that the verdict can stand only if the first inference, i.e., that the landlord negligently performed the repair, was established to the exclusion of any other reasonable inference. Although it is possible that the roof repair was negligently undertaken, one could also reasonably infer that any later leak had some other *941 cause, such as concealed damage from the two recent hurricanes. Because the first inference was not established to the exclusion of all other reasonable inferences, the trial court should have granted the defendants' motion for a directed verdict. See also Malon v. Serv. & Mgmt. Co., 416 S.W.2d 44 (Mo.App.1967) (affirming directed verdict where tenant failed to show that landlord did not use ordinary care in performing roof repairs). Reversed. KLEIN and DAMOORGIAN, JJ., concur.	01-04-2023	10-30-2013
https://www.courtlistener.com/api/rest/v3/opinions/4474736/	OPINION. Hill, Judge: Petitioner claims exemption under section 101 (8) as a civic league “not organized for profit but operated exclusively for the promotion of social welfare.” The respondent contends that petitioner fails to meet the requirements of the statute. The fact that petitioner was in a business which is ordinarily carried on for profit or that it was formed to make profit is not necessarily fatal to its claim, Debs Memorial Radio Fund, Inc. v. Commissioner, 148 Fed. (2d) 948, unless the facts disclose that a substantial portion of its net earnings was distributed or distributable to its members during the taxable year involved. In that event it could not be said that petitioner operated exclusively for the promotion of social welfare or for “charitable, educational, or recreational purposes.” Sec. 101 (8), Internal Kevenue Code. We have found as a fact that petitioner was organized for a profit-making purpose, despite the statement in the certificate of incorporation that it was formed “for mutual help, not conducted for profit.” Helen Hall, one of its founders and directors, testified as follows at the trial: Q. It was not your idea that milk should be sold to the public without a profit being made? A. No. Q. It was only to have a reasonable profit? A. That is right. On brief petitioner requested the following finding of fact: “* * * All of the petitioner’s operations are intended to return a fair profit, without any price-cutting below cost. * * *” The facts also show that a substantial portion of petitioner’s net earnings was distributed or distributable for purposes other than social welfare. Petitioner’s bylaws provide for the distribution of “net earnings from the operation of the business” in the form of patronage dividends “to consumer members and to producer members.” Meyer Parodneck, petitioner’s president and another of its directors, stated that petitioner was not formed to operate on a price-cutting basis, but followed a cooperative principle of selling at the lowest possible retail rates and dividing the profits among the members in proportion to the amount of milk that had been sold to or purchased from petitioner. The foregoing statement might indicate a contention on the part of petitioner that it was exempt from tax as a cooperative under section 101 (12), notwithstanding its disavowal of such claim. If petitioner is advancing such contention, we direct attention to the fact that neither section 101 (12) nor any other provision of the revenue law exempts from tax a consumer’s cooperative. However, assuming arguendo, that petitioner may properly contend that it is exempt from tax as a consumers’ cooperative, it has not brought itself within the requirements of law providing for tax exemption as a cooperative. It appears that all of the patronage dividends declared payable to the producer (or farmer) members from .1943 earnings were paid. It also appears that less than 3 per cent of the dividends declared payable to consumer members out of earnings for such year was paid. Regarding dividends declared payable to consumer patrons, the facts show (1) that such declared dividend was 15 cents per hundred quarts of milk purchased during the dividend year, (2) that to entitle a consumer patron to claim and receive a dividend he must separate .from the cardboard milk container a voucher for each quart of milk purchased and present it as proof of his purchase, (3) for each 100 vouchers so presented the patron would be entitled to a 15-cent dividend, less a 25-cent membership fee, and (4) petitioner canceled all such unclaimed dividends after the lapse of one year. In view of the restrictions as to payment of dividends to consumer patrons, it is small wonder that, of the $25,920.88 of dividends declared payable to them from 1943 earnings, only $871.05 was claimed and paid. The record shows that the total amount of dividends declared payable to consumers for the fiscal years 1939 to 1943, inclusive, amounted to $39,922.53 and of this amount only $3,050.25 was paid. The result is that at the end of the fiscal year 1943 petitioner had a net -worth of $15,211.18. This net worth represents a surplus from earnings. The record does not disclose the amount of net earnings for the fiscal year 1943. It does not disclose the amount of such earnings placed in the general reserve fund. It does appear that no part of such earnings was put into the fund for cooperative education in the fiscal year 1943. The record does not disclose the proportion of the net earnings in 1943 which was declared payable as dividends to patrons, or what amount, if any, of the net earnings was not disposed of as above indicated. - Neither petitioner’s certificate of incorporation nor its bylaws contains any statement concerning the distribution of its surplus. We believe the members of petitioner are the equitable owners of the surplus, as are the stockholders of an ordinary corporation, and that upon dissolution any surplus would be distributable to them. In any event, since section 22, New York’s Co-Operative Corporation Law (McKinney’s Consolidated Laws of New York, vol. 10 (a)) provides that surplus shall be distributed in accordance with the articles of incorporation or bylaws, the members, by amending the bylaws, could provide for the distribution of any surplus to themselves. We believe, therefore, that petitioner has not proved that it was not operated for profit, but exclusively for the promotion of social welfare. The stated conclusion is further fortified by a consideration of the burden and impracticability of complying with the conditions upon which consumer dividends are payable. It will be observed that only a comparatively insignificant portion of the dividends declared payable to consumer patrons was paid. We think it inescapable that petitioner anticipated that result, since under the provision of the bylaws respecting dividends to consumer patrons no other result could reasonably have been intended. We think, therefore, that it was not petitioner’s expectation or intention that the main portion of the dividends declared payable or distributable to consumer patrons would be paid. Petitioner made no door-to-door deliveries of milk and apparently had no arrangement with consumers to take a certain quantity of milk daily or oh any other time basis. It had no record showing who were its consumers or how much milk any consumer purchased during the year. The consumer went personally to the retail milk station and purchased and paid for each quart of milk when purchased. Obviously, petitioner had no subscribing and contract consumers. In declaring dividends for consumer patrons petitioner could only declare a total amount determined by the total quantity of milk sold during the fiscal year. It did not and could not declare a patronage dividend in a definite amount to any individual consumer patron. We think it improbable that petitioner expected or intended that more than a negligible number of its consumer patrons would tear off, hoard during the year, and present purchase vouchers for the meager dividend of 15 cents per hundred quarts, less a 25-cent membership fee. Also, we think it improbable that petitioner contemplated or intended that it would be put to the task of counting fifteen million (the number of quarts of milk sold in 1943) vouchers in individual consumer lots to determine to whom and in what amounts the declared dividends were to be paid. The obvious practical result of the operation in respect to consumer dividends was that petitioner built up a substantial net surplus out of its earnings which was not distributable as patronage dividends, but was, in our opinion, distributable in case of dissolution to petitioner’s members as equitable owners. We think, however, that under the facts here the distribution of so-called patronage dividends was a distribution of profits to the members who received them. Industrial Addition Association, 1 T. C. 378; affd., 149 Fed. (2d) 294; see also Automobile Club of St. Paul, 12 T. C. 1152. See Better Business Bureau of Washington, D. C., Inc. v. United States, 326 U. S. 279. Petitioner maintains, however, that it was not organized for profit, but exclusively for the promotion of social welfare within the meaning of the section involved. It states under this argument that “the major purpose of the petitioner [was] to increase the consumption of milk in low income families by passing on the economies of a special type of distribution.” It points out the many reforms it was interested in, such as eliminating grading of milk in New York City, and distributing milk in paper cartons at the same price as bottled milk. It carried on educational programs among farmers and consumers alike. As shown in our findings, however, only a small percentage of petitioner’s income was set aside each year for educational purposes and after 1942 no additional sums were added to this fund. And as indicated above, petitioner also operated for a return of profit which was or might become distributable to its members otherwise than as so-called patronage dividends, and, therefore, we can not agree with petitioner that it was operated exclusively for social welfare. The cases which petitioner cites in support of its argument are distinguishable. In Debs Memorial Radio Fund, Inc. v. Commissioner, supra, the profits of the taxpayer were used for its ultimate purpose of maintaining a free public forum for educational, cultural, and social services, “without financial gain to any individual.” The taxpayer was prohibited by its bylaws from using profits or surplus as dividends. In United States v. Pickwick Electric Membership Corporation, 158 Fed. (2d) 272; Hanover Improvement Society, Inc. v. Gagne, 92 Fed. (2d) 888; and Garden Homes Co. v. Commissioner, 64 Fed. (2d) 593, the courts found as a fact that the taxpayers were not organized for profit. It follows that respondent did not err in his determination. Decision will be entered under Rule 50.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4474737/	OPINION. Hill, Judge: Respondent determined a deficiency in estate tax against the petitioner in the amount of $5,883.93. The only question presented is whether the amount of $20,000 or any part thereof received by the decedent’s widow pursuant to a provision of the constitution of the New York Stock Exchange is includible in the gross estate of the decedent under section 811 (g) of the Internal Revenue Code. The facts were stipulated and they are so found. This proceeding is brought by Marjorie F. Treganowan, executrix of the last will and testament of the decedent, Max Strauss, also known as Marx Strauss. The estate tax return involved was filed with the collector of internal revenue for the third district of New York. Decedent was born in 1886. He died September 11, 1944. On January 15, 1925, decedent was elected a member of the New York Stock Exchange (hereinafter referred to as the Exchange) and was thereafter a member until his death. In 1873 the Exchange adopted a plan providing for the payment by the surviving members of a certain sum to the families of deceased members. At the time the plan was instituted in that year a constitutional amendment was adopted by the Exchange enjoining the governing committee of the Exchange (now the board of governors): * * * to increase the surplus revenues of the Exchange as far as possible by rigid economy of expenditures, and by increase of receipts in every legitimate way, for the purpose of accumulating a fund to be styled the “Gratuity Fund” to be administered and applied as directed in the Constitution of the Exchange. The constitution also provided that no alteration in any essential particular “shall ever be made” to that part of the constitution providing for payment to the families of deceased members. The constitution of the New York Stock Exchange, which contains all the provisions concerning the gratuity fund involved, is incorporated herein by this reference. The constitution provides that before anyone may be admitted to membership in the Exchange he shall pay to the trustees, which consist of the chairman of the board of governors and six members of the Exchange elected by the members, of the gratuity fund the sum of $15. By the constitution the member also: * * * pledges himself to make, upon the death of a member of the Exchange, a voluntary gift to the family of each deceased member in the sum of fifteen dollars, which shall be paid by the member at quarterly periods on the dates on which dues to the Exchange are to be paid. * * * Section 3 of article XYI of the constitution states'. Sec. 3. The faith of the Exchange is hereby pledged to pay, within one year after proof of death of any member, out of the money collected under the provisions of this Article, the sum of twenty thousand dollars, or so much thereof as may have been collected, to the persons named in the next Section as therein provided, which money shall be a voluntary gift from the other members of the Exchange, free from all debts, charges or demands whatever. Section 5 provides: Sec. 5. Nothing herein contained shall ever be taken or construed as a joint liability of the Exchange or its members for the payment of any sum whatever; the liability of each member, at law or equity, being limited to the payment of fifteen dollars only on the death of any other member, and the liability of the Exchange being limited to the payment of the sum of twenty thousand dollars, or such part thereof as may be collected, after it shall have been collected from the members,' and not otherwise. * * * It is further provided that the sum shall be paid to the widow and children, or issue of a deceased child or children of the deceased member, or, if he died leaving neither widow, child, nor issue of a child, then to his legal heirs or the persons who, under the laws of the State of New York, would take the sum by reason of relationship to the deceased member if he owned it at the time of his death. No member has at any time had the right to name, select, or designate any beneficiary or beneficiaries other than those named above or in any other way to divert the benefits from the persons specified in the constitution. At all times since the adoption of the plan of 1873, the constitution of the Exchange has contained a provision (article XYI, section 6) similar to the following: Sec. 6. Nothing herein contained shall be construed as constituting any estate in esse which can be mortgaged or pledged for the payment of any debts; but it shall be construed as the solemn agreement of every member of the Exchange to make a voluntary gift to the family of each deceased member, and of the Exchange, to the best of its ability, to collect and pay over to such family the said voluntary gift. Section 5 of Article X provides that if any contribution due to the Exchange, which includes the contribution to the gratuity fund, is not paid by any member within 45 days, after it becomes due, he: * * * shall be reported by the Treasurer to the Chairman of the Board and, after written notice mailed to him of such arrearages, may be suspended by the Board of Governors until payment is made. Should payment not be made within one year after payment is due, the membership of the delinquent may be disposed of by the Board, on at least ten days’ written notice mailed to him at his address registered with the Exchange. The amendments to the constitution can be made by submitting the proposed amendment to the board of governors, which either approves or disapproves the proposal. After approval by the board, the amendment is submitted to the full membership for vote. If more than 688 of the 1,314 members vote within the time prescribed and if a majority of those express a preference for the proposed amendment, it becomes part of the constitution. In the early period of the fund it was built up in four ways: (1) From an initial payment of $10 by each member of the Exchange and each person who was thereafter admitted to membership; (2) from allocation to the fund of half the annual profits of the Exchange in excess of $10,000; (3) from the excess of the amounts collected from surviving members over the amount paid to the kin of deceased members (which was originally $10,000) ; and (4) from the accumulation of interest on the invested capital of the fund. In 1898 the allocation to the fund of half of the annual profits in excess of $10,000 was terminated. In 1915 the accumulation of the income of the fund was terminated and thereafter the net income was credited pro rata to the members of the Exchange in reduction of the amounts payable by them on the deaths of other members. On March 26, 1941, a constitutional amendment was adopted providing for the use of both capital and income of the fund as a credit against amounts otherwise payable by surviving members so long as the value of the fund should remain in excess of $500,000. During the period from January 15, 1925, to January 1, 1941, the trustees of the gratuity fund at the close of each fiscal or calendar year paid over to the treasurer of the Exchange the annual net income received as interest on the gratuity fund, which in turn was credited pro rata to the members of the Exchange as of the first day of the succeeding fiscal or calendar year and applied in reduction of amounts payable by each member in respect of the deaths of other members. During the period from January 1,1941, through July 19, 1945, the date on which the decedent’s membership in the Exchange was transferred by the executrix, the trustees of the fund paid to the treasurer of the Exchange at the close of each quarterly period the aggregate of all amounts paid or payable by members of the Exchange under the provisions of the constitution in respect of deaths occurring duiing such quarter and the treasurer of the Exchange credited those amounts proportionately against the amounts so paid or payable by each member in respect of the deaths of members occurring during that quarter. From January 15,1925, through January 10,1941, the gross amounts payable by decedent in respect of deaths of other members of the Exchange amounted to $3,185. During the same period the amounts credited to the decedent amounted to $1,024.52. From January 11,1941, through September 11, 1944, when decedent died, the gross amounts payable by decedent in respect of deaths of other members of the Exchange amounted to $795. During the same period the amounts credited to decedent, as above stated, amounted to $795. From September 11, 1944, through July 19, 1945, the gross amounts payable by decedent’s estate in respect of deaths of other members amounted to $255. During the same period the amounts credited to the decedent’s estate in accordance with the above amounted to $255. Adele L. Strauss, the widow of decedent, received the sum of $10,000 by check dated October 16,1944, issued by the “Trustees of the Gratuity Fund” of the Exchange, and also received the further sum of $10,000 by chéck dated July 9, 1945, issued by the “Trustees of the Gratuity Fund” of the Exchange. In a statement attached to the notice of deficiency respondent stated as follows: It is determined that the death benefit paid by the Gratuity Fund of the New York Stock Exchange is includible as part of the decedent’s gross estate within the provisions of Section 811 (g) of the Internal Revenue Code. Whether the $20,000 involved should be included in decedent’s gross estate under section 811 (g) of the Internal Revenue Code depends, first, upon whether that amount is proceeds of life insurance and, second, upon whether such insurance was purchased with premiums or other consideration, paid directly or indirectly by the decedent, or whether decedent possessed at his death any of the incidents of ownership, exercisable either alone or in conjunction with any other person with respect to that insurance. Respondent contends that all of those elements are present with respect to the amount here involved. We do not agree with respondent that the $20,000 involved represented proceeds of life insurance within the meaning of section 811 (g). We have reached this conclusion despite our dicta in Central Hanover Bank & Trust Co., Executor, 40 B. T. A. 268,1 which involved the same gratuity plan before us and section 302 (g) of the Revenue Act of 1926, which was later incorporated into the code as section 811 (g), that “the Exchange may have been ‘engaged in the business of life insurance upon the cooperative or assessment plan’ within the purview of the New York statute.” In the first place, the characterization of amounts as insurance by state courts has no binding effect upon the interpretation of section 811 (g). Paul, Federal Estate and Gift Taxation, vol. 1, § 10.07, footnote 1; Kernochan v. United States, 89 Ct. Cls. 507; 29 Fed. Supp. 860, 866; certiorari denied, 309 U. S. 675; Estate of Stuart Wilson, 42 B. T. A. 1196, 1200. The Supreme Court of the United States, in Helvering v. Le Gierse, 312 U. S. 531, considered the meaning of insurance as used in section 811 (g). In that case the Court was concerned with section 302 (g) of the Revenue Act of 1926, as amended, which, as above mentioned, later became section 811 (g) of the Internal Revenue Code. The Court stated that it had found little assistance in the construction of the word “insurance” in the section involved in either the legislative history or the Treasury regulations (Regulations 105, section 81.25) and stated: Necessarily, tlien, the language and the apparent purpose of § 302 (g) are virtually the only bases for determining what Congress intended to bring within the scope of the phrase “receivable as insurance”. In fact, in using the term “insurance” Congress has identified the characteristic that determines what transactions are entitled to the partial exemption of § 302 (g). We think the fair import of subsection (g) is that the amounts must be received as the result of a transaction which involved an actual “insurance risk” at the time the transaction was executed. Historically and commonly insurance involves risk-shifting and risk-distributing. That life insurance is desirable from an economic and social standpoint as a device to shift and distribute risk of loss from premature death is unquestionable. That these elements of risk-shifting and risk-distributing are essential to a life insurance contract is agreed by courts and commentators. See for example: Ritter v. Mutual Life Ins. Co., 169 U. S. 139, * * * In re Walsh, D. C., 19 F. Supp. 567; Guaranty Trust Co. v. Commissioner, 16 B. T. A. 314; Ackerman v. Commissioner, 15 B. T. A. 635; Couch, Cyclopedia of Insurance, Vol. I, § 61; Vance, Insurance, § 1-3; Cooley, Briefs on Insurance, 2d edition, Vol. I, p. 114; Huebner, Life Insurance, Ch. 1. Accordingly, it is logical to assume that when Congress used the words “receivable as insurance” in §302 (g) [notv section 811 (g)] it contemplated amounts received pursuant to a transaction possessing these features. * * * [Italics supplied.] See also Keller v. Commissioner, 312 U. S. 543. Since the Le Gierse decision the courts have uniformly held that where there are no features of risk-shifting or risk-distributing present any amount received can not be designated insurance within the scope of section 811 (g), supra. Goldstone v. United States, 325 U. S. 687, 690; Seward's Estate v. Commissioner, 164 Fed. (2d) 434, 437; Chew's Estate v. Commissioner, 148 Fed. (2d) 76, affirming Estate of William Douglas Chew, Jr., 3 T. C. 940; certiorari denied, 325 U. S. 883; Knight v. Finnegan, 74 Fed. Supp. 900; Estate of William J. O'Shea, 47 B. T. A. 646, 652. Cf. Estate of Charles H. Thieriot, 7 T. C. 1119, 1128. In Central Hanover Bank & Trust Co., supra, page 271, we said: “* * * there is nothing to indicate that an insurance or investment risk was undertaken by the exchange or its members * * No additional evidence was presented in this proceeding to show that any risk against the probability of premature death was assumed by the Exchange. There was no agreement between it and the decedent whereby, in consideration of payments by each member of a named sum, it' pledged'or stipulated the payment of a larger sum on the death of any member. The Exchange’s only obligation is to pay over what it collects from the members to the family of a deceased member, that is, to pay $20,000 “or such part thereof as may be collected * * See section 5 of article XYI of the constitution, set forth in part in the findings. Neither the health nor the age of the member nor his living habits are taken into account in determining the member’s payments. The Exchange does not require the passing of a physical examination as a condition of participation in the gratuity plan. The amount of the gift made by each member to the kin of a deceased member is not fixed with reference to his life expectancy as determined by the mortality tables. Certainly, some of these elements must exist in the purported contract of insurance before any amounts payable thereunder may be deemed “proceeds of insurance” or “receivable as insurance” within the purview of section 811 (g), supra, as that section was construed by the Supreme Court in the Le Gierse case, supra. See also Ritter v. Mutual Life Insurance Co., 169 U. S. 139, cited with approval in the Le Gierse case, supra. In accordance with the above, therefore, we believe that the amount involved was not “receivable as insurance” in the statutory sense. The respondent implicitly admits in his brief that the elements of risk-shifting and risk-distributing must be present before the proceeds involved may be designated insurance within the scope of section 811 (g), citing Helvering v. Le Gierse, supra, but claims that those elements as set forth by the Supreme Court in that case are present here. He states on brief that: The case at bar comes squarely within the above definitions of life insurance. Each member of the Exchange was required to make certain specified payments toward the fund at designated times in the nature of premiums; the death of each member, an uncertain event, was the occasion of the payment to his widow, children or heirs of a specified amount; * * * Respondent fails to recognize, however, that the insurance risk associated with a contract of life insurance is the “risk of loss from premature death,” as stated by the Supreme Court in the Le Gierse case, not of death itself. Any risk of loss from premature death is not present in the case at bar, for the reasons above stated. In addition, as pointed out above, the exchange was not required to pay a “specified amount”; instead, it was obligated to pay $20,000 or such part thereof as may be collected from the members. In further support of his argument, respondent cites a number of New York cases involving the teachers’ retirement system of that state, which, he states, serve to qualify the character of the death benefits under discussion as insurance. As pointed out above, state law as to what constitutes insurance is not controlling for the purpose of construing section 811 (g), supra. In addition the New York case of In re Fitzsimmons’ Estate, 158 Misc. 789; 287 N. Y. 171, states in part as follows : A review of the provisions of the Teachers Retirement Raw (Greater New York Charter, § 1092, as amd.) and its operation discloses a close similarity of the benefits to ordinary insurance. The use of mortality tables is authorized and an actuary is employed to compute the contributions to be made by a member of the system and the benefits payable at the death of a member. * * * It is thus apparent that the benefits from that plan are “a device to shift and distribute risk of loss from premature death * * Helvering v. Le Gierse, supra. In view of our conclusion, it is not necessary to discuss the payment of premiums or incidents of ownership tests of section 811 (g). It follows that respondent erred in his determination. Reviewed by the Court. Decision will be entered for petitioner. In that case we held that payments from the New York Stock Exchange Gratuity Fund were not includible in the gross estate of a deceased member, since decedent bad no legal interest in tbe policy which terminated at his death. The respondent acquiesced in that decision. 1939-2 C. B. 6.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621093/	Estate of Gordon A. Stouffer, Deceased, Mark A. Loofbourrow, Executor, Petitioner, v. Commissioner of Internal Revenue, RespondentEstate of Stouffer v. CommissionerDocket No. 63606United States Tax Court30 T.C. 1244; 1958 U.S. Tax Ct. LEXIS 88; September 19, 1958, Filed 88 Decision will be entered under Rule 50. 1. Decedent held an option dated in 1937 to purchase wife's 2,000 shares of class B stock in a corporation for $ 40,000, which option he relinquished in 1951 in a divorce settlement and decree. Held, the stock that was the subject of the option agreement was the same (after stock splits and stock dividends, etc.) as 20,000 shares of $ 2.50 common stock in wife's name in 1951, and so considered by the parties to the option agreement. Held, since the parties to the divorce action in 1951 dealt with the stock on the basis of $ 20 a share and this was its fair market value, decedent realized a long-term capital gain by reason of the divorce settlement and decree of $ 359,999, the value of the option less $ 1 consideration recited therein.2. Held, the gain was not a short-term capital gain under section 117 (g) (2), I. R. C. 1939. Warren E. Hacker, Esq., and Mark A. Loofbourrow, Esq., for the petitioner.William O. Allen, Esq., for the respondent. Mulroney, Judge. Murdock, J., dissenting. Tietjens, J., agrees with this dissent. Pierce, J., dissenting. Tietjens, J., agrees with this dissent. MULRONEY 1244 The respondent determined a deficiency in the income tax of petitioner's decedent for the year 1951 in the amount of $ 90,077.75, and in an amended answer alleged that the petitioner was liable for an additional deficiency of $ 233,418.48. The issues are (1) whether Gordon A. Stouffer, deceased, realized a gain when, in a divorce settlement with his wife, he surrendered an option that purportedly gave him the right to purchase certain shares of 1245 stock in her possession; and (2) whether such gain, if realized, was long-term or short-term capital gain.FINDINGS OF FACT.Gordon A. Stouffer filed his Federal income tax return for the90 calendar year 1951 with the then collector of internal revenue for the eighteenth district of Ohio, at Cleveland, Ohio. He died testate June 6, 1956, and Mark A. Loofbourrow is the qualified executor of his estate acting under authority of the Probate Court of Cuyahoga County, Ohio.Some of the facts were stipulated and are found accordingly.Ina Mae and Gordon A. Stouffer were first married on February 22, 1930. On May 24, 1934, upon petition of Ina Mae, this marriage was dissolved by an absolute divorce decree of the Common Pleas Court of Cuyahoga County, Ohio. Provisions of this decree relative to support payments to be made by Gordon for the support of their minor child were later the subject of motions to modify and orders thereon were appealed to the Court of Appeals for the Eighth District of Ohio and attempts made to appeal to the Supreme Court of Ohio. It was not until November 20, 1936, that this divorce litigation between the parties ended.In the course of this litigation decedent broached the subject of remarriage to Ina Mae. Ina Mae insisted that if she did remarry, Gordon would have to provide her with some financial security such as giving her 40 or 50 thousand91 dollars. Gordon did not have such funds but he offered to transfer to her 2,000 shares of class B stock of the Stouffer Corporation (hereinafter sometimes called the company) upon which he was to have an option to purchase at $ 40,000, the then fair market value of such shares, and the irrevocable right to vote such shares. Accordingly, on March 6, 1937, Gordon transferred to Ina Mae 2,000 shares of class B stock of the company (which had an adjusted basis in his hands of $ 5 a share), under an instrument of assignment providing Ina Mae execute in irrevocable proxy in favor of Gordon to vote the stock and, on the same day, Ina Mae executed and delivered to Gordon the option agreement as follows:OptionCleveland, OhioMar. 6, 1937.In Consideration of One Dollar ($ 1.00), receipt of which is hereby acknowledged, I hereby give and grant to GORDON A. STOUFFER the right and option to purchase from me at any time prior to the first day of January, 1967, two thousand (2000) shares of the Class B. Common Stock of THE STOUFFER CORPORATION at Twenty Dollars ($ 20.00) per share, payable in cash. Should any stock dividends be paid on said stock, the price herein 1246 stipulated92 shall include such stock dividends. All cash dividends shall belong to the undersigned unless and until said option shall have been exercised.[s] Ina Mae StoufferThe next day, March 7, 1937, Gordon and Ina Mae were remarried. During the years after 1937 and up until 1951 the company engaged in several transactions amounting to capital reorganizations involving stock dividends, stock splits, and changes in description and denomination of exchanged stock. In these transactions the 2,000 class B shares in the name of Ina Mae in 1937 became 20,000 shares of $ 2.50 par value of common stock which Ina Mae held in 1951.In 1950 Ina Mae and Gordon again experienced marital difficulties and each retained counsel in anticipation of Ina Mae's suit for divorce. During the latter part of 1950 and the early part of 1951 counsel for Gordon and counsel for Ina Mae entered into negotiations for an agreement to be submitted to the court for approval in the event of a divorce. On May 10, 1951, Ina Mae and Gordon executed an agreement, the purpose of which was to settle and adjust the property rights of the parties. The agreement provided, among other things, that:4. Gordon agrees that, upon93 the entry of such decree of divorce, any interest which he, or any other person, might, but for this agreement, have in any shares of stock of The Stouffer Corporation now registered in the name of Ina Mae shall forthwith terminate, and Ina Mae shall continue to own, hold and vote such stock free of any claim by Gordon or anyone claiming by, through, or under him.On May 11, 1951, Ina Mae filed petition for absolute divorce in the Court of Common Pleas of Cuyahoga County and on June 27, 1951, the court entered a decree of divorce in that case. The decree incorporated the agreement entered into by the parties under the date of May 10, 1951.The fair market value of the 20,000 shares of $ 2.50-par-value common stock in the company held by Ina Mae on June 27, 1951, was $ 20 a share.OPINION.It is the contention of the respondent that upon the surrender of the option in the divorce settlement and decree, in return for the surrender by Ina Mae of her rights to support and maintenance and to a share in Gordon's property at his death, Gordon realized a taxable gain in the amount of $ 359,999 (the value of the option agreement, $ 360,000, less $ 1 consideration recited therein). Petitioner94 resists this contention on three grounds: (1) That no gain could be realized under a transaction of this type; (2) that the option had no determinable fair market value on June 27, 1951, the date of the divorce decree; and (3) that the stock subject to the option had a 1247 value less than $ 400,000 on June 27, 1951, thus affecting the amount of the gain determined by the respondent.Petitioner's argument on the first point is that the transaction was merely a division of property between Gordon and his wife and Gordon cannot be held to have realized taxable gain by thus giving up a substantial portion of his property and also it would be impossible to value what Gordon received for his release of the option. The argument on the latter point is that Gordon received for his option release the release of Ina Mae's rights to support and maintenance and the right to share in his property at his death and these are rights that are impossible to value.In Commissioner v. Mesta, 123 F. 2d 986 (C. A. 3), reversing 42 B. T. A. 933, the taxpayer and his wife reached an agreement, prior to a decree of divorce, in which the 95 taxpayer contracted to give his wife shares of stock and other consideration in lieu of a legal obligation to support her. The obligation imposed upon the taxpayer by the contract was substituted for the obligation imposed upon him by the State law and, therefore, when he delivered the stock to his wife, it was in partial discharge of his obligation under the contract. The court said:There is no doubt that Mesta achieved a capital gain. He paid $ 7,574.56 for stock which when disposed of in discharge of his obligation to Mrs. Mesta was worth $ 156,975. Had the stock not been transferred, he would not have achieved a taxable gain because the economic gain would have been unrealized. The disposition of the stock was the taxable event in the case at bar. This is so even though Mesta may not have received payment in money or property from Mrs. Mesta. * Section 111 (b) of the Internal Revenue Code of 1939 provides that 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." Petitioner argues that the rights given up by Ina Mae were unliquidated and not susceptible96 of valuation and, therefore, had no "fair market value" within section 111 (b). This same argument was made in the Mesta case, and the Court of Appeals, in rejecting this contention, said:We think there can be no doubt that Congress intended a measurement of values under the circumstances indicated by the statutes quoted, notwithstanding difficulties in determining those values. In the case at bar there is a gain in the value of the stock and an event whereby that gain was realized. The fair market value of the property or benefit received by Mesta for the stock may be difficult to ascertain, but in the absence of any other value being shown we think that it is proper to take fair market value. In the case at bar the amount of the taxpayer's obligation to his wife was fixed in part in terms of stock by the parties themselves who really dealt at arm's length with one another. It was so found by the Commissioner and the taxpayer has not rebutted the presumption that the Commissioner's ruling is correct. We think that we may 1248 make the practical assumption that a man who spends money or gives property of a fixed value for an unliquidated claim is getting his money's97 worth.The only difference between the Mesta case and the instant case is that here Gordon surrendered an option to purchase stock rather than the stock itself. We do not think this difference significant. An option, such as is here involved, can have a fair market value and this value is established by proof showing the property covered by it was worth a certain sum in excess of the option price. Robert Brunton Studios, Inc., 15 B. T. A. 727.It is true that in the Mesta case the property settlement agreement was not mentioned in the divorce decree while here it was. Any argument that this case is distinguishable from the Mesta case, on the ground that the decree operates as a division of property between the parties and hence husband's property was not used to discharge his obligations, is without substance. Commissioner v. Halliwell, 131 F. 2d 642 (C. A. 2), certiorari denied 319 U.S. 741">319 U.S. 741, reversing 44 B. T. A. 740.Petitioner's specific argument here is that this option was legally open to dispute as an option to buy 20,000 shares of company 98 stock and therefore incapable of valuation. We do not need to pass on the validity of the option. We do not understand that petitioner argues it was invalid. The argument is that a court of competent jurisdiction might hold it unenforcible in 1951 since it purported to cover 2,000 shares of class B stock in the company and this stock was not in existence in 1951 and that there was a dispute between the parties as to the enforcibility of the option agreement.We have not detailed all of the evidence of the stock splits and capital changes that occurred in the years between 1937 and 1951 but it fairly appears from the record that the 2,000 class B stock named in the option was the antecedent stock for the 20,000 shares held by Ina Mae in 1951. But the most significant fact is that the great weight of the evidence establishes that there was no dispute between the parties as to the validity and enforcibility of the option contract as covering the 20,000 shares in 1951. It is admitted that Gordon was asserting that it covered the 20,000 shares and the weight of the evidence was that Ina Mae agreed that it covered the 20,000 shares.All of their acts showed that they interpreted the99 option contract as covering the 20,000 shares. Gordon voted the stock long after it ceased to be class B common stock. If the option contract be considered ambiguous, this record leaves no doubt that the parties to it regarded it as giving Gordon the right to purchase the 20,000 shares of $ 2.50-par-value common stock of the corporation in 1951. The interpretation given to the contract by the parties to it will govern. Restatement, Contracts sec. 235 (e). We hold taxable gain to Gordon resulted from his relinquishment of the option.1249 The amount of gain is the fair market value of the property or benefit received by Gordon for the release of the option which had the effect of transferring 20,000 shares of stock to Ina Mae. As was stated in the Mesta case, the obligations of the husband to support and maintain the wife and her right to a portion of his property when he died would be difficult to value. There the court took the practical approach and, on the "assumption that a man who spends money or gives property of a fixed value for an unliquidated claim is getting his money's worth," the court turned to the fair market value of the stock to measure the value 100 of the benefit received by the husband. But it must be remembered it is the value of the husband's obligations to support and maintain the wife and her right to share in his estate when he dies, that is to measure the gain. We only turn here to the value of the option to purchase the stock (and therefore the value of the stock) because that was the medium of payment used by the husband and accepted by the wife for the wife's relinquishment of his obligations to her. This means that if the parties placed a valuation on the stock and dealt in the stock at a valuation they fixed, the measure of Ina Mae's rights which were relinquished would be measured by that fixed value. Aleda N. Hall, 9 T. C. 53; Christina de Bourbon Patino, 13 T. C. 816, affd. 186 F.2d 962">186 F. 2d 962.It is quite evident from all the evidence that during the prolonged negotiations leading to the divorce decree in 1951 the attorneys for both Ina Mae and Gordon treated the option held by Gordon as an asset with a value of $ 360,000. In a schedule of assets submitted by Gordon's attorneys to Ina Mae's attorneys the option was shown as101 having a value of $ 360,000. (Stock of $ 400,000 less $ 40,000 option price.) Ina Mae accepted this value as a basis for entering into the separation agreement. She undeniably had valuable marital and other property rights as the wife of Gordon and she was evidently convinced that in obtaining the release of the option, with its agreed upon value of $ 360,000, she was getting a fair equivalent of a portion of her marital and other property rights. She accepted this release in exchange for such rights. This was deemed fair by counsel for both sides.In the Patino case, supra, the issue was the proper basis to be used by the taxpayer-wife for certain shares of stock received by her from her husband under an agreement in which she renounced her marital right in her husband's property. The Commissioner, who argued that the transfer of stock to her was a gift, went on to argue that even if the transfer were not entirely gratuitous, the presumption was that it was partly so and that therefore the burden of proof was on the taxpayer-wife to show to the contrary by establishing the precise value of the rights she surrendered and the rights she received. 1250 The Court 102 of Appeals for the Second Circuit, in rejecting this argument, said:It is entirely proper for parties to a contract to make their own estimates of values; and if they are dealing at arms length and there is no reason to question the bona fides of the transaction, their valuations may be accepted as correct. * Under the record here and the authority of the Hall and Patino cases we are of the opinion that petitioner's gain was $ 360,000, as determined by respondent, less the $ 1 recited in the option agreement.Even if we approach the problem by an attempt to determine the fair market value of the stock on the date of the settlement agreement, as was done in the Mesta case, the result is the same. Petitioner alleged the stock in question had a fair market value on June 27, 1951, of $ 291,000. The figure $ 360,000 was computed by giving each of the 20,000 shares of Stouffer common stock subject to the option a fair market value of $ 20, or a total of $ 400,000, and then subtracting $ 40,000, which was the amount at which the option would be exercised. There is independent evidence in the record to support this valuation. The Stouffer common stock was not listed 103 on any exchange but it was sold and quoted in over-the-counter market in Cleveland during 1951 as follows:Quotation perSalesshareDateper shareBidAsked1951March 220March 220 1/4April 2519 3/4April 3019 1/220 1/2May 101920 1/2May 111920 1/2May 2519 1/2June 120June 1119 3/4July 201820July 271819September 1720Moreover, there is evidence that the Stouffer Corporation was definitely a growth corporation. Its sales and earnings record over the years was impressive and it showed clear signs of improving. Petitioner argues that the market for Stouffer stock in 1951 was thin and that any attempt to place 20,000 shares of such stock on the market would have a depressing effect on the market price. We are not persuaded that such would be the case. There was testimony by two expert witnesses of the petitioner to the effect that 20,000 shares of stock could have been disposed of in the 1951 market without any appreciable depressing effect on the market price.Considering all of the evidence as to valuation we are of the opinion that $ 20 a share would be the fair market value of the stock in question.In the notice104 of deficiency respondent determined that the income realized by Gordon in connection with the divorce decree "represents a long-term capital gain under the provisions of section 117 of the 1251 Internal Revenue Code of 1939." By an amended answer filed a few months before trial respondent changed his position to increase the proposed deficiency from $ 90,077.75 to $ 323,096.23 on the ground that the alleged gain "constitutes a gain attributable to the failure to exercise an option to buy property, which under section 117 (g) (2) of the Internal Revenue Code of 1939 is considered as a short-term capital gain, rather than a long-term capital gain."Section 117 (g) (2) provides that "gains or losses attributable to the failure to exercise privileges or options to buy or sell property shall be considered as short-term capital gains or losses."There is no merit in respondent's position. Here the gain was not "attributable" to the failure to exercise. It was "attributable" to the court decree that terminated and ended the option. The case is distinguishable from Seth M. Milliken, 15 T.C. 243">15 T. C. 243, where the optionee voluntarily allowed the option to *105 expire. Here this option had 16 more years to run in 1951 when it was terminated by the court decree. That it is the decree and not the predivorce agreement that fixes the rights and obligations of the parties, see Harris v. Commissioner, 340 U.S. 106">340 U.S. 106; Commissioner v. Maresi, 156 F.2d 929">156 F. 2d 929.Decision will be entered under Rule 50. MURDOCK; PIERCE Murdock, J., dissenting: I dissent for the reasons stated by the late Judge Mellott in L. W. Mesta, 42 B. T. A. 933.Pierce, J., dissenting: I would have held, for the reasons stated in L. W. Mesta, 42 B. T. A. 933, which was reversed by divided court in 123 F. 2d 986, that the husband's relinquishment and termination of his stock option, in the divorce settlement with his wife, did not for income tax purposes give rise to taxable gain.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621094/	William H. Wemyss, Petitioner, v. Commissioner of Internal Revenue, RespondentWemyss v. CommissionerDocket No. 110419United States Tax Court2 T.C. 876; 1943 U.S. Tax Ct. LEXIS 42; October 14, 1943, Promulgated 42 Decision will be entered for the respondent. Pursuant to antenuptial agreement between petitioner and his intended wife, he transferred to her 13,139 shares of stock in consideration for her promise to marry him, and to compensate her for the loss of income under two trusts created by her former husband. Held:(1) The transfer was made for less than an adequate and full consideration in money or money's worth and was subject to gift tax under section 503 of Revenue Act of 1932.(2) Marriage, as a consideration, is not measurable in money or money's worth and the amount taxable as a gift is the value of the property transferred.(3) Section 503, as construed, does not violate guaranty of due process of law under the Fifth Amendment to the Constitution.(4) The amount of the taxable gift may not be reduced by the value of the wife's interest in two trusts, lost by her upon her marriage to petitioner. Cecil Sims, Esq., and James W. Allen, C. P. A., for the petitioner.Charles P. Bagley, Esq., for the respondent. Mellott, Judge. Disney, J., dissenting. MELLOTT877 Respondent determined deficiencies in a gift tax in the amount of $ 12,995.66 for the 43 calendar year 1939 and $ 3,965.20 for 1940. The issue is whether the transfer on May 24, 1939, by petitioner to his prospective bride of 13,139 shares of common stock of General Shoe Corporation, having a value of $ 149,456.13, constituted a taxable gift.FINDINGS OF FACT.Petitioner is a resident of Davidson County, Tennessee. On January 1, 1919, he married Helen Peters. She died on April 1, 1934, leaving two children surviving. On June 20, 1939, petitioner married Ellen Stokes More, a widow.The former husband of petitioner's second wife, E. L. More, died on February 9, 1934, leaving one son surviving. Prior to his death, E. L. More executed two trust indentures, one on June 6, 1927, and one on June 15, 1929, naming the Nashville Trust Co. as trustee. The corpus of the first trust was 650 shares of the capital stock of the Arcade Co., Nashville, Tennessee, and the corpus of the second trust was 20 shares of the capital stock of the same company. Each trust instrument provided that the entire net income of the trust estate should be paid to the grantor's widow during her lifetime or until her remarriage to be used for the maintenance and support of her and her son.Ellen Stokes44 More was forty-four years of age on February 9, 1939. The amounts received by her from the trustee or successor trustee of the trusts referred to above from the date of the death of her husband until June 20, 1939 (the date of her marriage to petitioner), were as follows:June 6,June 15,1927, trust1929, trust1934 (from Feb. 9)$ 9,222.45$ 283.81193511,034.14337.2519369,411.50289.7519379,253.32285.001938$ 11,211.92$ 342.001939 (to June 20)6,972.10214.54Total57,105.431,752.35The trust instruments were construed to constitute separate and independent trusts for the grantor's widow and son. One-half of the above amount, or $ 29,428.89, was accordingly treated as received by the widow for her own use and an equal amount for the benefit of her child.Some time prior to May 24, 1939, petitioner made a proposal of marriage to Ellen Stokes More. She told him she would not be willing to marry him and lose her life income under the trusts created by her first husband unless he would enter into a premarriage contract with her to make good the loss. On May 24, 1939, they entered into the following agreement:878 This contract45 and agreement entered into by and between William H. Wemyss and Ellen Stokes More, both residents of Davidson County, Tennessee:Witnesseth That:Whereas, the said Ellen Stokes More has promised to marry William H. Wemyss on June 20, 1939; and,Whereas, upon the consummation of said marriage, under the terms of a trust now being administered by the Girard Trust Company of Philadelphia, Pennsylvania, the said Ellen Stokes More will be deprived of a large monthly income; and,Whereas, it is the desire and intention of the said William H. Wemyss to compensate said Ellen Stokes More for her aforesaid loss and to provide for and maintain her so long as she may live in keeping with her station in life; andNow, Therefore, I, William H. Wemyss, have this day transferred in blank and delivered to the said Ellen Stokes More thirteen thousand one hundred and thirty nine (13,139) shares of the common capital stock of the General Shoe Corporation evidenced by the following certificates;Certificate No.No. Shares6,0014726,4952318449008401,0008391,0008379,536In testimony whereof we, William H. Wemyss and Ellen Stokes More, have hereunto affixed our signatures. 46 This May 24th, 1939.[Signed] William H. WemyssEllen Stokes MoreThis contract was recorded on June 21, 1939, in the office of the registrar of Davidson County, Tennessee.Petitioner transferred the 13,139 shares of General Shoe Corporation stock to Ellen Stokes More on May 24, 1939. Upon their marriage on June 20, 1939, the income she had been receiving for her own use under the trusts created by her first husband ceased and thereafter all of the income was paid to or for the benefit of her only child by her first husband. On the same date and immediately following the marriage petitioner executed a will, providing therein that his wife should have an estate for life or widowhood in a certain farm, and that one-third of his estate, less the value of 11,139 shares of common stock of General Shoe Corporation, should be held in trust for her.Respondent determined that the transfer on May 24, 1939, of the 13,139 shares of General Shoe Corporation common stock was not made for a consideration in money or money's worth, and that the transfer constituted a gift of an amount equal to the value of the stock. He determined this value to be $ 149,456.13.879 OPINION.The sole issue47 is whether the transfer of the stock, the value of which is not controverted, constituted a taxable gift. The applicable provisions of the statute are shown in the margin. 1The parties agree that the transfer was made in consideration of the promise of marriage by petitioner's prospective wife and, as stated in the contract, to compensate48 her for the loss of income which she had been receiving under the trusts created by her first husband as well as "to provide for and maintain her for so long as she may live in keeping with her station in life." We agree with petitioner's contention that the agreement to marry constituted valuable consideration for the transfer, Prewit v. Wilson, 103 U.S. 22">103 U.S. 22; Barnum v. Le Master, 110 Tenn. 638">110 Tenn. 638; 75 S. W. 1045; hence no taxable gift was made if only section 501 (a), supra, be considered. We pass at once, therefore, to the other contentions of the parties.Section 503, supra, provides that where property is transferred for less than an adequate and full consideration in money or money's worth the amount by which the value of the property exceeds the value of the consideration shall, for the purpose of the tax imposed by the title, be deemed a gift and be included in computing the amount of gifts made during the year. Respondent has construed the section as authorizing the inclusion of the entire value of property transferred for "a consideration not reducible to a money value, as49 love and affection, promise of marriage, etc." 2Petitioner50 contends that respondent's interpretation is erroneous. He argues that section 501 imposes an excise only upon the transfer of property by gift; that section 503 is applicable only where property 880 is transferred for a monetary consideration less than its actual value or is exchanged for property of less value; that the latter section is subordinate to the former and is to be applied only where there is a plain attempt at evasion through making a purported sale of property for less than its actual value; and that if section 503 be construed as taxing bona fide transfers for a valuable consideration it would be "contrary to the actualities * * , unreasonably oppressive * * * , would arbitrarily ignore recognized rights to enjoy and convey individual property for a valuable and adequate consideration, and * * * violate the guaranty of due process of law * * * ." Finally and in the alternative he urges that even if the promise of marriage be wholly disregarded there was nevertheless an adequate and full consideration in money or money's worth for the transfer in the legal detriment which the wife agreed to suffer in surrendering an annuity valued at $ 77,550. Therefore, he51 says, the gift made by him could not exceed the difference between that amount and the value of the stock, or $ 71,956.13. 3We are not persuaded that respondent has erred in his interpretation of section 503. The legislative history 4 indicates that Congress was endeavoring "to state with brevity and in general terms the provisions of a substantive character." Referring to some of the terms used -- property, transfer, gift, etc. -- it is said that52 they "are used in the broadest and most comprehensive sense." Cf. Robinette v. Helvering, 318 U.S. 184">318 U.S. 184, and Smith v. Shaughnessy, 318 U.S. 176">318 U.S. 176. There is nothing to indicate that Congress intended to make section 503 subordinate to section 501 or that it should be limited to instances where property is "sold or exchanged" for less than an adequate and full consideration in money or money's worth, as urged by petitioner. The fact that such words had been used in an earlier act (sec. 320, Revenue Act of 1924) is unimportant. In our judgment Congress deliberately and intentionally chose to include, within the category of property to be taxed, not only that passing by a transfer which constituted a gift at common law, but also all which was transferred for less than an adequate and full consideration in money or money's worth. In other words, section 503 is supplementary to section 501.53 The conclusion which we have reached is supported not only by the language of the act and the legislative history, but also by the regulations which have been in effect without change for many years. (Arts. 881 1 and 8, Regulations 79, supra. Cf. Arts. 1 and 8, 1936 Edition, approved Feb. 26, 1936.) "Treasury Regulations and interpretations long continued without substantial change, applying to unamended or substantially reenacted statutes, are deemed to have received Congressional approval and have the effect of law." Helvering v. Winmill, 305 U.S. 79">305 U.S. 79; Taft v. Commissioner, 304 U.S. 351">304 U.S. 351.The only consideration received by petitioner for the transfer of the stock was the promise of marriage. While it, as pointed out above, is a valuable consideration, it is not measurable in "money or money's worth." Prewit v. Wilson, supra. Cf. Central Union Trust Co. of New York et al., Executors, 24 B. T. A. 296. It is obvious, therefore, that "the amount by which the value of the property [transferred] exceeded the value of the consideration" equaled54 precisely the value of the property transferred. While the regulation states that a consideration not reducible to money value "is to be wholly disregarded," that is merely giving recognition to the fact that an attempt to make the calculation specified in the act would be nugatory.The parties discuss at some length Commissioner v. Bristol, 121 Fed. (2d) 129, reversing Bennet B. Bristol, 42 B. T. A. 263. The issue in that case was whether certain properties and annuities transferred by petitioner to his wife upon marriage were gifts subject to tax. We concluded that Congress did not intend the interpretative restriction placed around the estate tax (the amendment made by section 804 of the Revenue Act of 1932 to the estate tax law being declaratory of the law as it was prior thereto) to apply to the gift tax law and that the relinquishment of dower or other marital rights might, under the gift statute, be adequate and full consideration in money or money's worth. We pointed out that an arithmetical comparison of the value of the rights given up by the wife -- relinquishment of her statutory rights in her husband's55 estate -- with the value of the property received by her demonstrated that the transfer was full and adequate in money or money's worth. We have subsequently expressed our belief that the basic principle upon which decision was reached is sound (Herbert Jones, 1 T. C. 1207, 1209) and the District Court for the Southern District of Florida recently chose to follow it "rather than the contrary view set forth" in the opinion of the Circuit Court. Merrill v. Fahs, 51 Fed. Supp. 120. But an attempt to apply it here could not aid petitioner; for no property or property rights of his prospective wife, vested, contingent, or inchoate, were transferred by her to him. All that he received was her promise to marry him.Petitioner's argument in support of his contention that the interpretation placed upon section 503 by the Treasury Department renders it unconstitutional is based largely upon Helvering v. City Bank Farmers Trust Co., 296 U.S. 85">296 U.S. 85. In that case the taxpayer urged that section 302 (d) of the Revenue Act of 1926 was unconstitutional, 882 it providing that there should be 56 included in the gross estate of a decedent the value at the time of his death of property transferred prior to death where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any other person, to alter, amend, or revoke the transfer. The Court denied the contention, saying inter alia:* * * Congress may adopt a measure reasonably calculated to prevent avoidance of a tax. The test of validity in respect of due process of law is whether the means adopted are appropriate to the end. A legislative declaration that a status of the taxpayer's creation shall, in the application of the tax, be deemed the equivalent of another status falling normally within the scope of the taxing power, if reasonably requisite to prevent evasion, does not take property without due process. But if the means are unnecessary or inappropriate to the proposed end, are unreasonably harsh or oppressive, when viewed in the light of the expected benefit, or arbitrarily ignore recognized rights to enjoy or to convey individual property, the guarantee of due process is infringed.Petitioner concedes that 57 Congress has the power to classify, as taxable gifts, colorable transactions intended to evade the gift tax. He insists, however, that it may not tax a bona fide transfer for a valuable consideration, pointing out it is elementary the power to prevent evasions is to be reasonably exercised. The premise is sound but the conclusion is nevertheless erroneous. The taxation as a gift of the transfer by a wealthy man of a substantial portion of his property to his intended spouse is, in our judgment, a reasonable exercise of the power to prevent evasions. Normally property so transferred will not be included in his gross estate in the absence of some affirmative act by the wife. Unless the tax is imposed when the transfer is made the excise upon the transfer will be altogether escaped. The gift tax and the estate tax are in pari materia and "an important, if not the main purpose of the gift tax was to prevent or compensate for avoidance of death taxes by taxing the gifts of property inter vivos which, but for the gifts, would be subject in its original or converted form to the tax laid upon transfers at death." Estate of Sanford v. Commissioner, 308 U.S. 39">308 U.S. 39.58 It is reasonable to assume that Congress was aware of the fact that a transfer in consideration of marriage would not be a true gift since it would be based upon a valuable consideration. The fact that it chose language appropriate, under the Supreme Court decisions, to subject such a transfer to tax indicates that it was familiar with the court's interpretation and that it deliberately adopted the language for the purpose of closing the door against this method of escaping tax upon a transfer of property. In this view it is immaterial that the transfer, as here, may not have been animated by a tax-saving motive. We believe that the regulations correctly interpret the law and that section 503 as 883 thus construed does not violate the guaranty of due process of law under the Fifth Amendment to the Constitution.Petitioner's alternative contention is that if section 503 be construed as applicable to the transfer made by him then the taxable gift must be limited to the excess of the value of the stock over the value of the interest in the income of the two trusts which his wife lost by reason of and upon her marriage to him.Even if it be assumed that the loss by his wife of59 the income of the trusts was a consideration for the transfer of the stock rather than a mere consequence of the marriage, petitioner's contention must fail because he did not receive the income of the trusts or acquire any right thereto. All that he received was a promise of marriage, which, as heretofore pointed out, is not measurable in money or money's worth. But he can not prevail on this ground for other reasons. If it should be held that the taxable gift is to be computed as he suggests, then he should have proved the actual value of the wife's interest under the trusts. Cf. John D. Archbold, 42 B. T. A. 453. The fact that the average income received by her during the period of her widowhood was at the approximate rate of $ 5,484 per annum is no assurance that the income would thereafter continue at the same rate. Neither trust instrument gave her an annuity for life. Each merely provided that she should have an aliquot part of the income, whatever it was. The corpus of each trust consisted of capital stock of the Arcade Co. of Nashville, Tennessee. No evidence as to the financial condition of the company or of the assets owned by it was60 adduced.Petitioner's argument that the "detriment" suffered by his wife was consideration for the transfer even though it did not result in any financial gain to him loses much of its force when it is kept in mind that the income which she would have received under the trusts inured wholly to her infant son. It may well be, though we make no holding to that effect, that her maternal instinct prompted her to take the step which would give him double assurance of an adequate income for life.Respondent in our judgment committed no error in determining the deficiencies in tax.Decision will be entered for the respondent. DISNEYDisney, J., dissenting: Although perhaps, on the ground of failure of consideration, the ultimate conclusion of the majority opinion may be correct, the opinion is in large part based upon a concept to which I can not subscribe, that is, that section 503 of the Revenue Act of 1932 uses the word "consideration" as meaning consideration only to the donor, and may not be applied if the consideration consists only 884 of detriment suffered by the donee. Neither in that section nor elsewhere in the revenue act do I find the word "consideration" defined. 61 I conclude, therefore, we should apply that meaning which has developed through centuries of experience in the civil and common law. That meaning, beyond controversy, includes detriment suffered by the promisee. Corpus Juris Secundum on Contracts, p. 425. It is true that Commissioner v. Bristol, 121 Fed. 129, contains language to the effect that section 503 provides that the transferor must receive consideration. The statute, however, does not so provide, but requires only that property be "transferred for less than adequate and full consideration," and if not, that the excess be deemed a gift. Property was transferred in this case for a consideration. Reasonable and realistic construction of the contract indicates clearly. I think, that the wife-to-be agreed to do two things, to wit, to marry petitioner and to forego her rights under a trust. The findings of fact recite that she told the petitioner that she would not marry him and lose her life income under the trust unless he would enter into a premarriage contract with her to make good her loss. In truth the making good of the loss appears the principal element of the written agreement62 entered into. It was upon the representation and understanding that marriage would entail such loss to his intended wife that the petitioner agreed to, and did, make the transfer; and if this representation had proved unfounded and she had in fact continued to receive, as before, the income under the trust, there would, in my opinion, have been partial failure of consideration for petitioner's transfer. Of course, the fact that it may not have represented full and adequate consideration goes only to the amount to be deemed gift. To the wife-to-be the detriment was consideration "in money or money's worth." The only point, then, is whether the consideration may be only to the promisee.The Congressional Committee Reports covering section 503 of the Revenue Act of 1932, the same in both House and Senate, say that, "the tax is designed to reach all transfers to the extent that they are donative" and therefore that where the transfer is made for less than adequate and full consideration, the excess in value of property transferred over such consideration shall be deemed a gift. Patently, the object of the statute is to tax only so much of a transfer as is donative. This requires 63 application of the usual concepts of gift and therefore of consideration. In my view, the language of section 510 of the same revenue act bears out this idea; for that section provides that the donee is personally liable for the gift tax, if not paid when due, to the extent of the value of the gift. The majority opinion, therefore, subjects the petitioner's wife to the entire gift tax upon something for which she gave a very real consideration, in money or money's worth, to some apparently considerable degree; for though the majority opinion holds 885 that in any event the value of her interest in the trust was not proven, and obviously it was not fully proven, nevertheless, clearly it appears that it had no small monetary value. An interest in a trust which had for the last six years produced about $ 5,000 per year can hardly be denominated without money's worth. I find no reason, either in the words of the statute or in the requirement of the situation sought to be covered by the statute, to desert the long respected concept of "consideration." Why not take the law as we find it? The statute, in my opinion, fairly and reasonably requires the application thereof and negatives64 intent to tax that portion of a transfer which as between the parties is covered by consideration in its usual and ordinary legal sense.In the above nothing is said as to whether an agreement to marry is a consideration measurable in money, for the reason that the agreement to marry was only one of the considerations entering into the contract, and therefore it appears immaterial as to whether marriage as consideration was pecuniarily measurable. The above conclusions, therefore, are based only upon the financial detriment suffered by the wife-to-be, as a consideration which in my opinion the law requires us to take into account. I therefore respectfully dissent. Footnotes1. SEC. 501. IMPOSITIONS OF TAX.(a) For the calendar year 1932 and each calendar year thereafter a tax, computed as provided in section 502, shall be imposed upon the transfer during such calendar year by any individual, resident or nonresident, of property by gift.SEC. 503. 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 title, be deemed a gift, and shall be included in computing the amounts of gifts made during the calendar year.↩2. Articles 1 and 8 of Regulations 79 provide:"Art. 1. * * The tax is not limited in its imposition to transfers of property without a valuable consideration, which at common law are treated as gifts, but extends to sales and exchanges for less than an adequate and full consideration in money or money's worth. (See article 8.) * * ""Art. 8. * * 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. * * * A consideration not reducible to a money value, as love and affection, promise of marriage, etc., is to be wholly disregarded, and the entire value of the property transferred constitutes the amount of the gift."↩3. The only evidence touching upon this phase is the wife's age -- 44 years -- at the time of her marriage to petitioner and the income of the trusts. The $ 77,500, used by petitioner as the value of the right of Ellen Stokes More to receive for life one-half of the income of the trusts created by her first husband, is the result of a calculation under a table set out in respondent's regulations for the value of annuities. In making the calculation petitioner used the average annual income ($ 5,484) received by Mrs. More under the trusts prior to her marriage to him.↩4. Senate Rept. No. 665, 72d Cong., 1st sess.; House Rept. No. 708, 72d Cong., 1st sess.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621095/	EWALD IRON COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Ewald Iron Co. v. CommissionerDocket No. 81919.United States Board of Tax Appeals37 B.T.A. 798; 1938 BTA LEXIS 987; April 29, 1938, Promulgated 987 ABANDONMENT OF PROPERTY - LOSS OF USEFUL VALUE. - In 1933 petitioner discontinued the manufacture of drilled staybolts, primarily for the reason that, under the existing conditions, such department of its business was being operated as a loss. Petitioner did not scrap the bolt machines, but stored them in its drilling plant, where they were available at any time for resumption of operations. Held, petitioner is not entitled to a deduction from gross income for the taxable year on account of loss of useful value of its bolt machines. E. J. Wells, Esq., for the petitioner. Jonas M. Smith, Esq., for the respondent. HILL 798 OPINION. HILL: Respondent determined a deficiency in petitioner's income tax for the year 1933 in the amount of $1,712.61, from which petitioner appeals and assigns as error the refusal of respondent to allow a deduction of $11,127.79 as a loss sustained upon machinery alleged to have been discarded during the taxable year. Petitioner is a Kentucky corporation, with its principal office at Louisville. In the year 1922 petitioner began the manufacture of drilled staybolts, which were sold to railroads and locomotive988 companies for use in railroad locomotives. Petitioner continued to manufacture such bolts until about October 1, 1933, when it went out of the hollow drilled bolt business entirely. Petitioner ceased to manufacture the bolts for several reasons. The first was because there had always been a large loss in this department of its business, resulting from the fact that petitioner could not charge a greater differential over the price of solid iron bars than its competitors charged, which was 3 cents per pound additional, and petitioner found it cost about 6 cents per pound additional. Petitioner manufactured the bolts only for the protection of its solid iron business, and when the N.R.A. first came into being it became apparent that the petitioner would have to operate under some other code if it continued to manufacture hollow bolts. About that time petitioner was approached by the Flannery Bolt Co. with the proposition that petitioner withdraw from the manufacture of bolts under an arrangement whereby the Flannery Bolt Co. would manufacture and supply bolts to petitioner's customers out of petitioner's iron. A similar arrangement was made with the American Locomotive Co., which989 also manufactured hollow staybolts. 799 Within two or three months after October 1, 1933, when petitioner discontinued the manufacture of bolts, all the machinery formerly used for that purpose, except a single machine, was moved over to one corner of the drilling plant or department. A vertical heading machine, which was very heavy, was not moved but left in position. In respect of the machinery used by petitioner in the manufacture of bolts, the parties have stipulated the date of purchase of each machine, depreciation, and salvage value as of January 1, 1933, and agree that if petitioner is entitled to any deduction for loss of useful value, the amount so allowable is $11,127.79. The sole issue submitted for decision here is whether or not petitioner in fact abandoned its machinery during the taxable year and thereby sustained a loss of the residual value, less salvage, in the amount above stated, so as to render such amount properly allowable as a deduction from gross income. Petitioner contends that it discarded and abandoned its bolt machinery in 1933, with the intention of never again engaging in that line of business; that it thereby sustained a loss of the990 stipulated residual value, less salvage, and is entitled to a deduction for loss of useful value in the amount claimed. Respondent denied the deduction substantially on the ground that abandonment was not established, and hence there was no present loss sustained on that account. The evidence adduced, we think, supports respondent's position. Whether or not there has been an abandonment of property depends upon the intention of the owner, coupled with the act of abandonment, both of which are to be ascertained and determined from all the surrounding facts and circumstances. ; . We shall not here attempt to make any specific determination in respect of petitioner's intention, for the reason that the evidence, in our opinion, is wholly insufficient to show an act of abandonment. While abandonment necessarily involves nonuse, proof of nonuse is not sufficient to constitute abandonment. Petitioner discontinued the manufacture of bolts in 1933, primarily because that department of its business was being operated at a loss in order to protect991 its solid iron business. Such discontinuance was effected under arrangements made with other companies whereby petitioner could avoid further operating loss from the manufacture of bolts without injury to its solid iron business. But petitioner did not scrap its bolt machines; they were not even removed from the drilling plant or department. The heavy vertical heading machine was left in its original position, and the smaller machines were stored in one corner of the plant. By this action it is apparent that, if the arrangement made with the Flannery Bolt Co. and the 800 American Locomotive Co. to supply petitioner's customers with bolts made of its iron, had thereafter proved unsatisfactory to petitioner, or if petitioner had desired to do so for any other reason, it could have resumed the manufacture of bolts, with little delay. The necessary machinery was on hand and available for such purpose at any time. Petitioner made no effort to scrap and sell the machines, so far as the record shows, notwithstanding they had an admitted salvage value of $3,750. We think petitioner has not shown any loss of useful value. *992 Respondent has determined that petitioner did not abandon its bolt machinery during the taxable year, and petitioner has the burden of proving by satisfactory evidence that such determination is erroneous. This, in our opinion, petitioner has failed to do. The deficiency determined by respondent is approved. Cf. ; ; affd., ; . Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621096/	DAVID M. TREATMAN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentTreatman v. CommissionerDocket No. 9244-78.United States Tax CourtT.C. Memo 1981-74; 1981 Tax Ct. Memo LEXIS 668; 41 T.C.M. (CCH) 934; T.C.M. (RIA) 81074; February 23, 1981. 668 Herbert L. Reff, for the petitioner. Darwin R. Thomas, for the respondent. GOFFEMEMORANDUM FINDINGS OF FACT AND OPINION GOFFE, Judge: The Commissioner determined the following deficiencies in the Federal income tax of the petitioner: Taxable YearDeficiency1974$ 57,660197527,106Due to concessions, the only issue is whether capital was a material income-producing factor in petitioner's mail order business during the taxable years in question. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference. The petitioner timely filed head of household Federal income tax returns for his 1974 and 1975 taxable years. He resided in Los Angeles,California, when he filed his petition herein. During 1974 and 1975, petitioner owned and operated, as a sole proprietorship, a mail order business. He devoted a substantial amount of time (seven days per week, from ten to sixteen hours per day) to the conduct of the business. Petitioner would travel throughout the United States locating merchandise which he considered suitable to market through his business and arranged with the manufacturer 669 to have the goods ready for prompt sale and shipment if orders for them were received from petitioner's customers. No one assisted him in this activity. After lining up suitable merchandise, petitioner would carefully and laboriously design a brochure advertising the products he wished to sell. Designing the brochure made extensive demands upon petitioner's creative and artistic capacities, requiring him to "convey [his] personal creative ability into an art form * * ." No one assisted petitioner in designing the brochure. The brochure was then sent to the printer and printed copies were mailed out to potential customers whose names petitioner had obtained by renting mailing lists. Petitioner used employees and mailing equipment to assist him in mailing the brochures. Orders received by petitioner in response to the brochures were prepaid. Petitioner himself processed the orders. He opened the mail, deposited the checks, and then acquired the merchandise which had been ordered by his customers from the manufacturer. The manufacturer would ship the merchandise to petitioner who employed shipping clerks to mail the goods to his customers in fulfillment of their orders. In addition 670 to the employees who operated the mailing equipment and the shipping clerks, petitioner employed a woman who handled correspondence with customers. Petitioner acquired, in February 1974, a building and the land upon which it stood for use in his mail order business. As stated previously, he also owned mailing equipment. The unaudited balance sheets of petitioner's business as of December 31, 1973 and 1974 appear below: ASSETSCurrent Assets12/31/7312/31/74Cash$ 589.55$ 93.46Loans Receivable7,500.0084,000.00Short Term Investments0100,093.50Inventory1,016.3534,922.00Prepaid Expenses5,424.324,266.50TOTAL CURRENT ASSETS$ 14,530.22$ 223,375.46Fixed Assets 1Land0$ 40,000.00Building & Improvements079,610.56Equipment065,323.97Auto07,220.00$ 192,154.53Less: Accumulated Depreciation21,437.12FIXED ASSETS at NET BOOK VALUE$ 18,164.07$ 170,717.41Deposits$ 1,125.000TOTAL ASSETS$ 33,819.29$ 394,092.87LIABILITIES & NET WORTHCurrent LiabilitiesLoan Payable - City Nat'l Bank$ 10,000.00$ 100,000.00Accounts Payable12,868.8652,273.47Payroll Taxes Payable1,022.020Current Portion of Long Term Debt02,879.04TOTAL CURRENT LIABILITIES$ 23,890.88$ 155,152.51Long Term DebtMortgage Payable$ 0$ 54,099.28Second Trust Deed Payable020,272.50$ 02$ 74,369.78Less: Current Portion2,879.04NET LONG TERM DEBT$ 0$ 71,490.74Net Worth9,928.41167,449.62TOTAL LIABILITIES & NET WORTH$ 33,819.29$ 394,092.87671 Sales and expense data of the mail order business for 1974 and 1975 are shown below: 19741975Sales$ 1,735,286.00$ 861,314.00Less: Cost of Goods Sold429,882.00206,229.00Gross Margin$ 1,305,404.00$ 655,085.00Expenses: Postage308,181.00147,510.00Rental of mailing lists209,275.0068,849.00Depreciation12,675.0010,726.00Salaries & wages43,710.0024,085.00Advertising112,619.0056,738.00Other expenses141,126.0078,069.00Total Expenses$ 827,586.00$ 385,977.00NET PROFIT$ 477,818.00$ 269,108.00Typically, petitioner's inventories of goods were minimal in relation to his sales, averaging only from $ 3,000 to $ 4,000. The December31, 1974, inventory was abnormally high because petitioner had just purchased merchandise at a substantial discount fora forthcoming mailing. Petitioner treated all of his net profits for the years in issue as "earned income" for purposes of computing 672 his maximum tax under section 1348, Internal Revenue Code of 1954. 3 The Commissioner determined that none of the net profits could be treated as earned income and, hence, that none of petitioner's taxable income was subject to the maximum tax provisions. OPINION For the taxable years before us, only "earned income" qualified for maximum tax benefits. Section 1348 defined "earned income" as follows: SEC. 1348. FIFTY-PERCENT MAXIMUM RATE ON EARNED INCOME. (b) DEFINITIONS.--For purposes of this section-- (1) EARNED INCOME.--The term "earned income" means any income which is earned income within the meaning of section 401(c)(2)(C) or section 911(b) * * . Section 911(b) provided: (b) DEFINITION OF EARNED INCOME.--For purposes of this section, the term "earned income" means wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered * . In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income-producing factors, 673 under regulations prescribed by the Secretary or his delegate, a reasonable allowance as compensation for the personal services rendered by the taxpayer, not in excess of 30 percent of his share of the net profits of such trade or business, shall be considered as earned income. Thus, if capital were a material income-producing factor in petitioner's mail order business, only 30 percent of his net profits therefrom may be considered earned income for purposes of the maximum tax computation. Section 1.1348-3, Income Tax Regs., provides general guidelines for determining when capital is a material income-producing factor and a specific example: SEC. 1.1348-3. DEFINITIONS. (a) Earned Income.-- (3) Earned income from business in which capital is material. (ii) Whethercapital is a material income-producing factor must be determined by reference to all the facts of each case. Capital is a material income-producing factor if a substantial portion of the gross income of the business is attributable to the employment of capital in the business, as reflected, for example, by a substantial investment in inventories, plant, machinery, or other equipment. In general, capital is not a material 674 income-producing factor where gross income of the business consists principally of fees, commissions, or other compensation for personal services performed by an individual. Thus, the practice of his profession by a doctor, dentist, lawyer, architect, or accountant will not, as such, be treated as a trade or business in which capital is a material income-producing factor even though the practitioner may have a substantial capital investment in professional equipment or in the physical plant constituting the office from which he conducts his practice since his capital investment is regarded as only incidental to his professional practice. (6) Examples. The application of this paragraph may be illustrated by the following examples: Example (2). In his unincorporated business as a real estate broker, which he conducts on a full-time basis, A performs substantial personal services, including solicitation of home buyers and sellers, escorting prospective buyers on house visits, arranging appraisal, financing, and legal services, and other related tasks. In the course of conducting such business, A often finances sales of real estate with his own capital, makes all the necessary arrangements 675 incident to such financing, and a substantial portion of the gross income of the business consists of interest income from such financing. Under these facts and circumstances, both personal services and capital are material income-producing factors in A's real estate business within the meaning of paragraph (a)(3) of this section since the financing of real estate sales is an integral part of the entire business. Accordingly, A's earned income from his real estate business is limited to a reasonable allowance as compensation for the personal services A actually renders, but not in excess of 30% of the net profits from the business, including the interest income derived from financing sales of real estate. Petitioner argues that he was merely a "broker" of merchandise, an intermediary between buyer and seller, and that capital was only incidental to his operation. Petitioner cannot, however, bring himself into the "professional fee" concept discussed in the regulation because he sold goods and not services. Even if he could somehow be viewed as a "chattel broker," we would find the example dispositive against him because, in effect, he "financed" the sale of merchandise by buying 676 and reselling it, much as the real estate broker in the example financed the sale of homes. Compare these facts with Bruno v. Commissioner,71 T.C. 191">71 T.C. 191 (1978)(bail bonds person's use of real estate to secure bonds written was merely incidental to primary business of providing services). We have no doubt that petitioner's personal services accounted for far more than 30 percent of his business' net profit, but cannot escape the conclusion that capital was also a material income-producing factor. While it is true that petitioner's inventories were minimal, other capital sources of income are readily apparent. Perhaps the most important were the lists of names which petitioner rented. The rentals he paid for them were substantial, indicating that they had a high value in relation to sales. Petitioner also made heavy use of capital in the form of customer prepayments of orders which he used to finance his purchase of the ordered goods. Absent the prepayment arrangement, petitioner would have had to seek alternative financing of his purchases, either through the manufacturers or banks. See Moore v. Commissioner,71 T.C. 533">71 T.C. 533 (1979)(capital was a material income-producing factor 677 in retail grocery business). The Commissioner's determination that none of petitioner's net profits may be treated as earned income is therefore clearly erroneous. Under the statutory provisions quoted above, however, petitioner is entitled to treat only 30 percent of his net profits as "earned income." While we do not here pass on the wisdom of this somewhat arbitrary limit, we note that, for taxable years commencing after 1978, Congress has removed it. Sec. 442(a), Revenue Act of 1978, Pub.L. 95-600, 92 Stat. 2878. To reflect the foregoing, Decision will be entered under Rule 155. Footnotes1. Fixed assets were not separated into categories on the December 31, 1973, sheet. ↩2. This figure should actually be $ 74,371.78 rather than the $ 74,369.78 which appears on petitioner's balance sheet. Likewise, the amount listed for NET LONG TERM DEBT should be $ 71,492.74 and TOTAL LIABILITIES & NET WORTH should be $ 394,094.87.↩3. All section references are to the Internal Revenue Code of 1954, as amended and in effect for the taxable years in issue, unless otherwise noted.↩	01-04-2023	11-21-2020

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