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https://www.courtlistener.com/api/rest/v3/opinions/4621256/	DAVID R. EVERETT, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEverett v. CommissionerDocket No. 45823-86United States Tax CourtT.C. Memo 1989-605; 1989 Tax Ct. Memo LEXIS 607; 58 T.C.M. (CCH) 642; T.C.M. (RIA) 89605; November 6, 1989David R. Everett, pro se. Clare J. Brooks, for the respondent. GOFFEMEMORANDUM OPINION GOFFE, Judge: This matter was heard by Special Trial Judge Helen A. Buckley pursuant to the provisions of section 7443A of the Code and Rule 180. 1 The Court agrees with and adopts her opinion. OPINION OF THE SPECIAL TRIAL JUDGE BUCKLEY, Special Trial Judge: This matter is before us on respondent's608 motions to impose sanctions and to award damages. We have decided to impose the sanction of dismissal pursuant to Rule 104(c) and to award damages pursuant to section 6673. Respondent determined deficiencies in petitioner's Federal income taxes, together with additions thereto, as follows: Additions to taxYearTaxSec. 6651(a)(1)Sec. 6653(a) 2Sec. 6654(a)Sec. 66611979$ 25,908$ 6,477$ 1,295$ 1,206$ - 198029,7447,4361,4871,898- 198133,9658,4911,6983,700- 198233,6148,4031,6813,2713,361198337,6599,4151,8832,3103,766198439,7089,9271,9852,5003,971Respondent determined that petitioner had unreported income as follows: YearAmount1979$ 56,139198061,753198167,928198274,721198382,193198490,412Respondent, in computing the deficiency609 amounts, allowed petitioner a personal exemption of $ 1,000 in each of the above years. Respondent also determined that petitioner was liable for self-employment tax and computed that tax upon the maximum amount of self-employment income subject to the tax. Petitioner filed his petition timely in this Court. In the petition, he listed his address as Fork, Maryland. After the filing of the petition and answer, respondent served upon petitioner a request for production of documents and other things as well as interrogatories. Petitioner, by letter, objected to the request for production, querying respondent as to what made petitioner a "taxpayer." He did not produce requested documents nor did he answer the interrogatories. Respondent thereupon filed two motions, one to compel responses to interrogatories and the other to compel production of documents. Upon petitioner's request, we gave him additional time to respond to the motions, and on October 22, 1987, he filed his objections to the motions. This Court granted respondent's motion to compel response to interrogatories and motion to compel production of documents on November 17, 1987. Our order stated: ORDERED that respondent's610 above-referenced motions are granted in that petitioner shall, on or before December 23, 1987, (1) serve on counsel for respondent answers to each interrogatory served upon petitioner on June 16, 1987, and (2) produce to counsel for respondent those documents requested in respondent's request for production of documents served on petitioner on June 16, 1987. It is further ORDERED that in the event petitioner does not fully comply with the provisions of this Order, this Court will be inclined to impose sanctions pursuant to Tax Court Rule 104, which may include dismissal of this case and entry of a decision against petitioner. Rather than comply with our Order, petitioner filed a frivolous motion for summary judgment with brief, and we denied that motion. Petitioner also filed a so-called "Answer" to the interrogatories, stating he had no income within the jurisdiction of the United States, that any companies with which he was involved were outside the jurisdiction of the United States as were any sales such company might have made or income he might have received. The "Answer" was nonresponsive. He did not produce documents as ordered. Respondent thereupon moved for sanctions611 and for an award of damages. Petitioner filed his objections to these motions, both of which are frivolous in nature. Petitioner did not appear at the hearing on the motions. We grant respondent's motion to impose sanctions and have determined that the appropriate sanction is dismissal pursuant to Rule 104(c). Rule 104(c)(3) provides that where a party fails to obey an order made by the Court with respect to interrogatories or the production of documents the Court may make an order: RULE 104. ENFORCEMENT ACTION AND SANCTIONS (c) Sanctions: * * * * * * (3) An order striking out pleadings or parts thereof, or staying further proceedings until the order is obeyed, or dismissing the case or any part thereof, or rendering a judgment by default against the disobedient party. We warned petitioner in our Order of November 17, 1987, that a possible repercussion of his failure to comply with our Order would be the sanction of dismissal. We have decided that under the circumstances of this case that dismissal is appropriate. In arriving at this conclusion, since petitioner advises612 us he is a layperson, we have reviewed all papers filed by petitioner in this matter. In the petition petitioner contends that he is not a person subject to United States tax or income. He states: Petitioner is an ordained Presbyterian Elder, Pastor, and radio preacher, living by the grace and mercy of God, and not by receipt of "taxable" worldly income. The petitioner gives of himself freely, as God has given to him, charging no fee, salary, compensation, nor requiring no "contribution" in exchange for his services and ministry to others on behalf of Christ Jesus. Any sums of money, or "support" received or administered by the Petitioner to meet the material needs for himself or his family do not accrue to Petitioner on account of any earned "income", or "taxable" income. Petitioner went on to deny all items, without reasons, mentioned in the deficiency notice. He alleges the adoption of the 16th Amendment to have been fraudulently certified. We conclude that the petition, in any event, would be subject to dismissal for failure to state a claim. In his motion for summary judgment petitioner alleges that income taxes are imposed on income from services within the613 United States only upon aliens and foreign corporations; on sources without the United States only upon United States citizens residing abroad or within a possession of the United States; that the only persons liable to file an income tax return are withholding agents for aliens and foreign corporations; and that petitioner did not fall into such category, nor did he reside abroad as a United States citizen. Petitioner's 65-page brief elaborates extensively upon his theories, commencing with the charter establishment of the 13 colonies and his views of the limitations of Federal jurisdiction. We quote petitioner's own summary: In summary, jurisdiction of the states is essentially the same as that possessed by the states which were leagued together under the Articles of Confederation. The confederated states possessed absolute, complete and full jurisdiction over property and persons located within their borders. * * * * * * The argument set forth in this brief involves a construction of Title 26 which holds that only aliens and foreign corporations are taxed on income derived from sources within the United States and that, for United States citizens, only income from sources614 outside the continental United States are taxed. * * Not surprisingly, we denied this motion for summary judgment for petitioner. In his objection to respondent's motions for sanctions and damages, petitioner agrees with respondent that he answered most of the questions propounded by the interrogatories by his statement "that income, his companies, dealings, its sales, or any other activity occurred outside the jurisdiction of the United States." Petitioner argues that the jurisdiction of the United States is fully described in 18 U.S.C.§ 7, that he is a citizen of Maryland and subject to its jurisdiction and was not a United States citizen subject to the jurisdiction of the United States. Further he goes on to contend that he had no income derived from a source within the jurisdiction of the United States and was not subject to the jurisdiction of the United States from 1978 through 1984. Although petitioner did not file objection to the motion in regard to production of documents and thus did not explain why he failed to produce documents and other things, we are willing to assume that it was for the same "reason" he set forth in regard to the interrogatories.615 Petitioner's various positions have long been rejected by this and every other court which has had such frivolous arguments before it. We note that although petitioner's brief cites a great number of cases, the Federalist Papers, and statutes, he has somehow not cited any of the many cases directly disagreeing with his tax protestor theories. We do not believe this omission to have been accidental. The bulk of the contentions raised by petitioner were considered and rejected in our opinion in Rowlee v. Commissioner, 80 T.C. 1111 (1983). We will not waste time and energy repeating them here. We do, however, point out that this Court has jurisdiction over this matter and it was invoked by petitioner when he filed his petition herein. Simanonok v. Commissioner, 731 F.2d 743">731 F.2d 743 (11th Cir. 1984); Denison v. Commissioner, 751 F.2d 241">751 F.2d 241 (8th Cir. 1984), cert. denied 471 U.S. 1069">471 U.S. 1069 (1985); Stevens v. Commissioner, 709 F.2d 12">709 F.2d 12 (5th Cir. 1983), affg. a Memorandum Opinion of this Court; Stix Friedman & Co. v. Coyle, 467 F.2d 474">467 F.2d 474 (8th Cir. 1972); Nash Miami Motors v. Commissioner, 358 F.2d 636">358 F.2d 636 (5th Cir. 1966),616 cert. denied 385 U.S. 918">385 U.S. 918 (1966). The 16th Amendment was constitutionally adopted, Knoblauch v. Commissioner, 749 F.2d 200 (5th Cir. 1984); Stahl v. Commissioner, 792 F.2d 1438 (9th Cir. 1986), cert. denied 479 U.S. 1036">479 U.S. 1036 (1987), and there is constitutional authority to impose an income tax on individuals. Brushaber v. Union Pacific R. Co., 240 U.S. 1 (1916); Ficalora v. Commissioner, 751 F.2d 85 (2d Cir. 1984), cert. denied 471 U.S. 1005">471 U.S. 1005 (1985); United States v. Stillhammer, 706 F.2d 1072">706 F.2d 1072 (10th Cir. 1983); Hayward v. Day, 619 F.2d 716 (8th Cir. 1980), cert. denied 446 U.S. 969">446 U.S. 969 (1980). Further, the statutory authority to impose an income tax on individuals is clear. Ficalora v. Commissioner, supra;United States v. Moore, 692 F.2d 95">692 F.2d 95 (10th Cir. 1979). It is apparent that petitioner's stale protestor claims, with no substantive allegations of error in respondent's determinations, do not in any event*617 present a justiciable claim for this Court. Accordingly, it would be a waste of time in this matter to continue it further. We have determined that petitioner failed to obey a direct order of this Court, and the appropriate sanction under Rule 104(c) is that his petition is dismissed. A decision will be entered against him. We turn now to respondent's motion for damages. Section 6673 of the Code provides we shall award damages whenever it appears to us that proceedings before us have been instituted or maintained primarily for delay, that the taxpayer's position is frivolous or groundless, or that the taxpayer unreasonably failed to pursue available administrative remedies. Such a situation obtains here. Petitioner's position is completely groundless and frivolous. We award damages to the United States in the amount of $ 5,000. An order of dismissal and decision together with an award of damages will be entered. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect for the year at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. The additions to tax for the years 1981, 1982, 1983, and 1984 are pursuant to sec. 6653(a)(1). In addition, respondent determined additions pursuant to sec. 6653(a)(2) for each of the years 1981 through 1984 in the amount of 50 percent of the interest due on the underpayment.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621257/	Gaines Williamson and Edith Williamson (Husband and Wife) v. Commissioner.Williamson v. CommissionerDocket No. 40558.United States Tax CourtT.C. Memo 1955-131; 1955 Tax Ct. Memo LEXIS 208; 14 T.C.M. (CCH) 487; T.C.M. (RIA) 55131; May 23, 1955208 Held: The deficiency asserted for 1948 is sustained. 2. Held: The deficiency asserted for 1947 is sustained. 3. Held: Petitioners understated taxable net income for 1945 with intent to evade tax and are liable for the deficiency and addition to tax imposed therefor. 4. Held further: Respondent failed to prove that the deficiencies asserted for 1946 and 1947 were due to fraud with intent to evade tax and the additions to tax provided by Section 293(b), Internal Revenue Code of 1939, are accordingly not sustained as to either of these years. 5. Held: The deficiency determined for 1946 is barred by the statute of limitations. Chat Chancellor, Esq., McClure Building, Frankfort, Ky., for the petitioners. Charles R. Hembree, Esq., for the respondent. BRUCE Memorandum Findings of 209 Fact and Opinion BRUCE, Judge: Respondent determined deficiencies in income tax and additions to tax because of fraud in the following amounts: 50% additionYearDeficiencyto tax1945$ 1,895.44$ 968.22 194617,428.548,714.2719475,851.692,925.8519482,693.98A jeopardy assessment of the deficiencies was made by respondent. Petitioners assigned error with respect to the deficiencies determined by respondent for each of the taxable years involved, and, by amended210 petition, pleaded the statute of limitations with respect to the years 1945 to 1947, inclusive. Neither of the petitioners appeared at the hearing and no evidence was offered in their behalf. Respondent moved for judgment in the amount of the deficiencies. This motion was taken under consideration by the Court pending proof by respondent that the deficiencies for 1945, 1946, and 1947 are not barred by limitations. The issues presented are (1) whether any part of the deficiencies determined by respondent for each of the years 1945, 1946, and 1947 was due to fraud with intent to evade tax so as to invoke the provisions of section 293(b) of the Internal Revenue Code of 1939, and (2) whether the deficiencies determined by respondent for the years 1945, 1946, and 1947 are barred by the statute of limitations. Findings of Fact The petitioners were husband and wife during the years 1945 through 1948. The income tax returns for the years involved were filed with the then collector of internal revenue for the district of Kentucky. The amounts of net income reported by petitioner, Gaines Williamson, on his individual income tax return for the years 1945 to 1947, inclusive, and the amounts211 of net income as determined by respondent for said years are as follows: Net incomeNet incomedeterminedYearreportedby respondent1945$ 1,489.00 $ 9,140.72194612,595.5444,859.88194716,493.2028,087.73Beginning in October 1945, and continuing throughout the years involved, petitioner Gaines Williamson (hereinafter referred to as petitioner), was a partner having a fifty per cent interest in the Manhattan Grill (hereinafter sometimes referred to as the partnership), located in Middlesboro, Kentucky. During the taxable years involved, the partnership had income from the sales of alcoholic beverages, from slot machines, and from tip boards. No partnership return was filed by the partnership for the year 1945. Neither petitioner nor the partnership maintained books of account for the years involved, and the only records submitted to the internal revenue agents consisted of invoices of the partnership; some, but not all, of the bank statements, check book stubs and cancelled checks; and one large columnar work sheet covering only the year 1946, which was used in preparing the 1946 partnership return and212 which listed in summary form items of cash expenditures. The partnership did not have a record of withdrawals by the partners, a detailed record of receipts or inventories taken, a ledger showing asset accounts, or inventory ledger cards. Neither petitioner nor the partnership maintained adequate records from which the income reported on the returns of the petitioner and the partnership could be verified, or from which the summary figures listed on the accounting sheet covering the year 1946 could be verified. The original individual income tax return filed by petitioner for the calendar year 1945 reported total income in the amount of $1,489.00 and the source of such income as "self". His occupation was stated thereon as "Business (merchant)". On June 14, 1950, after respondent started his investigation of petitioner's tax liability for the years involved, petitioner filed an additional return, dated "5/12/50", covering the period "beginning Oct. 12, 1945, and ending Jan. 1, 1946", and disclosing income from "Ed Clark (deceased)" in the amount of $800.00 and from the partnership "Manhattan Grill" in the amount of $1,292.42, or a total of $2,092.42. In the absence of a partnership213 return for the year 1945 and adequate records maintained by the petitioner or the partnership, respondent used the net worth plus personal expenditures method in determining petitioner's corrected income for the year 1945. Petitioner's taxable net income for 1945 based on his net worth plus personal expenditures is as follows: 1/1/4512/31/45ASSETS: Commercial Bank$ 12.49$ 55.41U.S. Government "E" Bonds1,000.001,000.00Mining Equipment1,300.001,300.00Manhattan Grill5,761.68Oldsmobile750.00750.00Packard1,100.001,100.00Total$4,162.49$9,967.09LIABILITIES: Reserve for Depreciation, Mining Equip-ment$ 130.00$ 260.00Net Worth$4,032.49$9,707.094,032.49Increase in Net Worth$5,674.60Personal Expenditures: Federal income tax payments21.70Life Insurance Premiums111.40Living Expense Estimate3,000.00Political Contributions200.00Taxable Net Income$9,007.70The net worth of the Manhattan Grill on December 31, 1945, is as follows: 1/1/4512/31/45ASSETS: Cash on Hand$ 1,000.00Commercial Bank1,298.04Inventory6,221.36Equipment: Two Beer Coolers$ 926.00Three Beer Coolers545.00Fixtures3,850.005,321.00Total Assets$13,840.40LIABILITIES: Scruggs Equipment Co.$2,051.00Reserve for Depreciation266.05Total Liabilities2,317.05Net Worth$11,523.35214 The item "Manhattan Grill" listed as an asset of petitioner on December 31, 1945, represented a one-half interest in the net worth of the partnership. All other items listed as assets of petitioner were either supplied by or agreed to by petitioner, except the item listed as "Commercial Bank", which was obtained from the bank's records, and the item "Mining Equipment" which was obtained from the county chattel mortgage records. All items of personal expenditures of petitioner, except "Federal income tax payments" were also supplied by or agreed to by petitioner. In the net worth statement of the partnership for 1945, the asset items of "Inventory" and "Equipment" were obtained from the partnership returns for 1946. The "Cash on hand" item was an estimate and the "Commercial Bank" item was obtained from the partnership's check stub book. Items listed as liabilities were derived or computed from information obtained from the county records. A part of the deficiency for the taxable year 1945 is due to fraud with intent to evade tax. For the years 1946 and 1947, the additional income attributed to petitioner in respondent's determination, except for $356.80 in the year 1947, represents215 increase in petitioner's distributable share of the partnership income as determined by respondent for said years. For the years 1946 and 1947, the partnership filed returns in which it reported gross receipts "from business or profession" exclusive of receipts from slot machines and tip boards, in the respective amounts of $351,000.42 and $291,749.48, and net income, exclusive of income from slot machines and tip boards, in the respective amounts of ($2,443.71) and $6,223.32. October 16, 1945 was given as the date of organization of the partnership on the 1946 return. Due to the lack of adequate books and records from which the income reported by the partnership for 1946 and 1947 could be verified, respondent, in his determination of the income of the partnership for said years, increased gross profits by applying a percentage of gross sales mark-up. The percentage used was 27 per cent, which was the same as the percentage computed from the figures reported on the partnership return for 1948. During the years involved a state law required a minimum mark-up of 10 per cent on the sale of liquor by the case and 33 1/3 per cent on the sale of packaged liquor, based on the cost of216 the merchandise, exclusive of certain federal taxes. It prohibited the purchase of liquor on credit. The gross income reported by petitioner on his individual income tax returns for the years 1945 to 1947, inclusive, and the amounts determined by respondent to have been omitted from the returns, are as follows: Determinedto haveYearReportedbeen omitted1945$ 1,489.00$ 7,651.72194613,748.4032,264.34194718,348.6811,594.53The individual income tax returns of the petitioner for the years 1945, 1946, and 1947 were filed on or before March 15, 1946, March 15, 1947, and March 15, 1948, respectively. On or about February 12, 1951, petitioners and respondent entered into and executed written agreements whereby the time for assessing the taxes due from the petitioners for the respective years 1945 and 1947 was extended to any time on or before June 30, 1952. The statutory notice of deficiencies for the years involved was mailed on February 5, 1952. Opinion Neither of the petitioners appeared at the hearing and no evidence was offered in their behalf. The burden of proof being upon petitioners with respect to the deficiencies (exclusive217 of the additions to tax) the motion of the respondent for judgment in the amount of such deficiencies is sustained. The only questions left for determination are whether any part of the deficiencies for each of the years 1945, 1946, and 1947 is due to fraud with intent to evade tax, and, whether the assessment and collection of the deficiencies for such years is barred by limitations. The applicable statutes are set forth in the margin. 1218 No additions to tax having been asserted with respect to the year 1948, and the notice of deficiency having been mailed within the three-year period allowed by section 275(a) of the Internal Revenue Code of 1939, no further question is presented as to petitioners' liability for the deficiencies determined for 1948. It may likewise be pointed out at this time that the assessment and collection of the deficiency in tax (exclusive of the additions to tax) for the year 1947 is not barred by limitations in view of the waiver, executed prior to the expiration of the time prescribed by section 275(a), extending the time for assessment to June 30, 1952, and the mailing of the notice of deficiency on February 5, 1952. Section 276(b), Internal Revenue Code of 1939. Petitioners on brief have conceded that the deficiencies for 1947 and 1948 are not barred by limitations and, therefore must be sustained. We accordingly proceed to determine the question of fraud as to the years 1945, 1946, and 1947, and the question of limitations as to the years 1945 and 1946. The burden of proof with respect to both these questions is upon the respondent and fraud is required to be established by clear and convincing219 evidence. Henry S. Kerbaugh, 29 B.T.A. 1014">29 B.T.A. 1014, 1016; Joseph V. Moriarty, 18 T.C. 327">18 T.C. 327, affd. 208 Fed. (2d) 43; C. A. Reis, 1 T.C. 9">1 T.C. 9. We first consider the year 1945. Our finding that a part of the deficiency for the year 1945 is due to fraud with intent to evade tax is clearly supported by the evidence. In his original return filed for the year 1945, the petitioner reported total income in the amount of $1,489.00. On June 14, 1950, after the investigation of petitioner's tax liability for the years involved was begun, he filed a return covering the period "beginning October 12, 1945, and ending January 1, 1946," disclosing income from "Ed Clark (deceased)" in the amount of $800.00 and from the partnership "Manhattan Grill" in the amount of $1,292.00, or a total income not previously reported of $2,092.42. The filing of the second return more than four years after the statutory date of filing did not relate back to the original return either as to time or as to its effect in correcting any original inadequacies in the original return. Ira Goldring, 20 T.C. 79">20 T.C. 79; George M. Still, Inc., 19 T.C. 1072">19 T.C. 1072, affd. 218 Fed. (2d) 639;220 Herbert Eck, 16 T.C. 511">16 T.C. 511, affd. 202 Fed. (2d) 750, certiorari denied 346 U.S. 822">346 U.S. 822. Petitioner has offered no evidence in explanation of the failure to include the income received from "Ed Clark" and the "Manhattan Grill" in his original return, and as it is inconceivable that he was not aware that this was taxable income, we hold that the failure to report such income in his original return was due to fraud with intent to evade tax and consequently that petitioners are liable for the addition to tax imposed by the provisions of section 293(b) of the Internal Revenue Code of 1939. This holding makes unnecessary any discussion, insofar as the question of fraud is concerned, of respondent's use of the net worth method in making his determination of the deficiency and addition to tax for the year 1945. We call attention, however, to what appears to be a mathematical error in respondent's computation of petitioner's taxable income for the year 1945. Under the heading "Assets", respondent listed petitioner's interest in the "Manhattan Grill" as of December 31, 1945 as amounting to $5,894.70, whereas one-half of $11,523.35 (the net worth of the Manhattan221 Grill on December 31, 1945) amounts to only $5,761.68. There is no evidence in the record from which we are able to reconcile the difference in these figures. At the hearing respondent's witness testified that the value of this interest was $5,761.68. Accordingly, in our findings set forth above, we have found that petitioner's interest in the partnership on December 31, 1945 was $5,761.68. This reduced petitioner's taxable net income for 1945 to $9,007.70 instead of $9,140.72. We assume respondent will make the necessary correction for this in his Rule 50 computation. The above finding of fraud likewise disposes of any question of limitation with respect to the deficiency and addition to tax for the year 1945. Section 276(a), Internal Revenue Code of 1939. We next consider the years 1946 and 1947. For the purpose of establishing fraud for these years, respondent relies upon gross understatement, wholly unexplained by petitioners, of the amount of income received from the Manhattan Grill. In the absence of adequate records maintained by the partnership or by petitioners, respondent computed the gross profits of the partnership on the basis of a percentage of gross sales mark-up. 222 The percentage used was 27 per cent, which respondent says was reasonable on the ground that it is the same percentage as that computed from the 1948 partnership return and is less than the percentage of mark-up known to have been realized by other concerns in the same type of business. Respondent also points to the minimum mark-up required by state law on liquor sold by case lots and less than case lots. Bearing in mind that we are here considering, not the correctness of the amount of the income tax deficiencies as to which the burden was on petitioners, but whether any part of the deficiencies determined for the years 1946 and 1947 was due to fraud with intent to evade tax, which the respondent has the burden of establishing by clear and convincing evidence, we are unable, after careful consideration of all the evidence, to say that respondent has carried that burden. Essential to respondent's case is the question of reasonableness of the 27 per cent markup. The fact that this is the same percentage as that computed on the 1948 business is not conclusive in the absence of more showing of similarity in the operations of the business during these three years. 1948 was the third223 year of partnership business and it is natural to presume that greater efficiency in business operations was attained in the third year than in the first or second year. Likewise it is noted, there was a shortage of alcoholic beverages in 1945 and 1946, and to a somewhat lesser extent in 1947, so that retailers were required by the suppliers to buy certain quantities of wine and other slower moving beverages in order to obtain the more readily merchandisable whiskies. This condition had practically disappeared by 1948. There is no showing as to the quantities of the less desirable beverages handled by the partnership in the years 1946 and 1947, or how they were disposed of. Nor do we think respondent has demonstrated the reasonableness of a 27 per cent mark-up on the basis of comparison with other businesses of a like nature, all but one of which were located in Louisville and other parts of Kentucky and no comparable features were shown. Cf. In re Max Sheinman, Bankrupt, 14 Fed. (2d) 323. As to the one establishment located in the same block in Middlesboro, Kentucky, as the Manhattan Grill, the evidence was insufficient on which to base a comparison. Respondent's witnesses224 did not know the size or price of drinks sold by the other establishment, whether either was licensed to sell liquor by the case lot or what were the percentages of beer, wine, and whiskey handled by each. Also, it appears that the 27 per cent mark-up was applied to total receipts notwithstanding respondent's agent was apparently furnished all the invoices of the partnership. Respondent's agent testified he had not attempted to check the total purchases from the invoices because of the number of them and the lack of sufficient time. The magnitude of the task is certainly no excuse for not examining available records which would have shown the total purchases by the partnership, as well as the quantities of beer (whether bottled or barrelled), wine, whiskey and other beverages handled. With such information, and by ascertaining the prices at which sold, it appears reasonable that respondent could more accurately have computed the gross profits of the partnership, assuming of course the accuracy of inventories reported on the returns. Considering all the facts and circumstances, respondent has failed to establish the partnership income for 1946 and 1947 with that degree of clarity225 and conviction as would justify us in finding that petitioner grossly understated his income for those years. Consequently we hold that respondent has failed to establish that any part of the deficiencies asserted for the years 1946 and 1947 is due to fraud with intent to evade tax and petitioners are not liable for the additions to tax asserted for those years under section 293 (b) of the Internal Revenue Code of 1939. For the same reasons stated above, we likewise hold that respondent has failed to prove that petitioners omitted from gross income an amount in excess of 25 per cent of the gross income reported for 1946, which would have invoked the limitation provisions of section 275(c) of the Internal Revenue Code of 1939. Accordingly the deficiency asserted by respondent for the taxable year 1946 is barred by the statute of limitations. In his determination of the deficiencies and additions to tax, respondent has included the name of Edith Williamson along with her then husband, Gaines Williamson. As no error in this respect was assigned in the petition and the question was not mentioned or discussed at the trial or on briefs, respondent's determination is presumed to be correct. 226 W. L. Kann, 18 T.C. 1032">18 T.C. 1032, affd. 210 Fed. (2d) 247, certiorari denied 347 U.S. 967">347 U.S. 967. Decision will be entered under Rule 50. Footnotes. Based on the deficiency (amounting to $1,936.44) determined before consideration of the additional return filed for 1945.↩. Adjusted gross income.↩1. SEC. 275. PERIOD OF LIMITATION UPON ASSESSMENT AND COLLECTION. Except as provided in section 276 - (a) General Rule. - The amount of income taxes imposed by this chapter shall be assessed within three years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period. * (c) Omission from Gross Income. - 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, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within 5 years after the return was filed. SEC. 276. SAME - EXCEPTIONS. (a) False Return or No Return. - In the case of a false or fraudulent return with intent to evade tax or of a failure to file a return the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time. (b) Waiver. - Where before the expiration of the time prescribed in section 275 for the assessment of the tax, both the Commissioner and the taxpayer have consented in writing to its assessment after such time, the tax may be assessed at any time prior to the expiration of the period agreed upon. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon. 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/4621260/	CARIL K. and SHIRLEY A. DRUMMOND, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentDrummond v. CommissionerDocket No. 4087-78.United States Tax CourtT.C. Memo 1980-416; 1980 Tax Ct. Memo LEXIS 173; 40 T.C.M. (CCH) 1336; T.C.M. (RIA) 80416; September 22, 1980, Filed 173 Petitioner was employed as an "electronic supervisor" in a medical center. Petitioner's responsibilities included maintaining the center's electronic equipment. The center also required petitioner to maintain a telephone in his residence. Held, petitioner's expenses of obtaining a junior college degree in business management are not deductible. Held further, petitioner is entitled to deduct a portion of his home telephone expense. Caril K. Drummond, pro se. Patrick E. McGinnis, for the respondent. IRWINMEMORANDUM FINDINGS OF FACT AND OPINION174 IRWIN, Judge: Respondent has determined a deficiency in petitioners' 1975 income tax of $567. Due to concessions made by both parties the issues left for our decision are (1) whether petitioners are entitled to a deduction under section 162 1 for educational expenses of petitioner-husband, and (2) whether petitioners are entitled to a deduction under section 162 for one-half of the cost of maintaining a telephone in their residence. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Petitioners Caril K. and Shirley A. Drummond, husband and wife, resided in Keota, Oklahoma, when they filed their petition herein. Petitioners timely filed their 1975 joint Federal income tax return. Because the issues for decision relate solely to Caril K. Drummond any references to "petitioner" hereinafter shall be to Caril K. Drummond. During 1975 petitioner was employed at the Sparks Regional Medical Center in Fort Smith, Arkansas as an "electronic supervisor." Petitioner175 was responsible for maintaining the approximately 4600 items of electronic equipment owned by the medical center and was in charge of thirteen of fifteen employees. Petitioner had some electronics training while in the armed services. Petitioner had graduated from his school but did not continue his education beyond that point. In July 1974 petitioner was admitted to Carl Albert Junior College (CAJC) in Poteau, Oklahoma. Petitioner enrolled at CAJC as a Business Management major. Sparks Regional Medical Center did not require petitioner to attend any classes nor was petitioner reimbursed by the medical center for his educational expenses. CAJC grants Associate of Art degrees after a successful course of study. During 1975 petitioner took the following courses at CAJC: Residential Wiring, Commercial Heating and Air Conditioning, Basic Electronics, Plumbing, American Indian History, Personnel Management, Principles of Business Math, Salesmanship, General Drafting, and Freshman Composition. On January 14, 1975, petitioner Shirley A. Drummond paid an enrollment fee of $95.00 to CAJC for the spring session of 1975. On June 13, 1975 petitioner paid an enrollment fee of $48.50176 to CAJC for the summer session of 1975. Petitioner's residence was approximately 32 miles from CAJC. CAJC was in session approximately 44 weeks during 1975 and petitioner attended classes four nights per week. Petitioner deducted $1536 for transportation expense, based on 160 round trips of 64 miles each at a rate of 15 cents per mile. 2 Petitioner also deducted $267.88 for books and tuition at CAJC. During 1975 Sparks Regional Medical Center required all key personnel, including petitioner, to maintain a home telephone. Petitioner's home telephone was used primarily for personal calls. Petitioner paid $6.22 per month service charge for the telephone. Petitioners deducted $37.32, one-half the annual service charge of $74.64, on their 1975 return. By letter dated March 23, 1978 respondent disallowed petitioner's deductions for books, tuition, mileage and home telephone expense. OPINION Respondent argues that petitioner is not entitled to177 deduct his costs of attending CAJC for two reasons: the courses were not proximately related to petitioner's present trade or business and the courses qualified petitioner for a new trade or business. Petitioner maintains that his education expenses are deductible because they maintained or improved skills required in his trade or business. Section 162(a) allows as a deduction all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Section 1.162-5, Income Tax Regs., sets forth specific rules for the deductibility of educational expenses under section 162. Under section 1.162-5(a), Income Tax Regs., educational costs are deductible if the education either maintains or improves skills required in the individual's trade or business or meets the express requirements of the individual's employer or of applicable law or regulations. 3 Expenditures which are required for an individual to meet the minimum educational requirements for qualification in his or her trade or business are not deductible, section 1.162-5(b)(2), Income Tax Regs., nor are expenditures for education which is part of a program of study which will lead178 to qualifying the individual in a new trade or business, section 1.162-5(b)(3), Income Tax Regs.Section 162 requires a nexus between the individual's trade or business and the deduction claimed. Kornhauser v. United States,276 U.S. 145">276 U.S. 145 (1928). Respondent's determination is presumed correct and petitioner bears the burden of showing otherwise, Rule 142(a), Tax Court Rules of Practice and Procedure.Whether the classes are related to petitioner's trade or business is a question of fact. Baker v. Commissioner,51 T.C. 243">51 T.C. 243 (1968). Petitioner did not introduce syllabi of the courses he attended at CAJC. From the course titles we can glean several courses which may have the necessary relationship to petitioner's employment as electronic supervisor: Commercial Heating and Air Conditioning, Basic Electronics, Personnel Management and General Drafting (petitioner testified that he was required to draw the electrical plans for a proposed expansion of the medical center). However, 179 in the absence of any other evidence that the expenses were related to petitioner's employment we must deny petitioner's educational expense deduction in full. Because of our holding we need not consider respondent's alternative argument. Petitioner contends that he is allowed to deduct 50 percent of the annual service charge for his telephone as a business expense. Petitioner bases this contention on the medical center's requirement that all "key employees" maintain a telephone so that they can be reached by the medical center at all times. Petitioner argues that he would not have kept a telephone in his home but for his employer's requirement. Respondent argues that the cost of the phone is a nondeductible personal expense under section 2624 and section 1.262-1(a)(3), Income Tax Regs.5 Respondent recognizes that the cost of maintaining a telephone may be deductible but argues that petitioner is not entitled to any deduction for his telephone because the phone was used predominantly for personal calls by petitioner and his family. 180 The cost of a home telephone may, under certain circumstances, be a deductible expense. Laurano v. Commissioner,69 T.C. 723">69 T.C. 723 (1978) (catering service employee); Roth v. Commissioner,17 T.C. 1450">17 T.C. 1450 (1952) (fireman kept telephone in home solely for the purpose of receiving calls for the performance of service by him). If the acquisition and maintenance of petitioner's telephone related primarily to personal reasons then the entire cost of the telephone is nondeductible under section 262. International Artists, Ltd. v. Commissioner,55 T.C. 94">55 T.C. 94, 104 (1970). When substantial business and personal motives exist an allocation of the expense is necessary. International Artists, Ltd. v. Commissioner,supra,55 T.C. at 105. Petitioner testified that but for the requirement of his employer he would not have had a home telephone. Although by petitioner's admission the great majority of the telephone's use was for personal reasons, we have no reason to doubt petitioner's testimony. Because petitioner's home telephone was used for business and personal reasons we must allocate petitioner's cost between deductible business181 use and nondeductible personal use. Because petitioner's phone was kept to receive calls from the medical center, none of petitioner's outgoing calls were business related and only a portion of petitioner's incoming calls could have been business related. Therefore, petitioner is entitled to deduct $10.69 (15 percent of the annual $74.64 service charge) for the cost of his home telephone. Cohan v. Commissioner,39 F.2d 540">39 F.2d 540 (2d. Cir. 1930). Decision will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the year in issue.↩2. Petitioner used 40 weeks rather than 44 weeks in order not to "get away with anything." Respondent challenges petitioner's right to any deduction for travel to and from CAJC but does not challenge petitioner's calculations.↩3. Transportation expenses pursuant to deductible educational expenses are also deductible. See Carlucci v. Commissioner,37 T.C. 695">37 T.C. 695, 702↩ (1962).4. section 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. ↩5. § 1.262-1. Personal, living, and family expenses. (a) In general. In computing taxable income, no deduction shall be allowed, except as otherwise expressly provided in chapter 1 of the Code, for personal, living, and family expenses. (3) Expenses of maintaining a household, including amounts paid for rent, water, utilities, domestic service, and the like, are not deductible. * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621261/	Oklahoma Paper Company v. Commissioner.Oklahoma Paper Co. v. CommissionerDocket No. 100979.United States Tax Court1942 Tax Ct. Memo LEXIS 85; 1 T.C.M. (CCH) 97; T.C.M. (RIA) 42600; November 19, 194285 A. E. Hill, Esq., Commerce Exchange Bldg., Oklahoma City, Okla., and Edward Spiers, Esq., Colcord Bldg., Oklahoma City, Okla., for petitioner. Stanley B. Anderson, Esq., for the respondent. SMITH Memorandum Opinion SMITH, J.: This proceeding is for the redetermination of deficiencies in income tax for 1936 and 1937 of $1,002.46 and $816.74, respectively. The petition alleges that the respondent erred in the determination of the deficiencies by failing to allow it credits under section 26 (c) of the Revenue Act of 1936 equal to its entire undistributed net income for those years on account of a contract outstanding which restricted or prevented the payment of dividends. In the determination of the deficiencies the respondent found that the petitioner had a liability to surtax on undistributed income of $1,011.30 for 1936 and $816.74 for 1937. [The Facts] The petitioner is an Oklahoma corporation with its principal place of business at Oklahoma City. It filed its income tax returns for the taxable years with the collector of internal revenue for the district of Oklahoma. In 1933 the principal stockholders of the petitioner desired to retire from business on account of age and86 ill health. They proposed selling the business to valued employees of the corporation together with an interest of slightly in excess of 25 percent to a paper company with its principal place of business in St. Louis. The purchase price was to be the book value of the assets. Only a small part of the purchase price was required to be paid in cash. The balance was to be paid over a period of 10 years with interest at seven percent per annum. It was expected that these deferred payments would be made out of the profits of the company. The vendors had great faith in the purchasers and some of the terms of the agreement between J. W. Mack, representing the purchasers, and Harry Herman, representing the vendors, were not incorporated in the written contract. The contract was dated July 3, 1933. Under the provisions of this contract the Oklahoma Paper Co. was to execute a note payable to each vendor evidencing his portion of the unpaid purchase price with interest at seven percent per annum. There was an oral understanding between the representative of the purchasers and the representative of the vendors that no salaries should be paid the president or other officers of the corporation87 and that no cash dividends should be paid upon the stock until the outstanding notes were paid in full. This understanding was not incorporated in the written contract. But pursuant to the understanding no cash dividends were paid upon petitioner's common stock until the notes were paid in full. At a meeting of the petitioner's board of directors held on September 19, 1934, the following resolution was adopted: WHEREAS the Board of Directors of this Company entered into a contract with Harry Herman, J. W. Mack, Ruth Mack, Carrie Jacobi and Sam Herman for the purchase of stocks, accounts and bonds, on the 1st day of July, 1933, by the terms of said contract it was agreed that there would be no cash dividends issued by this Company until all of the indebtedness evidenced by the notes executed and delivered to the said Harry Herman, J. W. Mack, Carrie Jacobi and Sam Herman, Ruth Mack should have been paid; and WHEREAS said notes are long term notes: NOW, THEREFORE, BE IT RESOLVED that in order to carry out said agreement, that this Company agree, and it hereby does agree, that no cash dividends will be issued by this Company until said notes so executed shall have been paid in full88 or shall have been otherwise satisfied. Subsequent to the date of the written contract, July 3, 1933, it was determined that a few thousand dollars of the accounts receivable of the petitioner were worthless. The vendors agreed to scale down their notes to take care of such worthless accounts. Also, the vendors, a few months or years after the contract was entered into, agreed to reduce the interest on the notes from seven percent to six percent per annum. In 1933 or 1934 the petitioner acquired the assets of the Pioneer Paper Box Co. issuing therefor $12,000 par value of preferred stock, the petitioner's charter having been amended to authorize such issue. Dividends were paid upon this stock from the date of issuance in 1934 through 1937, inclusive. In accordance with the understanding of the vendors and the vendees referred to above no salaries were ever paid to the officers of the corporation and no cash dividends were paid upon its common stock until after the unsecured notes of the petitioner were fully paid off in August, 1941. [Opinion] In this proceeding the petitioner claims that no dividends could be paid upon its common stock during the taxable years by reason89 of the understanding which existed between the vendors and vendees under the contract of July 3, 1933. It admits that the written contract contains no provision prohibiting it from the payment of dividends. But it says that there was a verbal agreement not to pay dividends upon its common stock; that the resolution of the petitioner's board of directors on September 19, 1934, simply makes this agreement of record; and that the contract read in connection with the minutes of the meeting of the board of directors meets the requirement of section 26(c) of the Revenue Act of 1936, which provides that corporations shall be entitled to a credit of the amount of their adjusted net income which they are prohibited from paying out in dividends. Section 26 (c) (1) provides for a credit: * * equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without-violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. * * * Subsection (2) of the same section provides for a credit "equal to the portion of the earnings90 and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt." The petitioner admits that the contract executed on July 3, 1933, does not prohibit it from paying a dividend. It made its present contention before this court principally upon the authority of ; ; and . These decisions by the Circuit Court of Appeals for the Sixth Circuit were reversed by the Supreme Court, . Upon the authority thereof, and also of , the determination of deficiencies91 by the respondent is approved. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621263/	Romolo Mazzocone v. Commissioner.Mazzocone v. CommissionerDocket No. 13455.United States Tax Court1948 Tax Ct. Memo LEXIS 184; 7 T.C.M. (CCH) 298; T.C.M. (RIA) 48084; May 20, 1948184 Rames J. Bucci, Esq., 1943 E. Passyunk Ave., Philadelphia, Pa., for the petitioner. William H. Best, Jr., Esq., for the respondent. LEECHMemorandum Findings of Fact and Opinion LEECH, Judge: Respondent has determined deficiencies in income tax for the taxable years 1943, 1944 and 1945 in the respective amounts of $2,455.61, $1,905 and $1,903. The question presented is one of fact, to wit: the income realized by the petitioner during each of the taxable years 1942 to 1945, inclusive. It is necessary to determine income for 1942 by reason of the provisions of the Current Tax Payment Act. Findings of Fact The petitioner is an individual who resided during the taxable years 1942 to 1945, inclusive, at 2215 South 11th Street, Philadelphia, Pennsylvania. He filed individual income tax returns for those taxable years with the collector of internal revenue for the first district of Pennsylvania. The petitioner is of Italian ancestry and emigrated to the United States in 1922, becoming a naturalized citizen of this country in 1930 or 1931. In the year 1927, the petitioner established a baking business at 2215 South 11th Street, Philadelphia. He bought these premises185 at a cost of $10,000 and sold them in December 1946 for $15,000. The consideration on this sale was paid to the petitioner, $8,000 in cash, which was deposited in the Central-Penn National Bank, Philadelphia, and the remainder of the purchase price was represented by a mortgage in the sum of $7,000. Petitioner kept no records or books of any kind to indicate the amount of income he realized from his baking business. He filed returns for the taxable years 1941 to 1945, inclusive, reporting income from no source other than his baking business. For each of the years, the amount of net income and the resulting tax, as reported, was as follows: YearNet IncomeYear1941$ 309.70$ 01942410.70019431,449.6023.9419441,580.603.0019451,670.6030.00The petitioner resided at his place of business. His family consisted of himself, his wife and daughter and his wife's parents, all of these individuals being dependent upon him. In February 1947, the office of the collector of internal revenue at Philadelphia, as the result of an "informer's letter" purporting to give information as to income realized by petitioner, assigned two deputy collectors, 186 Norman Neff and Nicholas A. Lacovara, to investigate the case. These deputy collectors, on February 7, 1947, called on the petitioner at 2215 South 11th Street, Philadelphia, and questioned petitioner with respect to his income received during the years 1942 to 1945, inclusive. They had already ascertained the fact that petitioner had a safe deposit box in the Roosevelt Bank in Philadelphia. Finding that petitioner kept no records of any kind to reflect his income, these deputy collectors proceeded to question petitioner in an effort to determine his net worth as of December 31, 1941 and December 31, 1945. The petitioner is not a man of education and does not speak finished English but understands the ordinary conversation in English with respect to everyday matters. One of the deputy collectors, Mr. Lacovara, was of Italian descent and spoke sufficient Italian to make himself understood in that language and to understand ordinary Italian conversation. In answer to the inquiries by Neff and Lacovara, petitioner advised them that on December 31, 1941 he possessed cash in his safe deposit box in the sum of $2,400, a truck worth $800 and real estate which had cost him $10,000, or187 a total of $13,200. He further advised that the real estate was encumbered at that time with a mortgage for $3,800, leaving him a net worth on that date of $9,400. As of the date, December 31, 1945, he advised them that he had a net worth represented by $15,000 in his safe deposit box in the Roosevelt Bank, savings in cash at his home of $9,000, additional $3,000 in cash at home which he had realized from playing the "numbers", a truck worth $800 and the real estate constituting his place of business, which he had purchased for $10,000 and which as of that date had no encumbrance. He further advised that he had no liabilities. These items totaled $37,800 in net worth as of this latter date. The several assets and liabilities, as detailed above, were entered by the deputy collectors upon a "Statement of Financial Condition". This statement was then explained to the petitioner and was signed and sworn to by him. Petitioner's gross income for each of the four years in question was then determined upon a net worth basis by taking the total increase in assets over this term and increasing it by the amount of $2,000 each year, estimated as the minimum amount of the cost to petitioner188 in the support of his family. The resulting figure was pro rated equally over the four years, giving rise to the deficiencies here in issue. Opinion The evidence adduced on the hearing is directed almost wholly to an attempt to impeach the accuracy of the computation made by the two deputy collectors and their report of the information given them by the petitioner. We have no evidence establishing affirmatively a specific amount of income for any one of the four years. Petitioner admits that he did have $3,000 winnings on the "numbers" and this was not included in his return. He also admits that he loaned $9,000 in cash to a friend in 1945, this being repaid to him in August 1946. This was before the sale of his real estate and so none of this money represents the proceeds of that sale. He does not dispute the correctness of the items entered on the "Statement of Financial Condition" making up his net worth as of December 31, 1941. The main item of dispute appears to be the correctness of the item of $15,000, reported as in his safe deposit box on December 31, 1945. Petitioner says that he did not have this amount in the box on that date. The evidence to support this statement189 is his own testimony that on the day following the visit to him by the revenue agents, which was more than a year subsequent to December 31, 1945, he went to his safe deposit box and only found $700 in cash. This testimony does not, in fact, contradict his statement to the agents that there was $15,000 in cash in the deposit box at the close of 1945. In fact, it can be given little, if any, weight in view of the testimony of the petitioner that he does not know and can not say how much money was in the safe deposit box on that date. As to the $2,000 estimate made as the cost to petitioner of the support of his family in each of the five years, petitioner produces no proof of the actual cost. His testimony is that he did not know what it cost him. In the absence of books and records to determine income such determination may be made upon an increase in net worth basis. Pottash Brothers, 12 B.T.A. 190">12 B.T.A. 190; affd., 50 Fed. (2d) 317 and 50 Fed. (2d) 321; O'Dwyer v. Commissioner, 110 Fed. (2d) 925. That is the situation here and upon this basis the respondent has determined the contested deficiencies. The burden is upon the petitioner*190 to show error in that determination and the proof falls far short of that sufficient to determine it to be erroneous. Petitioner's own testimony establishes affirmatively that over the period here in question he has received substantial income in addition to that reported by him. His testimony that, aside from his winning of $3,000 on the "numbers", he had an income of from $40 to $50 a week from the operation of his bakery is manifestly untrue. Such an income would barely suffice to maintain his family. It would be impossible for him with this income, in our opinion, to accumulate sufficient to pay off during that period a mortgage of $3,800 and still leave accumulations, which he admits, sufficient to permit him to lend $9,000 in cash to a friend. On this record the conclusion is unavoidable that petitioner has failed utterly to overturn the correctness of the determination as made by the respondent. We so hold. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621265/	GEORGE VERCHICK, JR., and DENISE VERCHICK, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent GEORGE VERCHICK, JR., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentVerchick v. CommissionerDocket Nos. 3702-73, 3703-73.United States Tax CourtT.C. Memo 1976-126; 1976 Tax Ct. Memo LEXIS 276; 35 T.C.M. (CCH) 567; T.C.M. (RIA) 760126; April 22, 1976, Filed George Verchick, Jr., pro se. Guy G. La Vignera, for the respondent. FAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: In these consolidated cases respondent has determined the following deficiencies in and additions to Federal income tax: Additions to Tax§ 6651 (a)§ 6653(a)PetitionerYearDeficiency1 IRC 1954IRC 1954George, Jr., andDenise Verchick1969$ 1,809.99$ 90.50$ 161.24George Verchick, Jr.19701,090.04172.5154.50277 We must decide (1) if in reporting income for 1969 petitioners employed the cash receipts and disbursements or accrual method of accounting; (2) if for other than reasonable cause, income tax returns for the years in issue were not filed within the time prescribed by law; and (3) if any deficiency in Federal income tax for the years in issue was attributable in part to negligence or intentional disregard of rules and regulations. FINDINGS OF FACT The facts that have been stipulated are so found. On May 28, 1970, petitioners, husband and wife, filed a joint Federal income tax return for 1969 with the District Director of Internal Revenue, New York, New York. On February 22, 1973, a statutory notice of deficiency for 1969 was mailed to petitioners by respondent. On that same date respondent mailed to petitioner George Verchick, Jr. (George) a statutory notice of deficiency for 1970. On May 21, 1973, George filed an individual income tax return for 1970 with the District Director of Internal Revenue, New York, New York. Petitioners were residents of New York278 when the petitions in these cases were filed with this Court. At all times relevant, George worked as an independent photographer's representative in New York City. He would procure the services of photographers for customers who might request them, and make the arrangements necessary for the photographs to be taken. From the operation of his business, George received a total of $ 16,389.37 in 1969. On the return which petitioners filed for that year gross receipts of $ 12,606 were reported. The return which petitioners filed for 1969 plainly indicated that they were employing the cash receipts and disbursements method of accounting to report their income. Attached to the return filed for 1969 was an application for an extension of time to file a return, dated April 15, 1970, and signed by a certified public accountant duly qualified to practice in New York. The application states that petitioners needed additional time to file their return because necessary information had yet to be obtained. Attached to the return filed for 1970 was a letter dated May 15, 1973, and signed by George. The letter explained that his failure to file his return within the time prescribed279 by law was attributable to "reasonable cause" but failed to explain what that reasonable cause might have been. OPINION During 1969 George received $ 16,389.37 from the operation of his business. He reported only $ 12,606 on the return which he and his wife filed for that year. Respondent determined that the excess of the former figure over the latter ought to have been reported as income as well. In support of this determination he asserts that petitioners were on the cash receipts and disbursments method of accounting. The return which petitioners filed for 1969 indicates this to have been so. Petitioners contend that under the accrual method of accounting they had reported the amount in issue in a prior year. It is their burden to prove this. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). The only evidence relevant to this issue introduced into the record by petitioners is the testimony of George. In the course of our best efforts to understand the often incoherent testimony of this witness, we have found nothing to substantiate the contention that petitioners ever reported income prior to having received it under the accrual method of accounting. This280 being the case we have no alternative but to hold that petitioners ought to have reported additional income of $ 3,783.37 for 1969. A return made on the basis of the calendar year must be filed on or before the 15th day of April following the close of the calendar year. Section 6072, Internal Revenue Code of 1954, as amended. Respondent is authorized to grant reasonable extensions of the time in which returns may be filed. Section 6081. An application for such an extension must, however, be made on or before the date on which the return is due. Section 1.6081-1(b)(1), Income Tax Regs.The taxable years in controversy are the calendar years 1969 and 1970. For neither of those years was a return filed on or before April 15th of the following year. An application for an extension of time to file a return, dated April 15, 1970, was submitted for 1969. It was, however, submitted with the return subsequent to the aforesaid date and was therefore ineffective. Section 1.6081-1(b)(1), supra. No application for an extension of time to file was made with respect to 1970. For neither of the years in issue, therefore, was a timely return filed. Section281 6651(a)(1) provides for an addition to tax in the event of a failure to file a timely return, unless it is shown that such a failure is due to reasonable cause and not due to willful neglect. Respondent determined such an addition for each of the years in issue. Although there was attached to each return a document which either asserts or can be read to assert a reasonable cause for tardiness, nothing in the record substantiates these assertions. 2We therefore hold that for each of the years in issue, respondent properly determined an addition to tax under section 6651(a)(1). Section 6653(a) provides that if an underpayment of tax is due in part to negligence or intentional disregard of rules or regulations, there shall be added to the tax owing an amount equal to 5 percent of the underpayment. Respondent determined that for each of282 the years in issue, an addition to tax is owing under section 6653(a). No evidence to the contrary has been introduced. The determination has therefore to be sustained. James S. Reily,53 T.C. 8">53 T.C. 8 (1969). Due to concessions, Decisions will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended.↩2. We note in this connection, for example, George's testimony that petitioners' records were destroyed in a flood in their basement. This flood apparently took place late in 1971 or early in 1972, long after returns ought to have been filed for the years in issue. The flood is therefore no excuse for the delay in filing the returns.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621266/	Estate of Henry A. Rosenberg, Deceased, Ruth B. Rosenberg, Administratrix c.t.a. and Ruth B. Rosenberg, et al., 1 Petitioners, v. Commissioner of Internal Revenue, RespondentRosenberg v. CommissionerDocket Nos. 75781-75783United States Tax Court36 T.C. 716; 1961 U.S. Tax Ct. LEXIS 107; July 27, 1961, Filed 107 Decisions will be entered for the respondent. Petitioners, shareholders in a closely held family corporation, received as a result of a recapitalization class B first preferred shares, second preferred shares, and new common shares in exchange for their old common shares, the only class of stock formerly outstanding. The class B first preferred was convertible on a share-for-share basis into class A first preferred which contained a mandatory redemption provision. Immediately following the recapitalization, petitioners commenced negotiations to sell the class B first preferred shares to large corporate investors. The shares were subsequently sold to such investors but only after the corporation had amended its charter to include certain protective provisions demanded by the purchasers. On the day of the sale the corporate investors converted the class B first preferred into class A first preferred. Held, that in substance the sale was made directly from the corporation to the investors. Held, further, that the amounts received by petitioners from the corporate investors were essentially equivalent to a dividend constituting ordinary taxable income. Carolyn E. Agger, Esq., John S. McDaniel, Jr., Esq., John W. Cable III, Esq., Julius M. Greisman, Esq., and Louis Eisenstein, Esq., for the petitioners.George J. Rabil, Esq., for the respondent. Tietjens, Judge. Fisher, J., did not participate in the consideration and disposition of this case. TIETJENS716 The Commissioner determined deficiencies in income tax for 1952 as follows:PetitionersDocket No.DeficiencyEstate of Henry A. Rosenberg and Ruth B. Rosenberg75781$ 386,481.88Estate of Fanny B. Thalheimer and Alvin Thalheimer75782387,208.92Jacob Blaustein and Hilda K. Blaustein75783371,305.93109 The sole issue presented is whether under the circumstances here present, the proceeds realized from the sale of preferred stock in 1952 resulted in capital gain or ordinary income.FINDINGS OF FACT.Some of the facts have been stipulated and are incorporated herein by reference.Henry A. Rosenberg and Ruth B. Rosenberg, Alvin Thalheimer and Fanny B. Thalheimer, and Jacob Blaustein and Hilda K. Blaustein were, respectively, husband and wife in the year 1952 and each couple 717 filed a joint income tax return for that year with the director of internal revenue at Baltimore, Maryland. Henry A. Rosenberg died on February 23, 1955, and Ruth B. Rosenberg was appointed administratrix c.t.a. of his estate on March 29, 1955. Fanny B. Thalheimer died on May 28, 1957. Alvin Thalheimer, Herbert Thalheimer, Jacob Blaustein, and Ruth B. Rosenberg were appointed executors of her estate on June 21, 1957. Ruth B. Rosenberg, Fanny B. Thalheimer, and Jacob Blaustein were sisters and brother and are sometimes hereinafter referred to as petitioners.American Trading and Production Corporation, hereinafter designated as Atapco, is a corporation organized in 1931 under the laws of the State of110 Maryland. In 1951 and 1952 Atapco was engaged in the oil industry. Its interests included the marine transportation of petroleum products and the acquisition, exploration, and development of crude oil and gas properties. Also, Atapco and the Blaustein family together owned between 25 and 30 percent of the stock of Pan American Petroleum and Transport Company, the majority of which was owned by Standard Oil of Indiana. In addition, Atapco had stockholdings in the Crown Central Petroleum Corporation.On December 26, 1951, the authorized stock of Atapco consisted of 30,000 shares of no-par common stock of which 22,000 were outstanding. These shares were held as follows:StockholdersSharesJacob Blaustein, trustee5,500Henrietta Blaustein1,600Jacob Blaustein3,597Fanny B. Thalheimer3,917Ruth B. Rosenberg3,917In treasury3,46922,000The 5,500 shares held by Jacob Blaustein, as trustee, were in trust for the benefit of his wife and their three children. Henrietta Blaustein is the mother of petitioners.In 1951 Karl F. Steinmann, counsel for Atapco and the Blaustein family, contacted a broker in Baltimore with reference to doing some financing for Atapco. 111 The broker referred him to the First Boston Corporation. In the late spring of 1951, Steinmann and John W. Cable who also represented Atapco and the Blausteins met with Charles Glavin, a vice president of First Boston, to discuss the financial arrangements of Atapco and its stockholders. Steinmann at that time was contemplating making a recommendation that a public market be created in the common stock of Atapco. Glavin pointed out the problems involved with making an offering of that type, such as the registration with the Securities and Exchange Commission which 718 would include a complete disclosure, the cost and expense, as well as the substantial sacrifice in values that generally accompanies an initial offering by a company unknown to the public. The idea of creating a public market was subsequently abandoned.Steinmann, thereafter, disclosed to Glavin that petitioners were considering replacing the outstanding common stock of Atapco with several classes of stock. Glavin was asked to advise them on the terms of a first preferred stock which would be salable by the holders thereof. The objective was to create a good-quality preferred stock which would be accepted112 by institutional investors. Atapco did not need additional outside capital in 1951 as it had sufficient earnings and capital on hand.With respect to the contemplated preferred stock, Glavin recommended an adequate sinking fund or mandatory retirement provision, limitations on the amount of preferred stock and funded indebtedness of the corporation, limitations on the dividends of junior stocks, restrictions on the sale of the Pan American and Crown Central shares held by Atapco, and certain other terms which are normally contained in a good-quality preferred stock. Jacob Blaustein objected to the proposed limitations relating to the funded indebtedness and the disposition of the Pan American and Crown Central shares. He was of the opinion that these two limitations were not important as Atapco had no intention of selling either the Pan American or Crown Central shares and there was no need for such a debt limitation. Although Glavin thought the proposed preferred stock would be salable, he felt that the inclusion of the two limitations would make the issue more attractive.On December 26, 1951, the directors and stockholders of Atapco approved amendments to its charter providing113 for an authorized capital of 300,000 shares of class A first preferred stock with a $ 10 par value, 300,000 shares of class B first preferred stock with a $ 10 par value, 1 million shares of second preferred stock with a $ 10 par value, and 200,000 shares of common stock without par value. The amendments also provided for the exchange of 16 shares of class B first preferred stock, 32 shares of second preferred stock, and 10 shares of the new common stock for each share of common stock outstanding. On December 27, 1951, the articles of amendment were filed with and approved by the State Tax Commission.The directors of Atapco approved the new stock certificates and authorized the issuance of the new shares pursuant to the articles of amendment on December 27, 1951, and the new shares were duly issued to the stockholders.On December 27, 1951, immediately after the change in capital structure, the stockholders of Atapco and their respective holdings were as follows: 719 StockholdersClass B firstSecondCommonpreferredpreferredJacob Blaustein, trustee88,000176,00055,000Henrietta Blaustein25,60051,20016,000Jacob Blaustein57,552115,10435,970Fanny B. Thalheimer62,672125,34439,170Ruth B. Rosenberg62,672125,34439,170296,496592,992185,310114 The holders of class B first preferred shares were entitled to cumulative dividends at the rate of 5 percent, payable quarterly. The shares were redeemable in whole or in part, at the option of the corporation, for a sum equal to all unpaid dividends accumulated to date plus $ 10.30 per share if redeemed on or before January 1, 1955; $ 10.20 per share if redeemed on or before January 1, 1958; $ 10.10 per share if redeemed on or before January 1, 1961; and $ 10 per share if redeemed later. On default in the payment of four consecutive quarterly dividends, the holders of the first preferred shares were entitled to elect one-third of the board of directors. As long as any of these shares were outstanding, the corporation required the consent of holders of two-thirds of the shares in order to permit the aggregate of the issued first preferred stock to exceed 300,000 shares; to authorize or issue any class of stock on a parity with or having priority over the first preferred stock; to pay dividends or make distributions in redemption with respect to any subordinate stock while there were unpaid accumulated dividends on the first preferred stock; or to pay any dividends or make any distributions115 in redemption if the aggregate of all dividends and distributions authorized from December 30, 1950, to the date of the proposed dividend or distribution exceeded the earned surplus arising during that period. Any holder of class B first preferred shares could convert them into class A first preferred shares on a share-for-share basis. The terms of the class A stock were similar to those of the class B stock, except that each year the corporation was obligated to redeem 7 percent of the aggregate number of issued class A shares at par value plus all accumulated unpaid dividends. In the event of a default in discharging this obligation, the corporation was prohibited from paying dividends or making distributions in redemption with respect to any subordinate stock. The holders of the second preferred stock were entitled to cumulative dividends at the rate of 6 percent, payable semiannually. They could not vote under any circumstances except as otherwise provided by law. The second preferred shares were redeemable at the option of the corporation at par plus all unpaid dividends accrued to the date of redemption.Although petitioners made no effort prior to the recapitalization116 on December 27, 1951, to sell the class B first preferred shares, Glavin was advised by Steinmann on December 28, 1951, the day following the recapitalization, that members of the Blaustein family wished to sell 720 part of the shares issued, and he was asked to take charge of the offering. In a letter dated December 28, 1951, from Steinmann to Glavin, Steinmann stated:Our clients proposed to convert not less than a million and a half and probably up to two million dollars of Second Preferred stock and First Preferred stock, and would like you to handle the sale of not less than a million and a half and up to two million dollars of First Preferred stock.This is a formal authorization to offer this stock at par plus accumulated dividends. You are to receive compensation in the event of the sale equivalent to 1 1/2% of the amount of the sale. * * In a letter under date of January 2, 1952, Glavin replied:I believe two things are necessary before we make a positive step. First, I would like to know when you will decide how much you are going to sell. You speak of not less than $ 1,500,000 nor more than $ 2,000,000. It might not be good sales approach to talk to people117 on a variable amount, as it might give the atmosphere of uncertainty about our ability to sell it.The other thing I should have is a basic memorandum describing American Trading, so that we will have all of the basic facts about the Company and its operations. Either as a part of such a memorandum, or to be used with it, should be some up-to-date financial statements as well as a ten-year record of earnings in reasonable detail. You have talked about preparing such a memorandum in your office and I would be delighted to have you do so if you are still so inclined. The other alternative would be for us to take a crack at a presentation memorandum and send it down to you for filling in the blanks and correcting the errors. I am perfectly clear that we should have all this information in presentable form before calling on a prospective buyer rather than going in half prepared and then trying to get answers to questions raised. * * The presentation memorandum discussed by Glavin in the foregoing letter was particularly necessary before offering the class B first preferred shares because Atapco was an unusual company and investors were not familiar with its management. From January118 to April 1952 Glavin and two of his associates at First Boston, together with Steinmann, worked on a presentation memorandum to be used in approaching possible purchasers of the class B first preferred shares. The memorandum was completed in early April.First Boston began to offer the petitioners' shares after the presentation memorandum was completed. None of the shares of Henrietta Blaustein or Jacob Blaustein, trustee, which shares comprised 38 percent of the class B first preferred, was offered for sale. All potential buyers were to be approved by Jacob Blaustein before they could be approached by First Boston. Atapco was engaged in litigation with the Standard Oil Company of Indiana and Blaustein did not want the shares to get into the hands of the latter corporation directly or indirectly. First Boston confined its sales efforts to a limited number of prospects because a wider solicitation might have constituted a public offering requiring registration under the Securities Act.On October 17, 1952, petitioners entered into contracts with Massachusetts Mutual Life Insurance Company, Phoenix Mutual Life 721 Insurance Company, the Lincoln National Life Insurance Company, 119 Central Life Assurance Company, the Stein Roe & Farnham Fund Incorporated, and Milius Shoe Company, hereinafter sometimes referred to as the purchasers. Under these contracts petitioners agreed to sell and deliver and the purchaser agreed to buy and pay for an aggregate of 180,000 shares of Atapco class B first preferred stock at a price of $ 10 per share plus accrued dividends from September 1, 1952. Also on October 17, 1952, petitioners executed an indemnity agreement under which each of the petitioners agreed and undertook to indemnify and hold the purchasers harmless from any liability for or on account of any tax penalty or interest assessed or claimed against the purchasers or their assignees in respect of the issue of class A first preferred stock of Atapco upon conversion of shares of class B first preferred.On October 17, 1952, the class B first preferred shares were held as follows:Class Bfirst preferredJacob Blaustein, trustee88,000Henrietta Blaustein25,600Jacob Blaustein57,552Fanny B. Thalheimer62,672Ruth B. Rosenberg62,672On October 23, 1952, petitioners delivered to the purchasers 180,000 shares of class B first preferred stock under120 the terms of the contracts and they received from each purchaser the following amounts:Number ofGross amountName of companysharesreceivedtransferredRUTH B. ROSENBERGMassachusetts Mutual Life Insurance Company17,118$ 172,416.30Phoenix Mutual Life Insurance Company17,118172,416.30The Lincoln National Life Insurance Company17,118172,416.30Central Life Assurance Company5,13551,720.86The Stein Roe & Farnham Fund Incorporated3,42434,487.29Milius Shoe Company1,71217,243.6461,625620,700.69FANNY B. THALHEIMERMassachusetts Mutual Life Insurance Company17,118$ 172,416.30Phoenix Mutual Life Insurance Company17,118172,416.30The Lincoln National Life Insurance Company17,118172,416.30Central Life Assurance Company5,13551,720.86The Stein Roe & Farnham Fund Incorporated3,42434,487.29Milius Shoe Company1,71217,243.6461,625620,700.69JACOB BLAUSTEINMassachusetts Mutual Life Insurance Company15,764$ 158,778.51Phoenix Mutual Life Insurance Company15,764158,778.51The Lincoln National Life Insurance Company15,764158,778.51Central Life Assurance Company4,73047,641.61The Stein Roe & Farnham Fund Incorporated3,15231,747.64Milius Shoe Company1,57615,873.8256,750571,598.60121 722 Atapco's charter was amended on October 17, 1952, to include additional protective provisions relating to the class A first preferred stock. The amendments required Atapco to obtain the consent of holders of two-thirds of the outstanding shares of that stock before incurring a funded debt which, together with the par value of the outstanding class A and class B first preferred stock, exceeded $ 10 million, and before selling or otherwise disposing of more than 10 percent of its shares in Pan American or Crown Central. At the time of the offering, insurance companies were generally uninterested in issues of preferred stock and were largely investing in bonds. The changes in the charter were recommended by Glavin in order to make the first preferred a more attractive investment. Glavin had previously been informed by Massachusetts Mutual and Lincoln National that they desired such protective provisions. Glavin felt it better to satisfy this group of highly desirable investors than enter into any extensive solicitation that might be deemed a public offering under the Securities Act.The purchasers of the 180,000 class B first preferred shares exercised their option to 122 convert them into class A first preferred shares on October 23, 1952, which was the same day that petitioners delivered the 180,000 shares of class B first preferred stock to the purchasers.The petitioners paid $ 27,000 to First Boston as compensation for its services on their behalf in placing the 180,000 shares of class B first preferred stock. Of the $ 27,000 Jacob Blaustein paid $ 8,510.40, and Ruth B. Rosenberg and Fanny B. Thalheimer each paid $ 9,244.80. The petitioners also paid $ 7,751.11 for legal services and related disbursements in connection with the sales. Of the $ 7,751.11 Jacob Blaustein paid $ 2,443.15, and Ruth B. Rosenberg and Fanny B. Thalheimer each paid $ 2,653.98. The respondent has treated those payments as amounts deductible by the petitioners.The earned surplus of Atapco appears on its corporate income tax return as $ 1,086,294.34 at the end of 1950. During 1950, $ 4,406,681.29 was "transferred to capital stock." In 1951 the amount at the end of the period was $ 686,791.25 which was the remainder following a reduction of earned surplus of $ 2,163,005 for "recapitalization." The earned surplus at the end of 1952 was not less than $ 2 million.In 1951123 Atapco was aware that the Commissioner was examining its records with respect to the possibility of a surtax under section 102, I.R.C. 1939, for 1948. However, a conferee recommended that no deficiency be asserted for 1948. Subsequently a deficiency was asserted under section 102 for the years 1951, 1952, and 1953. The case is pending before this Court, American Trading and Production Corporation, Docket No. 76554.Between the years 1952 and 1958 Atapco's business continued to expand, two additional tankers were acquired and a third renovated. 723 In 1958 Jacob Blaustein and other executives of Atapco consulted Glavin with reference to methods of refinancing its outstanding obligations. It was finally decided to issue long-term notes which would be privately placed through First Boston. The amount of the proposed issue required Atapco to obtain the prior consent of the holders of the class A first preferred shares. It was Glavin's recommendation that the class A first preferred shares be redeemed. On December 2, 1958, 41,800 shares of class A first preferred stock were outstanding, Atapco having redeemed each year, in accordance with the provisions of its charter, 7 124 percent of the 180,000 class A first preferred shares originally outstanding. The remaining shares were redeemed on December 30, 1958.On February 10, 1959, First Boston, as agent for Atapco, sold $ 7,500,000 of 5 1/4-percent sinking fund notes due December 1, 1973. Two-thirds of the notes were bought by five holders of the class A first preferred stock. These were Massachusetts Mutual Life Insurance Company, Phoenix Mutual Life Insurance Company, the Lincoln National Life Insurance Company, Central Life Assurance Company, and the Stein Roe & Farnham Fund Incorporated. Several other insurance companies also acquired portions of the notes because of the favorable response by the large institutions which had previously invested in the class A first preferred stock.The petitioners' holding period for the class B first preferred shares sold by them on October 23, 1952, pursuant to the contracts of October 17, 1952, was more than 6 months. None of these shares was stock in trade of a holder thereof, or property of a kind properly includible in inventory if on hand at the close of the taxable year, or property held primarily for sale to customers in the ordinary course of a trade or125 business. The petitioners reported the following long-term capital gains after deducting the basis for the shares and the expenses of the sales and paid the following taxes:GainTaxRuth B. Rosenberg$ 583,203.17$ 151,632.84Fanny B. Thalheimer583,203.17151,632.84Jacob Blaustein537,071.45139,638.58The Commissioner determined that the amounts received by petitioners from the sale of the class B first preferred shares of Atapco were taxable as dividends under sections 22(a) and 115 of the Internal Revenue Code of 1939.OPINION.The instant case involves the siphoning off of the earnings and profits of a closely held corporation by a process which has come to be known as a "preferred stock bailout." After the earnings and profits have been capitalized the mechanics of the bailout varies with 724 the preferred stock being distributed either as a stock dividend as in Chamberlin v. Commissioner, 207 F. 2d 462 (C.A. 6, 1953), reversing 18 T.C. 164">18 T.C. 164 (1952), or as in this case as part of a recapitalization. The distribution is followed by a sale of the stock, the purchasers usually being large corporate126 investors. The preferred shares are then redeemed by the issuing corporation within a reasonably short period of time so that the original shareholder's equity is only temporarily diluted.In Chamberlin a corporation wanted to distribute its large accumulated earnings and profits but did not wish to declare a cash dividend. It settled on a plan whereby a pro rata dividend of cumulative preferred stock was issued to the common shareholders, common being the only class outstanding. Pursuant to a prearranged plan substantially all of the preferred shares were sold to two insurance companies which had formulated the terms of the issue. They provided that the shares would be redeemed over an 8-year period and also imposed restrictions on the corporation's assuming obligations, changing the capitalization, or paying dividends on the common stock. This Court held that such a preferred stock dividend when received was the equivalent of a cash dividend constituting ordinary taxable income. The Sixth Circuit reversed and held that the stock dividend was nontaxable following Strassburger v. Commissioner, 318 U.S. 604">318 U.S. 604 (1943).In the case before us 127 the Commissioner takes the position that the taxable event was the sale of the class B first preferred shares. However, he determined that the proceeds were not long-term capital gains but were taxable as dividends under sections 22(a) and 115, I.R.C. 1939. The issue here though not identical to that presented in Chamberlin, is related due to the similar purpose in carrying out the transaction.The theory of the Commissioner in arriving at his determination is that Atapco sold the first preferred shares directly to the corporate investors with the petitioners being mere conduits through whom the shares passed and the proceeds of the sales were then distributed to petitioners.Petitioners argue that there was no prearranged plan between Atapco and the corporate investors as in Chamberlin. They contend that the negotiations to sell the first preferred shares were not commenced until after the recapitalization and were conducted entirely between the corporate investors and themselves.The evidence substantiates petitioner's contention that there were no negotiations prior to the stock distribution, however we do not think that the form of the transaction is controlling as the128 Court of Appeals in Chamberlin apparently did.725 The incidence of taxation depends upon the substance of a transaction. The tax consequences which arise from gains from a sale of property are not finally to be determined solely by the means employed to transfer legal title. Rather, the transaction must be viewed as a whole, and each step, from the commencement of negotiations to the consummation of the sale, is relevant. A sale by one person cannot be transformed for tax purposes into a sale by another by using the latter as a conduit through which to pass title. To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress.Commissioner v. Court Holding Co., 324 U.S. 331">324 U.S. 331, 334 (1945).Our conclusion after viewing the substance of the transaction as a whole is that it was a predetermined plan with Atapco and the petitioners acting in concert to bail out the large amount of earnings and profits which had accumulated in the corporation for petitioners' personal use and to avoid the imposition129 of a surtax under section 102.The testimony that the preferred stock was issued in order to place Atapco shares in the hands of high-grade institutional investors and thereby establish the credit of the corporation with such investors and facilitate its later financing through such sources is not convincing. We think such a consideration was merely ancillary to the prime purpose of providing a route whereby petitioners could extract the earnings and profits from the corporation.There is no doubt that the first preferred shares were designed to accomplish this preconceived plan. The class B first preferred shares initially distributed permitted the shareholders who had planned to hold the stock to do so without a mandatory yearly redemption, a feature of the class A first preferred. Such yearly redemptions would have been a dividend to those shareholders under 115(g), I.R.C. 1939. At the same time the conversion privilege allowed petitioners to sell their shares to the corporate investors which petitioners knew would immediately convert them to the class A shares as evidenced by the indemnity agreement executed by petitioners in connection with the sale of the class B shares 130 to the corporate investors. A further consideration in utilizing this form was that it precluded any contention that the sale was an assignment of income by petitioners, Helvering v. Horst, 311 U.S. 112">311 U.S. 112 (1940), Hort v. Commissioner, 313 U.S. 28">313 U.S. 28 (1941), a theory predicated upon the fact that the yearly redemptions of the class A first preferred shares would have been dividends to petitioners. See sec. 115(g), I.R.C. 1939.In Chamberlin, the Court of Appeals in commenting on the distribution of shares with a mandatory redemption provision similar to the shares in this case, stated at page 471 that:726 Redemption features are well known and often used in corporate financing. If the * * * [redemption provision] was a reasonable one, not violative of the general principles of bona fide corporate financing, and acceptable to experienced bona fide investors familiar with investment fundamentals and the opportunities afforded by the investment market we fail to see how a court can properly classify the issue, by reason of the redemption feature, as lacking in good faith or as not being what it purports to131 be. * * In our opinion, the redemption feature, qualified as it was with respect to premiums, amounts subject to redemption in each year, and the length of time the stock would be outstanding, together with the acceptance of the stock as an investment issue, did not destroy the bona fide quality of the issue. * * Similarly, petitioners defend the mandatory redemption provision of the class A shares as necessary, because institutional investors desire to reconsider their positions from time to time and such a provision enables them to do so periodically. We think such a contention has little significance insofar as the substance of the transaction is concerned. Assertions of such business reasons might be appropriate if the corporate purpose was to sell the shares to raise additional capital but that is not the situation here. As we view it, the purpose was to siphon off the corporate earnings and profits and the importance which we attach to the redemption provision is that it enabled petitioners to accomplish the plan without a permanent impairment of their ownership and control of the corporation.Continuing with respect to the form of the transaction, petitioners claim132 that there were no negotiations to sell prior to the recapitalization in this case. While this is a fact to be considered, the controlling factor in ascertaining whether the sale was made by the corporation, as we see it, is the extent of the corporate activity throughout the entire transaction.In Commissioner v. Court Holding Co., supra, the corporation negotiated the sale of an apartment house; however, prior to the sale the asset was transferred in the form of a liquidating dividend to the shareholders who made the formal conveyance to the purchasers. This procedure was designed to avoid the imposition of a large income tax on the corporation. The Supreme Court held that it would treat the sale as if made by the corporation.Conversely, in United States v. Cumberland Public Service Co., 338 U.S. 451">338 U.S. 451, 453 (1950), a case similar to Court Holding Co., the Supreme Court held that the sale was made by the shareholders after finding that "the liquidation and dissolution genuinely ended the corporation's activities and existence" and "at no time did the corporation plan to make the sale itself."In a footnote133 in Cumberland at page 454, the Court said:What we said in the Court Holding Co. case was an approval of the action of the Tax Court in looking beyond the papers executed by the corporation and shareholders in order to determine whether the sale there had actually been made by the corporation. We were but emphasizing the established 727 principle that in resolving such questions as who made a sale, fact finding tribunals in tax cases can consider motives, intent, and conduct in addition to what appears in written instruments used by parties to control rights as among themselves. See, e.g., Helvering v. Clifford, 309 U.S. 331">309 U.S. 331, 335-337, 60 S. Ct. 554">60 S. Ct. 554, 556-557, 84 L. Ed. 788">84 L. Ed. 788; Commissioner of Internal Revenue v. Tower, 327 U.S. 280">327 U.S. 280, 66 S. Ct. 532">66 S. Ct. 532, 90 L. Ed. 670">90 L. Ed. 670, 164 A.L.R. 1135">164 A.L.R. 1135.The motive and intent of the transaction here was to bail out the corporate earnings and profits. The corporation was closely held and its conduct was always subject to the petitioners' dictates. Proof that Atapco was a pawn of petitioners' always ready to comply with their134 command is the fact that the corporate charter was amended to include certain protective provisions with respect to the first preferred shares when it became evident that petitioners could more easily dispose of the stock if such provisions were included in the charter. We believe that when a closely held corporation, manipulated by its shareholders, distributes shares to such shareholders with the knowledge that they will immediately be sold as part of a scheme to avoid taxes and the corporation then plays an active role in the subsequent disposal, the sale in substance is made by the corporation with the distribution to and sale by the shareholders being a transitory step with no independent significance. See United States v. Lynch, 192 F. 2d 718 (C.A. 9, 1951), certiorari denied 343 U.S. 934">343 U.S. 934 (1952).In the course of its reversing opinion in Chamberlin the Sixth Circuit said at page 471 that:A non-taxable stock dividend does not become a taxable cash dividend upon its sale by the recipient. On the contrary, it is a sale of a capital asset. * ** * * ** * * although the stockholder acquired money in the135 final analysis, he did not receive either money or property from the corporation. Sec. 115 (a), Internal Revenue Code, in dealing with taxable dividends, defines a dividend as "any distribution made by a corporation to its shareholders, whether in money or in other property * * out of its earnings or profits * * ." [Emphasis added.] The money he received was received from the insurance companies. It was not a "distribution" by the corporation declaring the dividend, as required by the statute.We are of the opinion that Congress under section 115, I.R.C. 1939, clearly intended to tax such distributions out of earnings and profits at ordinary income rates. The fact that the money did not physically pass between Atapco and the petitioners should not be the sole determinant. We believe the question to be answered is whether the net effect of the transaction was the realization of a dividend by the shareholders made by the corporation out of its earnings and profits.The courts have had little difficulty in finding that a shareholder realizes a dividend when the corporation discharges his indebtedness even though there has been no physical flow of money or property 136 728 between the corporation and the shareholder. See Duffin v. Lucas, 55 F. 2d 786 (C.A. 6, 1930), where the court held that when a corporation paid an indebtedness of a shareholder "it was analogous to and more or less equivalent to a regular earned and declared dividend and taxable as such" even "though it never came to his hands directly" from the corporation. See also United States v. Joliet & Chicago R. Co., 315 U.S. 44">315 U.S. 44 (1942); Commissioner v. Western Union Telegraph Co., 141 F. 2d 774 (C.A. 2, 1944).The net effect of the transaction in this case shows the realization of a dividend by petitioners. We think that to look only to the form of the transaction and ignore the substance gives credence to the circuitous method employed to achieve the dividend distribution. "A given result at the end of a straight path is not made a different result because reached by a devious path." Minnesota Tea Co. v. Helvering, 302 U.S. 609">302 U.S. 609 (1938). Accordingly, we sustain the Commissioner's determination.Decisions will be entered for the respondent137 . Footnotes1. Proceedings of the following petitioners are consolidated herewith: Estate of Fanny B. Thalheimer, Deceased, Alvin Thalheimer, Herbert Thalheimer, Jacob Blaustein, and Ruth B. Rosenberg, Executors, and Alvin Thalheimer, Docket No. 75782; Jacob Blaustein and Hilda K. Blaustein, Docket No. 75783.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621267/	Waldorf System, Inc., and Affiliated Corporations, Petitioner, v. Commissioner of Internal Revenue, RespondentWaldorf System, Inc. v. CommissionerDocket Nos. 27128, 32808United States Tax Court21 T.C. 252; 1953 U.S. Tax Ct. LEXIS 28; November 19, 1953, Promulgated 28 Decisions will be entered under Rule 50. The petitioner claims relief from excess profits tax under the provisions of Code sections 722 (a) and 722 (b) (3) (A). Held, petitioner has established the qualifying factors requisite to such relief and has established the amount that would be fair and just as the average of normal income for the base period years. Eugene Meacham, Esq., Fred R. Tansill, Esq., and Edmund M. McCarthy, Esq., for the petitioner.George L. LeBlanc, Esq., and Edward E. Pigg, Esq., for the respondent. Hill, Judge. HILL 252 Waldorf System, Inc., is the parent corporation of an affiliated group and will herein be referred to as the petitioner.The respondent determined deficiencies and overassessments in the income and excess profits tax liabilities of the petitioner and its affiliated29 corporations for the calendar years and in the amounts as follows:Income taxExcess profitsYeartax deficiencyDeficiencyOverassessment1941$ 1,755.29$ 4,759.47194214,407.2710,969.20194313,914.51102,842.86194414,313.0427,540.671945$ 1,819.535,106.54Total$ 1,819.53$ 44,390.11$ 151,218.74In connection with the foregoing determinations, the respondent rejected claims for relief from excess profits tax liability filed by the petitioner under Code section 722 and gave formal notice of such disallowance.As to the deficiencies, the petitioner alleges error in the determination on the ground that the amounts set forth were paid to the collector before the issuance of the notice. Facts have been stipulated which establish the dates and amounts of assessments and payments made. If any decision need be made on this issue, it can be made under Rule 50 on the basis of the stipulated figures.The petitions allege error in the respondent's failure to allow relief under the provisions of Code section 722, subsection (b) (3) (A) on the ground of the existence of a variant profits cycle, and subsection (b) (4) on30 the ground of a change in the character of the petitioner's business. The parties have stipulated that the petitioner has established 253 its right to reconstruct normal earnings under section 722 (b) (4) and that the result thereof is that the petitioner is entitled to additional constructive average base period net income in the amount of $ 75,000. This allowance affords no relief to the petitioner as the excess profits credit based on such increased income is less than the credit computed on invested capital.The applications for relief and claims filed are for the refund of excess profits taxes for years and amounts as follows:YearAmount1941$ 89,703.961942142,541.411943880,995.741944241,874.9019455,106.54Total$ 1,360,222.55In addition to the claims for relief for the taxable years based on constructive average base period net income for those years, the petitioner alleges that it is entitled also to reconstruct for the year 1940 which would give it an unused excess profits credit carry-over from 1940 to 1941.Summarizing the above, the issue to be decided is whether or not the petitioner is entitled to relief from excess profits taxes31 under the provisions of Code section 722, subsections (a) and (b) (3) (A). No claim for relief is made on behalf of the petitioner's subsidiaries.The proceeding was heard before Raymond J. Bowen as a Commissioner designated for that purpose pursuant to Rule 48 of the Rules of Practice before The Tax Court and section 1114 (b) of the Internal Revenue Code. Objections filed by the parties to the report of the Commissioner have been carefully considered. The findings of fact herein are substantially as found by the report of the Commissioner.FINDINGS OF FACT.I. General Facts.For all years pertinent hereto, the petitioner and its affiliated corporations maintained their books and records in accordance with the accrual method of accounting, and for the excess profits tax years involved in these proceedings they filed consolidated Federal excess profits tax returns on a calendar year basis in accordance with that method of accounting. The consolidated returns were filed in the name of Waldorf System, Incorporated, as the common parent.The excess profits net income (or loss) of each of the affiliated corporations, and of the consolidated group, for the base period years 193632 to 1939 was as follows: 254 YearWaldorfClarkGinter1936$ 513,901.96$ 174,090.78$ 2,044.31 1937302,339.39167,698.90(18,914.82)1938118,104.9860,877.87(8,513.83)1939266,759.73129,599.61(22,321.77)$ 1,201,106.06$ 532,267.16$ (47,706.11)Generalaverage300,276.51133,066.79$ (11,926.52)YearSt. Clairs'Fort HillConsolidated1936$ (3,684.74)$ 666.43$ 687,018.7419373,382.93 738.07455,244.4719388,449.12 623.87179,542.0119395,090.18 526.77379,654.52$ 13,237.49 $ 2,555.14$ 1,701,459.74Generalaverage$ 3,309.37 $ 638.79$ 425,364.93As computed under the provisions of section 713 (e) of the Internal Revenue Code, the average base period net income of the consolidated group was $ 475,599.30.The excess profits tax credits of the consolidated group for the taxable years, computed under the invested capital method provided by Internal Revenue Code section 714, were as follows:InvestedYearcapital credit1941$ 520,778.441942515,515.461943510,478.361944498,179.151945489,945.75The amounts of excess profits net income of the33 several corporations and consolidated excess profits net income, computed under the invested capital method, for the years 1940 to 1945 were as follows:WaldorfClarkSt.ClairYearDivisionDivisionDivision1940$ 382,683.62 $ 101,997.62$ 12,581.821941584,894.66 128,364.5018,259.131942462,352.20 217,852.8642,475.8619431,040,489.10 441,387.0791,546.841944166,001.22 504,352.2696,290.301945(558.33)363,219.4099,965.88GinterFt. HillTotalYearDivisionDivisionConsolidated1940$ (23,616.62)$ 552.75$ 474,199.191941(394.68)591.69731,715.30194213,824.62 585.50737,091.04194334,434.30 395.901,608,253.21194428,354.28 687.21795,685.27194544,025.04 908.29507,560.28The amounts of excess profits net income shown above for the year 1940 are after deduction of Federal income taxes. Prior to such deduction, the amounts of such income would be as follows:Waldorf$ 443,830.10 Clark134,207.39 St. Clairs'14,969.25 Ginter(23,616.62)Ft. Hill649.15 Consolidated570,039.27 The petitioner, Waldorf System, Inc., is a corporation organized on April 18, 1919, under34 the laws of Massachusetts, with its principal office and place of business at 169 High Street, Boston, Massachusetts.The consolidated excess profits tax returns for the taxable years were filed with the collector of internal revenue for the district of Massachusetts. The returns were filed by the petitioner on behalf of 255 itself and for its wholly owned subsidiaries, namely, The Clark Restaurant Company, the Ginter Restaurant Company, St. Clairs', Inc., and the Fort Hill Supply Company.The petitioner is both a holding corporation and an operating corporation. From the time of its incorporation through the taxable years, it operated a chain of cafeterias (hereinafter referred to as the Waldorf Division), in addition to owning the entire stock of its four affiliated corporations from the dates of acquisition thereof as shown below.II. Facts as to Affiliated Corporations.The Clark Restaurant Company was incorporated under the laws of Ohio in 1919. Its entire capital stock was acquired by the petitioner on or about January 1, 1922. The restaurants 1 operated by it (hereinafter referred to as the Clark Division) are operated under the name of "Clark's" and consist 35 of combination counter and waitress-table service. All of the restaurants of Clark Division were located in Ohio with the exception of one located at Erie, Pennsylvania.The Ginter Restaurant Company was incorporated under the laws of Massachusetts in January 1927, and at that time its entire capital stock was acquired by the petitioner. The restaurants operated by it (hereinafter referred to as Ginter Division), were of the waitress-table type except one which had only counter service with some incidental over-the-counter bakery sales. All of the restaurants operated by Ginter Division were located in Boston, Massachusetts.St. Clairs', Inc., was incorporated in 1907 under the laws of Massachusetts, and its entire capital stock was acquired by the petitioner on or about July 1, 1929. The restaurants36 operated by it (hereinafter referred to as the St. Clair Division) were of the table and counter type served by waitresses. All of the restaurants operated by the St. Clair Division were located in Massachusetts.Fort Hill Supply Company (hereinafter referred to as Fort Hill) is a Massachusetts corporation organized on March 7, 1927, by the petitioner which then acquired all of its capital stock. It was organized for the purpose of operating as a wholesale jobber of restaurant equipment. Its principal customers are the above mentioned Waldorf, Clark, Ginter, and St. Clair Divisions of the petitioner.III. Extent and Method of Operations of Waldorf Division.General Facts.During the period covered by the years 1922 to 1939, Waldorf Division operated cafeterias in the States of New York, Massachusetts, 256 Connecticut, and Rhode Island. The number of restaurants operated by it and its affiliated operating corporations at the close of each year was as follows:WaldorfSt.YearDivisionClarkGinterClairs'Total19229310103192310013113192410615121192510416120192611017127192711218813819281112581441929114257101561930118267111621931124276101671932124316101711933119296716119341172846155193511226461481936115233514619371182134146193811618241401939115191413937 The restaurants operated by Waldorf Division were of the cafeteria type. They differed from the usual cafeteria in that there was no rail in front of the counter and steam table from which food was served. Customers could approach directly that part of the service counter which contained the articles of food they desired and did not need to get in a line. Upon being served at the counter, the customers carried the food to tables where it was consumed.Restaurants and cafeterias that are members of chains customarily carry some sign that identifies them as being a part of a particular chain. In the case of Waldorf Division, the identifying sign was a big red apple bearing the name "Waldorf." Food prices in chain restaurants are generally low in relation to prices in other types of restaurants.The pattern of operations of Waldorf Division was generally the same in the base period and for many years prior thereto. All operations were directed from the petitioner's headquarters at 169 High Street, Boston, Massachusetts. At those headquarters, control was maintained over purchases of provisions and equipment, personnel, medical services, and leasing and real estate operations. 38 Accounting and financial operations were centered in the Boston headquarters. The claims department was located there. The Boston headquarters made up all menus, weekly, for all of the Waldorf Division cafeterias. It made up recipes and tested them before sending them out to the operating divisions. There were maintained and operated at headquarters a laundry and central commissary and bakery. A great deal of the jams, jellies, and tomato juice used by the cafeterias was prepared at the headquarters commissary. Each major operation at headquarters was under the direction of a manager who was a well-paid expert.257 The petitioner's management in the Boston headquarters maintained close control and supervision of the purchases of provisions. As to large quantity purchases, decisions were made as the result of joint consideration by the petitioner's president, general manager, and the head of the purchasing department. The cost of provisions was of critical importance in the petitioner's business and commodity prices were watched closely. In making purchases, management first determined the quantity of a given commodity that would be required by its restaurants over a 39 period of months. It attempted to determine the future market prospects of that commodity. If it appeared that there was a possibility of a rise in price, purchases were made of a sufficient quantity to last for a period of at least 9 months. Constant checking of markets often disclosed weak spots due to an over-supply in the hands of a producer or distributor. This situation would enable the petitioner to buy at a price below the market, and in such cases it would purchase large quantities. Commodity prices in different cities were watched, and advantage was taken of any differential in prices by purchasing in the lower priced market. If prices were lower in New York than in Boston, the petitioner's management would buy in New York and ship the merchandise to Boston in large vans that were rented on a favorable round-trip rental basis.It was the practice of the petitioner's management to purchase a large part of its provisions directly from producers. By so doing it eliminated the jobber and his profit. If the producers offered a commodity at a favorable price, the petitioner would purchase a large quantity. It would sometimes buy as much as 10 carloads of turkeys. At one40 time, on a favorable price offer, it purchased 14 carloads of pork loins. Seafood was purchased at the docks. One factor that enabled the petitioner to obtain the advantage of low prices was that it carried a sufficiently large cash balance so that it was able to, and did, pay cash on the delivery of supplies.Waldorf Division management set up detailed, written standards or specifications covering practically every item of food purchased. For example, it was specified that pork loins must be not lighter than 8 pounds nor heavier than 12, and that turkeys must weigh between 22 and 24 pounds. The written specifications were sent to suppliers who were required to meet them on all commodities that they sold to Waldorf Division.Menus were made up each week in conferences among the president, the treasurer, and heads of the purchasing and commissary departments. The petitioner had cost figures on all of its provisions, and the menus were prepared with a view to selling the provisions on hand that had been purchased at comparatively low prices, or such provisions as were then on the market at low prices. The menus usually carried 10 or 12 standard items in addition to pastries. 41 The menus 258 were posted in the cafeterias and customers were supplied only with the items so shown, except that short orders would be filled.If a new recipe proved satisfactory after testing at Boston headquarters, the recipe was sent out to the division commissaries for use in the preparation of food for the individual cafeterias.The management in Boston maintained a strict policy with respect to quantity and portions of food served in the cafeterias. When weekly menus were sent out, the size of the individual order was specified as to every item. The quantity of the ingredients that went into pastries was specified by headquarters so that the finished product was uniform in all cafeterias.During the period 1922 to 1939, Waldorf Division's operations were grouped into four geographical divisions, each of which was headed by a superintendent. The superintendent reported directly to the assistant to the president. Next in the chain of command were supervisors, each of whom usually was in charge of a city. Under the supervisors there came the store, or cafeteria, managers within the city. Each store manager was in charge of an operating unit, or cafeteria.Each division42 superintendent had at least one commissary under his supervision. Each local commissary had a manager in charge who took instructions from the division superintendent. Boston headquarters shipped raw material to the local commissaries which prepared the food that was served to the patrons of the cafeterias. The local commissaries made pies, cakes, and pastries in large quantities. They prepared the cooked foods that were listed on the daily menus that were sent out from Boston headquarters. They also prepared food for short-order cooking in the individual cafeterias. The food so prepared in the commissaries was packed in large vacuum cans and delivered daily to the individual cafeterias that were within the geographical division. The cafeterias, on receipt of the large vacuum containers, removed portions and placed them in smaller containers on the steam table. Only enough food was placed in the steam containers to meet what was judged to be the current need. If an unusual run developed for a particular item, the manager of the cafeteria telephoned his supplying commissary and additional supplies were delivered to him. The individual cafeterias did not do any cooking on 43 a major scale. They kept warm the cooked foods that were delivered to them from the commissaries. They did short-order cooking, such as the frying of hamburgers, and ham and eggs. 2 No real cooking, as such, was done in the cafeterias. No major food items were cooked on the premises of the cafeterias.259 In the period 1927 to 1939, commissaries were maintained and operated by Waldorf Division in the cities of Springfield, Worcester, and Boston, Massachusetts; New Haven, Connecticut; Albany, Syracuse, Rochester, New York City, Buffalo, New York; and Providence, Rhode Island. The expenses of operating the commissaries were allocated to the individual cafeterias on the basis of dollar sales.Waldorf Division carefully watched the activities44 of its competitors. It engaged "shoppers" who ate in competing cafeterias, and it required all of its supervisors to eat one or two meals each week in competitors' cafeterias and render weekly reports to Boston headquarters. These records were kept at headquarters, together with records of temperatures, conventions in a particular city, and other pertinent information, for a period of 5 or 6 years, or more.Competitors: Industry.The petitioner had a number of competitors in the field in which it operated. Among these were the John R. Thompson Company (hereinafter referred to as Thompson's), Bickford's, Inc., Childs Company, and Horn & Hardart Company. The Horn & Hardart Company operated a chain of restaurants in New York City. Horn & Hardart Baking Company of Philadelphia operated a chain of restaurants in Philadelphia. Unless otherwise distinguished, both will be referred to herein as Horn & Hardart. All were competitors in a low-price field. Childs' prices were slightly higher due to the fact that it gave table service. The several companies mentioned were in competition with each other. The competition consisted in that each operated in the same general manner, that45 is, they have centralized buying management and central commissaries in which the major cooking is performed. All operate chains of restaurants. Bickford's and Thompson's are Waldorf's principal competitors. The Horn & Hardart companies operate only in New York and Philadelphia. 346 Base Period Depression -- Waldorf's Profits Cycle.In the latter part of 1929, following the break in the stock market, wholesale food prices began to drop. The weighted index numbers of 260 all foods, on yearly averages (using 1926 as 100), for 1926 and succeeding years through the base period, were as follows:1926100.0192796.71928101.0192999.9193090.5193174.6193261.0193360.5193470.5193583.7193682.1193785.5193873.6193970.4Retail prices, as shown by average sales to customers, in Waldorf Division's restaurants did not drop as rapidly as wholesale food prices beginning in 1929, nor were they advanced as rapidly as wholesale food prices beginning in 1933. The following tabulation shows average sales to customers in Waldorf's principal subdivisions from 1926 through 1939:Albany &BostonSpringfieldYearBuffaloLowell && New YorkDivisionsProvidenceDivisionsDivisions192629.6 cents29.3 cents28.3 cents192729.329.828.8192829.228.128.4192929.428.029.2193028.527.628.8193126.526.226.9193224.024.024.2193323.022.823.1193423.523.323.4193523.423.223.4193623.823.423.5193724.123.523.6193824.023.123.3193923.923.523.647 During the depression following the stock market break in 1929, chain restaurant operators were able to purchase food at favorable prices. Waldorf and other chains did not drop their retail prices ratably with the drop in wholesale prices because there was no certainty that the bottom in prices had been reached, and they did not want to be in the position of having to raise prices in their restaurants if wholesale prices did increase. However, the lowering food costs enabled them to reduce prices to the extent that they were able to attract new customers. Such new customers, some of whom had been accustomed to eating in higher priced restaurants, replaced those who because of loss of jobs were no longer financially able to eat in restaurants.The income, cost of sales, expenses, and result of operations of the Waldorf Division for the years 1922 to 1939, inclusive, expressed in round figures, were as follows: 261 Other incomeCost ofGross profitGross profitYearSalessales on salesProfits onIntereston salesIndustrialdiscountsplus otherDivisionand miscel.income1922$ 10,368,569$ 7,837,373$ 2,531,195$ 18,080 $ 88,901$ 2,638,176192311,799,2009,185,7422,613,45850,358 77,6922,741,508192411,211,4578,565,0952,646,36223,835 59,4462,729,643192510,710,7488,127,6182,583,13013,301 72,7602,669,191192611,257,8548,380,5932,877,2619,512 86,2642,973,037192711,148,8148,357,0852,791,72914,917 68,0362,874,682192810,814,0008,098,6752,715,32517,361 73,8892,806,575192911,395,5108,339,4033,056,10738,141 57,3303,151,577193010,976,6937,814,2753,162,41845,807 43,9843,252,209193110,866,4677,632,5033,233,96415,210 47,4733,296,64719329,971,4307,089,3062,882,124(1,082)32,9532,913,99519339,395,2766,965,8032,429,4726,000 31,1652,466,63819349,546,0727,169,7802,376,292(2,210)33,1502,407,23219359,868,5167,370,0892,498,427(2,856)33,3952,528,967193610,573,3857,743,1452,830,24039,5322,869,772193710,681,2668,208,0272,473,23943,0132,516,252193810,054,5397,703,9102,350,62922,4302,373,059193910,323,1607,881,5542,441,60647,5102,489,11648 Net expensesAdministrativeTotalYearrelating toandoccupancyoccupancy otherandexpensesadm. expense1922$ 923,287$ 545,101$ 1,468,38819231,056,725556,1401,612,86519241,181,289481,6551,662,94419251,238,288454,7711,693,05919261,364,620506,4061,871,02619271,384,317449,7641,834,08119281,437,544473,1661,910,71019291,576,596528,8852,105,48119301,541,843549,8172,091,66019311,698,845493,9042,192,74919321,818,116401,0472,219,16319331,725,672467,8732,193,54519341,691,498541,4992,232,99719351,657,651425,7552,083,40619361,732,902524,6952,257,59719371,634,266483,8272,118,09319381,719,546412,9762,132,52219391,680,443423,1132,103,556Loss onNet incomenon-operatingYearfrom storeleaseoperationstransferredNet incomefrom GinterRes. Co.1922$ 1,169,788$ 1,169,78819231,128,6431,128,64319241,066,6991,066,6991925976,132976,13219261,102,0111,102,01119271,040,6011,040,6011928895,865895,86519291,046,0961,046,09619301,160,5491,160,54919311,103,8981,103,8981932694,832694,8321933273,093273,0931934174,235174,2351935445,561$ 115,812329,7491936612,17598,273513,9021937398,15995,819302,3401938240,537122,432118,1051939385,560118,800266,76049 Averages:Gross profitYearSalesCost of saleson sales1922-1939$ 10,609,053$ 7,914,999$ 2,694,0541922 193510,666,4727,923,8102,742,6621929-193410,358,5757,501,8452,856,7301936-193910,408,0887,884,1592,523,928Other incomeGross profitYearProfits onIntereston sales plusindustrialdiscounts andother incomeDivisionmiscellaneous1922-1939$ 13,687$ 53,274$ 2,761,0151922 193517,59857,6032,817,8631929-193416,97841,0092,914,7171936-193938,1212,562,049TotalNet expensesAdministrativeoccupancyYearrelating toand otherandoccupancyexpensesadministrativeexpense1922-1939$ 1,503,525$ 484,466$ 1,987,9911922 19351,449,735491,1281,940,8631929-19341,675,428497 1712,172,5991936-19391,691,789461,1522,152,941Loss onNet incomenon-operatingYearfrom storeleaseoperationstransferred fromNet incomeGinter Res.Co.1922-1939$ 773,024$ 30,619$ 742,4051922 1935877,0008,272868,7281929-1934742,118742,1181936-1939409,108108,831300,27750 262 SocialOtherTotalYearProvisions,Laborsecuritycost ofcost ofetc.taxsalessales1922$ 5,190,285$ 1,781,912$ 865,177$ 7,837,37319236,088,5102,097,960999,2729,185,74219245,545,1632,034,388985,5448,565,09519255,296,0111,872,210959,3988,127,61819265,371,2991,996,1701,013,1248,380,59319275,322,5502,071,665962,8708,357,08519285,106,7372,029,368962,5708,098,67519295,441,1342,095,766802,5038,339,40319304,984,1622,104,311725,8017,814,27519314,789,4382,041,629801,4377,632,50319324,464,4251,843,298781,5847,089,30619334,458,8161,796,234710,7536,965,80319344,560,7901,876,918732,0727,169,78019354,793,4261,874,835701,8287,370,08919365,067,5211,953,284$ 33,362688,9787,743,14519375,160,7022,202,341106,326738,6588,208,02719384,589.0942,240,705141,340732,7707,703,91019394,733,3352,282,432142,535723,2527,881,554Averages:1922-19395,053,5222,010,85723,531827,0887,914,9991922-19355,100,9101,965,476857,4247,923,8101929-19344,783,1281,959,693759,0257,501,8451936-19394,887,6632,169,691105,891720,9157,884,15951 The number of customers of Waldorf Division, in each case not including the industrial division, for the years 1922 to 1939 were as follows:WaldorfYearDivision192238,511,895192342,153,229192439,966,447192537,684,690192638,582,702192738,541,013192838,098,722192940,044,936193039,243,361193141,058,433193241,521,236193341,005,551193440,871,550193542,372,836193644,984,546193745,212,329193843,142,935193943,769,130The index of income of all corporations that filed returns in the period 1922 to 1939, using 100 as the index for the entire period, reached a high 191.4 in 1929. In 1930 it was 89.8, in 1931 it was 16.9, and in 1932 it was minus 22.4, which was the depth of the depression that began in 1929. The index figures for the years 1933 to 1939, inclusive, are as follows:193313.5193449.3193569.41936104.41937103.8193862.81939102.4The period 1922 to 1929 was one of expansion and prosperity for the chain restaurant business, particularly that of cafeterias. Operators were picking better locations, paying higher rents, and improving 263 the appearance, equipment, and methods of operation52 of cafeterias.During the early years of the depression, the low-priced chain restaurants fared well in relation to other businesses. Figures as to John R. Thompson Co. for the years 1928 to 1931, inclusive, are as follows:Number ofYearGross salesNet earningsCustomerrestaurantsbefore taxescountat end ofeach year1928$ 14,585,049.74$ 1,334,706.6762,354,564124192914,541,533.411,325,641.9461,356,799120193013,725,296.771,148,891.1558,763.752119193113,457,037.561,019,531.4962,373,215115The records of Bickford's Inc., for the years 1929 to 1932, inclusive, show the following results:YearSales, foodProfit fromCheck averageonlyoperations1929$ 4,411,896.74$ 583,403.80.259819304,960,148.52728,932.07.242019315,054,667.40665,596.95.242019324,596,447.42418,180.18(not shown)Figures as to sales of other chain restaurants are:YearB/GPig'n WhistleHorn & Hartdart(N. Y.)1929$ 3,404,523$ 3,671,248$ 17,436,15519303,405,9923,996,42018,592,79719312,883,2003,688,34019,143,52119322,151,1922,670,01917,294,947The number53 of food checks issued to customers of low-priced chain restaurants, as far as available, remained relatively constant in the early depression years. The figures as to Childs Company are as follows:YearNo. ofNo. of foodrestaurantschecks192911048,422,942193011246,512,429193110844,512,429In the case of Waldorf System, the restaurants operated at the close of each of the same years and the customers served in each year were:YearNo. of storesNo. ofCustomers192915651,752,459193016252,395,677193116754,157,538264 Average net income of Waldorf Division for the years 1930, 1931, and 1932 was $ 986,426.The index of net income of 6 chain restaurants operating in the low-priced field was 114.9 for the years 1929 to 1933 as compared with an index of 100 for the period 1923 to 1939. 454 Wholesale food prices began to rise in 1933. The rise on an annual basis first shows up in figures for 1934. In 1933 the weighted index number of all foods was 60.5 (on the basis of a figure of 100 for 1926); in 1934 it was 70.5, and in 1935 it was 83.7. Low-priced restaurant chains were not able to increase their retail prices to keep pace with the increase in wholesale prices due to several factors. One of these was customer resistance to any increase in prices. Any increase by Waldorf Division in the price of an article on its menu resulted in decreased sales, complaints, letters, and telephone calls. Price increases could be made without loss of sales only after the consumer public had become educated as to the market costs of commodities. Such resistance continued from 1933 to 1939, inclusive.The low-priced restaurant chains customarily sell food items in multiples of 5 cents, as their customers object to paying odd cents, and on a rising market Waldorf Division often found it necessary to absorb increased costs of odd cents per order until there came a time when it felt that the price at the counter could be increased by a full 5 cents. On what were known as fast selling55 items, such an increase in price would often result in a decrease of sales of anywhere from 40 to 60 per cent.During the period following 1933, labor costs increased substantially. Workers in Waldorf Division and othter chain restaurants were paid higher wages which the operators found it difficult to pass on to customers. Under the National Recovery Act, the hours of Waldorf Division's employees were shortened and their minimum wage levels raised which resulted in increased labor costs in 1933 of $ 125,000. Compliance with provisions of the Restaurant Code in 1934 resulted in a material increase in the cost of labor. In 1936 wages of all Waldorf employees, except supervisors and executives, were raised 10 per cent. In the years immediately preceding 1939, the average hourly wage of Waldorf Division's employees increased by more than 23 per cent, and wage and hour adjustments added over $ 600,000 to its annual payrolls. Social Security taxes averaged $ 105,891 in the period 1936 to 1939.The result of increased food costs and operating costs, and the inability of operators to pass on the increased costs to customers, was that many low-priced chains ran into financial difficulties56 in the period 265 1933 to 1939. Some went out of business completely and others were forced to reorganize. The number of business failures among such chains during that period was greater than in the whole prior history of the business.The net income of Waldorf Division, Waldorf System, Inc., with its affiliated corporations on a consolidated basis, of the five restaurant chains above mentioned shown separately and also combined with the income of Waldorf System, and the income of all corporations, are shown in the tabulation below. The dollar amount in each case is net income before taxes, less tax-exempt income, plus interest paid:Waldorf SystemYearWaldorfIncorporatedFive restaurantDivision(Consolidated)chains1923$ 1,161,729$ 1,404,554$ 6,098,47719241,105,2761,360,0497,333,18319251,018,8251,213,7197,032,28219261,159,0301,336,3938,622,08019271,092,0931,309,2818,162,3501928961,1181,179,5458,032,53919291,108,7411,392,3288,771,69119301,219,6001,445,1188,293,66119311,164,5001,252,9047,695,8511932753,388664,6404,435,0321933332,953128,2172,447,5361934221,41851,2722,750,1551935371,025421,5511,944,5341936556,468729,6704,061,7551937335,039487,9451,446,7111938140,772202,2092,623,8211939288,821401,7873,344,015Computed average:1923-35897,6691,012,2756,278,4131923-39764,164881,2465,476,2161936-39330,275455,4032,869,07557 Five restaurantYearchains &All corporationsWaldorfConsolidated1923$ 7,503,031$ 9,586,000,000 19248,693.2328,808,000.000 19258,246,00111,238,000.000 19269,958,47311,493,000,000 19279,471,63110,885,000,000 19289,212,08412,808,000,000 192910,164,01913,665,000,000 19309,738,7796,413,000,000 19318,948,7551,204,000,000 19325,099,672(1,600,000,000)19332,575,753964,000,000 19342,801,4273,516,000,000 19352,366,0854,957,000,000 19364,791,4257,451,000,000 19371,934,6567,410,000,000 19382,826,0304,479,000,000 19393,745,8027,306,000,000 Computed average:1923-357,290,6887,226,000,000 1923-396,357,4627,093,000,000 1936-393,324,4786,662,000,000Expressing the above dollar amounts in index figures on the basis of the index figure for 1923 to 1939 being 100, gives the following results:Waldorf SystemYearWaldorfIncorporatedFive restaurantDivision(Consolidated)chains1923152.0159.4111.31924144.6154.3133.91925133.3137.7128.41926151.7151.6157.41927142.9148.6149.11928125.8133.8146.71929145.1158.0160.21930159.6164.0151.41931152.4142.2140.5193298.675.481.0193343.614.544.7193429.05.850.2193548.647.835.5193672.882.874.2193743.855.426.4193818.422.947.9193937.845.561.1Computed average:1923-35117.5114.9114.61923-39100 100 100 1936-3943.251.752.458 Five restaurantYearchainsAll corporations& WaldorfConsolidated1923118.0135.1 1924136.7124.2 1925129.7158.4 1926156.6162.0 1927149.0153.5 1928144.9180.6 1929159.9192.7 1930153.290.4 1931140.817.0 193280.2(22.6)193340.513.6 193444.149.6 193537.269.9 193675.4105.0 193730.4104.5 193844.563.1 193958.9103.0 Computed average:1923-35114.7101.9 1923-39100 100 1936-3952.394.9 266 General Business Cycle.There was a relatively short business depression in the United States in 1921. Thereafter, and into 1929, business conditions generally were rising. Security and commodity prices rose. Production, sales, employment, loans, debts, and interest rates were rising. There was a good deal of capital expansion in industry and of buying durable goods. Towards the end of the period, prices began to level and inventories began to accumulate to a rather unhealthy amount. In September 1929 the securities' market crashed. Immediately sales of durable goods and investments in plant and equipment fell off. This was followed by slumps in sales of other goods, 59 and production and employment decreased. This condition continued through 1930 and 1931. The low point in production was reached in 1932, and the low point in employment in 1933. There were many bankruptcies. Debts were scaled down and interest rates were lowered. Plants and equipment and durable goods wore out in the period 1929 to 1933. In 1933 and 1934 consumers started to spend on durable goods and industry started to invest in plants and equipment. Prices started to rise. Earnings of all corporations were on the plus side in 1933 and continued a steady rise through 1937. In 1938 there was a recession, but in 1939 earnings had risen to almost the 1937 level.Ultimate Facts.The operation of chain restaurants, such as Waldorf Division, Thompson's, Bickford's, Childs, Horn & Hardart, with a substantial number of units, centralized management, central commissaries, and purveying of food at the lowest price possible consistent with operating at a profit, constitutes an industry of which Waldorf Division was a member in the base period and in the excess profits tax years.The business of Waldorf Division was depressed during the base period by reason of conditions generally60 prevailing in the industry of which it was a member.The petitioner was subjected to a profit cycle differing materially in length and amplitude from the general business cycle.A fair and just amount representing the average of normal income during the base period years is $ 782,092.90.OPINION.The petitioner claims relief from excess profits tax under the provisions of Code sections 722 (a) and (b) (3) (A). Subsection (a) states the general rule as to relief if the tax is excessive and discriminatory and if the taxpayer establishes a fair and just amount representing normal earnings.267 Subsection (b) (3) (A) provides that the tax shall be considered excessive and discriminatory if --(3) the business of the taxpayer was depressed in the base period by reason of conditions generally prevailing in an industry of which the taxpayer was a member, subjecting such taxpayer to (A) a profits cycle differing materially in length and amplitude from the general business cycle * On the basis of the facts found we conclude that the tax here involved was excessive and discriminatory and that petitioner is entitled to relief under the provisions of the above quoted section of61 the Code. This section is commonly referred to as the variant profits cycle provision. In order to qualify under this provision, a taxpayer must establish a number of factors. It must establish (a) that its business was depressed in the base period; (b) that it was a member of an industry; (c) that the depression in its business was due to conditions generally prevailing in its industry; and (d) that the foregoing factors subjected the taxpayer to a profits cycle differing materially in length and amplitude from the general business cycle.The petitioner has undertaken to establish that it meets all of the above qualifying factors. At the outset, it should be noted that by the very nature of the provisions of subsection (b) (3) (A), consideration of any case claiming relief thereunder can not be confined to the base period as is true under other subsections. The provision as to depression in the base period requires comparison with prior years; the provision as to comparison of cycles requires consideration of factors over a longer period of time than the base period. Commissioner's Bulletin on Section 722, Part IV (B).Base Period Depression.It is obvious from the figures62 in evidence that the business of the petitioner was depressed in the base period in relation to its business in prior periods. The average excess profits net income of Waldorf Division for each of several periods in the history of its operations was as follows:1922-1935$ 868,727.991922-1939742,405.441936-1939 (base period)5 300,276.50The net profits of Waldorf Division and its four affiliated corporations on a consolidated basis for the same period were as follows:1922-1935$ 986,810.001922-1939862,044.501936-1939 (base period)425,364.93268 Industry.The parties differ sharply as to whether or not the chain restaurant business, in which Waldorf Division was engaged, constituted an industry within63 the meaning of subsection (b)(3). Regulations 112, section 35.722-2 (b)(8), on this subject, read in part:In general an industry may be said to include a group of enterprises engaged in producing or marketing the same or similar products or services under analogous conditions which are essentially different from those encountered by other enterprises. * Commissioner's Bulletin on Section 722, Part I (F), provides in part:In most general terms an "industry" comprises a group of business concerns sufficiently homogeneous in nature of production or operation, type of product or service furnished, and type of customers, so as to be subject to roughly the same external economic circumstances affecting their prices, volume and profits. * Without approving or disapproving the above definitions, we think that a holding that the low-priced restaurant chain business constitutes an industry does not do violence to them. The chain restaurants, similar to those of Waldorf Division, operate entirely differently from other types of eating places. Among the distinguishing features was centralized purchasing, with a constant survey of commodity markets to enable them to buy at the64 lowest possible prices. The purchase of food in large quantities for cash enables them to buy at prices generally lower than other types of restaurants. Menus are prepared by the headquarters' office, and are limited as to the number of food items offered. Perhaps the most striking difference is that food is prepared in central commissaries and sent to the individual restaurants ready to be served from the steam table or counter. No cooking is done in the restaurants except for short orders. Thus, the kitchen equipment in a chain restaurant is meager compared with that of other types of restaurants. The restaurants similar to those of Waldorf Division featured low individual food checks based on their policy of furnishing food at the lowest possible price consistent with making a profit. There is testimony that among business people acquainted with the restaurant business, the operation of the low-priced chains was regarded as an industry separate and distinct from that of other types of eating establishments.Upon consideration of all the evidence, we are satisfied that the operation of chain restaurants of a type similar to those of Waldorf Division constituted an industry65 within the meaning of Code section 722 (b) (3) and that the Waldorf Division of the petitioner was a member of that industry.269 Conditions in the Industry.One of the elements of section 722 (b) (3) is that the taxpayer's business was depressed in the base period by reason of conditions generally prevailing in its industry.The evidence leaves no doubt that the business of the petitioner was depressed in the base period in relation to prior years. The average excess profits net income of Waldorf Division in the base period was only $ 300,276 as contrasted to $ 868,727 in the period 1923 to 1935, and $ 742,405 over the entire period 1923 to 1939. The earnings of the petitioner and its subsidiaries on a consolidated basis averaged only $ 455,403 in the base period, whereas they had averaged $ 1,012,275 in the period 1923 to 1935 and $ 881,246 in the period 1923 to 1939.The evidence likewise leaves no doubt that the business of other restaurant chains was similarly depressed. It is shown that the average earnings of five representative chains, other than the petitioner, were $ 2,869,075 in the base period, contrasted with $ 6,278,413 for the period 1923 to 1935, and $ 66 5,476,216 over the longer period 1923 to 1939.On an index basis, using 100 for the period 1923 to 1939, the earnings of Waldorf Division were 117.5 for 1923 to 1935 and only 43.2 in the base period. The index of earnings of the five representative chains was 114.6 in 1923 to 1935 and only 52.4 in the base period.The evidence is not limited to figures as to the petitioner and the five representative chains. There is testimony that establishes that the depressed condition of business in the base period existed generally among low-priced restaurant chains, and a number of similar chains were either forced to reorganize or were liquidated. A witness for the petitioner, who has been familiar with the restaurant business for over 30 years and whose corporation has been dealing with restaurants over a longer period, testified that in and immediately prior to the base period the number of failures in the chain restaurant industry was larger than in any period in the previous 50 years.The evidence adequately shows the reasons for similarity of conditions in the petitioner's business and of those generally prevailing in its industry. All members of the industry were affected by the same67 factors. The chains had to pay increased prices for food, but were unable simultaneously to increase the prices that they charged because of consumer resistance. Other costs, particularly that of labor, increased substantially and such increases could not immediately be passed on to customers of the chains.We conclude that the business of Waldorf Division was depressed in the base period because of conditions that generally prevailed in its industry.270 Cycle Question.The most difficult phase of this case is whether the petitioner meets the variant profits cycle test. In the language of the Code, the taxpayer must have been subjected to " * * a profits cycle differing materially in length and amplitude from the general business cycle."The case has been tried on the theory that a business cycle is a period of business activity which includes four phases, namely, a period of prosperity, one of recession, one of depression, and one of revival. A complete cycle is measured from a period of prosperity to another period of prosperity, or from a period of depression to another period of depression. The Bulletin on Section 722, Part IV (B), provides that "the general business68 cycle must be defined as the profits cycle of all corporations."Accepting the above definitions for the purposes of this case, the stipulated figures indicate that for all corporations the period 1923 to 1939 represents a profits cycle. The years 1923 to 1929 were a period of prosperity when the index of income went from 135.1 to 192.7. The year 1930 can be said to be one of recession when the index dropped to 90.4. The years 1931 and 1932 were depression years when the indexes were 17.0 and minus 22.6, respectively. The period 1933 to 1939 was one of revival when the index rose from 13.6 to 103.0, with a temporary recession in 1938. The evidence in this case is to the effect that for cycle study purposes short-term movements, such as the recession in 1938, are ignored. In contrast, Waldorf Division's period of prosperity ran from 1923 through 1930 during which its index figures ranged from a low of 125.8 to a high of 159.6. It might with reason be said that the period of prosperity included the year 1931, as in that year the index was only 7.2 points lower than in the preceding year. The year 1932 was one of recession when the index figure dropped to 98.6. Its depression69 years were 1933 and 1934 when the indexes dropped to 43.6 and 29.0, respectively. Its recovery period did not start until 1935 when the index rose to 48.6. The recovery period lasted only through 1936 when the index again rose and was 72.8. Then another recession set in and lasted through the 3 succeeding years. It is thus seen that except for the early years of the period 1923 to 1939, Waldorf's periods of prosperity, recession, and depression did not coincide with those of all corporations.If we consider the "peak to peak" years as measuring a profits cycle, there is again a lack of coincidence. The first peak for all corporations was in 1929 when the index was 192.7, while Waldorf's did not occur until 1930 when its index was 159.6. The low point for all corporations was in 1932, whereas Waldorf's did not occur until 2 271 years later in 1934. On the rising side, all corporations again reached a recognized peak in 1939. In contrast, Waldorf did not reach a peak in any year that marked the rise for all corporations. It had reached a temporary high point in 1936 when its index was 72.8, but in the 2 succeeding years its earnings dropped drastically to a low of 18.470 in 1938, and by 1939 the index had risen only to 37.8. Even if we consider 1936 as Waldorf's second peak, the result is that its first peak occurred 1 year later than that of all corporations, and its second peak was 3 years earlier. This difference in time in this short span of years marks a material difference in length of the cycles.Little need be said as to the difference in amplitude of the cycles. The index figures make it clear that there was a marked difference in that respect. The contrast is sharp in any period or year that may be selected. For example, Waldorf's index for 1923 to 1935 was 117.5 while that of the general business cycle as measured by the income of all corporations was 101.9. The comparison for the base period is 43.2 for Waldorf and 94.9 for all corporations. Waldorf did not have a minus index figure in any year from 1923 to 1939, whereas the index for all corporations dipped to a minus of 22.6 in 1932. If we take Waldorf's cycle as being the period 1930 to 1936, the indexes are 159.6 and 72.8, respectively. If we consider the cycle of all corporations to be the years 1929 to 1936, the indexes are 192.7 and 105, respectively. Thus, the amplitude71 was markedly different, no matter what period be regarded as a cycle.The similarity of the earnings pattern of Waldorf Division and that of representive industry members, as well as the dissimilarity between the earnings pattern of Waldorf and its industry on the one hand, and business in general on the other, can be demonstrated by means of a Pearsonian correlation. A Pearsonian correlation is a method of determining the tendency of things to vary together. This method is a recognized statistical device. If two quantities correlate perfectly, the coefficient of correlation is expressed as plus 1. If there is no correlation, the coefficient is zero. The closer to plus 1 (or 1.00) the coefficient of correlation is, the closer the degree of correlation. The Pearsonian coefficient of correlation does not involve averages but involves comparison of pairs of index numbers in each year.The coefficient of correlation of Waldorf Division earnings for the period 1923 to 1939 compared with the aggregate earnings of Thompson's, Childs, Bickford's, and the two Horn & Hardart chains (hereinafter sometimes referred to as the "five chains") for the same years is plus .935, which is an unusually72 good correlation. If the earnings of Waldorf System, Inc., are added to the earnings of the 5 chains and the combined earnings of these 6 chains compared with Waldorf Division over the years 1923 to 1939, a coefficient of correlation of plus .957 results. This is an even better correlation.272 Comparing the aggregate earnings of the 5 chains for the period 1923 to 1939 with earnings of all United States corporations for the same period results in a correlation coefficient of plus .377 which is an extremely poor correlation. If the earnings of Waldorf System, Inc., are added to the aggregate earnings of the 5 chains and this total compared with the earnings of all United States corporations for the same period, 1923 to 1939, the coefficient of correlation is only plus .579, which is not good. If earnings of Waldorf Division are added to the earnings of the 5 chains and this total is compared to earnings of all corporations for the period 1923 to 1939 the coefficient of correlation becomes only plus .552.The earnings of the 5 chains and the earnings of Waldorf Division vary together during the period 1923 to 1939, and these two vary separately and distinctly from the earnings73 of all corporations.The chain restaurant industry lags 2 years behind all corporations so far as net earnings are concerned. This means that comparable points on the respective cycles occur 2 years later in the chain restaurant industry than for all corporations. In speaking of a 2-year lag in the chain restaurant industry, this does not mean exactly 24 months in one cycle and 24 months in the next cycle. The lag might vary a little. The description of a 2-year lag is in terms of what is reasonable and what appears to be true and the lag might be longer than 2 years.If earnings of the 5 chains are lagged 2 years (their earnings are all pushed back by 2 years) and compared with all corporation's earnings for 1923 to 1939, then the coincidence is very marked. The coefficient of correlation in such a case is very good, being plus .818 for the years 1923 to 1939. This is so even though there are up and down movements throughout this period. Both lines on the graph tend to go upward and the lines coincide very closely. The amount of difference between the lines is very small. The amount by which either series goes up or down is very little, and generally the lines parallel each74 other very closely. In a similar fashion, if earnings of Waldorf System, Inc., are added to those of the 5 chains and their combined earnings, with a 2-year lag, are compared with the earnings of all corporations for 1923 to 1939, the coincidence is marked. The coefficient of correlation in such a case is plus .832 for the years 1923 to 1939, which is an excellent correlation. If earnings of Waldorf Division only are added to those of the 5 chains and these earnings are lagged by 2 years and compared with earnings of all corporations, the coefficient of correlation is plus .825 for the years 1923 to 1939. The earnings of the Waldorf System taken alone and lagged 2 years produce a coefficient of correlation of .803 in comparison with the earnings of all United States corporations.273 A comparison of the combined earnings of Thompson's and Childs on the one hand, with the combined earnings of Waldorf Division and Clark on the other, both over the period 1923 to 1939, results in a correlation coefficient of plus .78, which is good. In a similar fashion, when combined earnings of Waldorf Division, Clark, Thompson's, and Childs over 1923 to 1939 are compared with earnings of75 all corporations over the same period with no time lag the coefficient of correlation is plus .27, very low. If earnings of these same companies are pushed back 2 years and compared with earnings of all corporations over the period 1923 to 1939, the coefficient of correlation becomes plus .85, which is very high. If Waldorf Division and Clark's combined earnings are compared with all corporate earnings over 1923 to 1939, the correlation is plus .30 which is poor. Making the same comparison with a 2-year lag for the earnings of Waldorf and Clark results in the amazingly high correlation of plus .96.The earnings pattern and the 2-year lag detailed above, which is characteristic of the petitioner and of the members of its industry, is attributable largely to the low price charged by the chain restaurant industry to its customers and the reaction of customers to increases and decreases in the low price. In a period of general recession the low prices charged to customers tended to maintain the customer level while food and labor costs dropped. At the same time prices to customers were lowered slowly but had a rate of decrease which was slower than costs. As a result the profits76 of the petitioner and of its industry generally tended to increase. This was true during 1929 through 1932. On the other hand, during a period of general recovery, food, labor, and other costs increased at a more rapid rate than the prices charged to customers because of customer resistance. Sales in the meantime remained constant with a resulting decline in profits. This was true throughout the period 1933 to 1939.The sum of these considerations is a rational and characteristic relationship between the petitioner's profit cycle and that of business in general, which considered in the light of the provisions of section 722 (a) and (b) ( 3) (A) of the Internal Revenue Code entitles the petitioner to relief, for the petitioner has met all of the tests requisite to relief imposed by that section.Reconstruction.We have found what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income.The Commissioner's Bulletin on Section 722 states that the reconstruction will take the form of finding the average income of the taxpayer for another series of years than the base period which can be 274 considered as normal. 77 It further provides that in ascertaining income in other years it is desirable to use data conforming as nearly as possible to the definition of excess profits net income. Bulletin on Section 722, Part IV (C). In suggesting several figures that may be used as constructive average base period net income, the petitioner has followed the pattern of the provisions of the Bulletin. The figures proposed are taken from Exhibit 5-E attached to the stipulation which shows the excess profits net income of Waldorf Division for each year from 1922 through 1939 and the average by three groups of years.One figure suggested is the average income for the entire period 1922 to 1939 in the amount of $ 742,405.44. It would appear that this is not a proper figure as representing normal earnings since it includes income for the period 1936 to 1939 in which we have held that the petitioner's business was depressed.Another suggested figure is the average income for the period 1922 to 1935 in the amount of $ 868,727.99. This would also appear to be an improper figure since in the years covered by the greater part of this span Waldorf Division had its highest earnings. This factor more than outweighs78 the fact that the period also includes the recession and depression years.The final suggested figure is the amount of $ 782,092.90 which is the average of income for the years 1926 through 1935. The argument in support of this figure is that the period covered starts 1 year after a pit in 1925 and ends 1 year after a pit in 1934. (The indexes for 1925 and 1926 are 133.3 and 151.7, respectively, and for 1934 and 1935 they are 29.0 and 48.6). This seems like a reasonable view. The period covered includes both good and bad earnings years and is a reasonable span of time.We think the evidence establishes all the factors requisite to qualify petitioner for relief under the above cited provisions of the statute.The respondent stresses the point that on or about January 1, 1935, Waldorf System, Inc., (parent) assumed, as he contends, the obligations of Ginter Restaurant Company under certain real estate leases on properties in Boston and thereby sustained losses in the following amounts:1935$ 115,812.10193698,272.64193795,818.941938122,431.581939118,799.76Average, 1936-1939108,830.73No findings have been made on this point. The respondent's view is that79 the above losses are properly chargeable to Ginter rather than to Waldorf and should not be taken into consideration in determining Waldorf's income. If it be assumed that the respondent's position is 275 correct, the addition of the $ 108,830.73 to Waldorf's income for the base period would raise the average for the base period only to $ 409,107.24, instead of $ 300,276.51, which would still leave Waldorf's income depressed in relation to prior periods.Reviewed by the Special Division.Decisions will be entered under Rule 50. Footnotes1. The stipulation speaks of "stores" operated by Clark Division. Throughout the record, the words "stores" and "restaurants" are used interchangeably. The word "stores" is understood to refer to restaurants of some kind.↩2. Quotation from page 102 of transcript:Q. The essence of the system then, if I am correct, is you do all your preparatory work in the commissary and ship it in a ready to serve condition in your stores, is that essentially correct?A. That is right sir. That is correct.↩3. Bickford's, Inc., operated from 37 to 91 restaurants in the period 1929-1939. The average number operated by Horn & Hardart Baking Company was 45. Horn & Hardart Company operated from 36 to 47 restaurants. Thompson's averaged about 114 units in the period 1922-1939. The maximum number operated by Childs Company was 121 in 1927 and 1928, and thereafter the number declined until it reached 86 in 1939.Other restaurant chains were B/G Foods, Inc., which in 1939 operated 43 units and Pig'n Whistle which operated 17 units on the West Coast.Of all of the chains, Thompson's served the greatest number of customers. It served, in round numbers, 52,151,000 customers in 1922. The number increased until it reached the maximum of 62,373,000 in 1931, and thereafter decreased to a low of 46,532 in 1939.↩. See schedule below.↩4. The 6 chains on which these figures are based are Waldorf System, Bickford's, Inc., Childs Company, Horn & Hardart Baking Company of Philadelphia, Horn & Hardart of New York, and John R. Thompson Company.↩5. This is the stipulated figure and also appears on Exhibit 5-E. Exhibit 17-Q shows net income, less tax-exempt income, plus interest paid as averaging $ 330,275 for the base period. The difference probably lies in the fact that in Exhibit 5-E interest has not been added back.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621269/	NAOMI JABLONSKI CASH, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCash v. CommissionerDocket No. 2070-77.United States Tax CourtT.C. Memo 1977-405; 1977 Tax Ct. Memo LEXIS 34; 36 T.C.M. (CCH) 1642; T.C.M. (RIA) 770405; November 23, 1977, Filed 34 R. Travis Douglas, for the petitioner. William A. Neilson, for the respondent. QUEALYMEMORANDUM OPINION QUEALY, Judge: Respondent determined deficiencies in petitioner's Federal income tax return as follows: Taxable Year EndedDeficiencyDecember 31, 1972$116.54December 31, 1973184.33December 31, 1974199.40On April 6, 1977, respondent filed a motion for judgment on the pleadings. After a hearing was held on the motion on April 25, 1977, the Court granted respondent's motion. An order and decision then was entered in respondent's favor on May 3, 1977. On June 6, 1977, petitioner filed a motion to vacate the Court's order and decision of May 3, 1977. The Court granted petitioner's motion on June 7, 1977, and gave petitioner 30 days to file a brief opposing respondent's motion for judgment on the pleadings. The Court also gave respondent 30 days from the date petitioner's brief was filed to file a reply brief. These briefs were filed timely. In addition, petitioner filed a reply brief on September 29, 1977. The sole question presented by the motion for a judgment on the pleadings is whether sections 214(e)(1)35 and 214(e)(3)1 deny petitioner due process of law under the Fifth Amendment of the U.S. Constitution. If the Court finds for the respondent on this issue, petitioner concedes that the deficiencies determined by respondent are correct. In deciding upon the motion of respondent for a judgment on the pleadings, allegations of fact contained in the petition are taken as true. Stanton v. Larsh,239 F.2d 104">239 F.2d 104 (5th Cir. 1957). Petitioner Naomi Jablonski Cash resided in Metairie, Louisiana, at the time the petition was filed. Petitioner's Federal income tax returns for the 1972, 1973 and 1974 taxable years were filed with the Austin, Texas, Internal Revenue Service Center. During May through December of the 1972 taxable year and during all of the 1973 and 1974 taxable years, petitioner was gainfully employed outside her home. More than one-half of the cost of maintaining a household36 for petitioner's son, 2 age one in 1972, was provided by petitioner during each of these taxable years. Petitioner's husband, unavailable to care for their son, was employed in the taxable years pertinent. Petitioner's husband did not contribute to the support of petitioner and their son. Employment-related expenses incurred by petitioner for the care of her son, not exceeding $200.00 during any month, were $496.00 in 1972, $855.00 in 1973 and $945.00 in 1974. Other expenses deducted by petitioner amounted to $968.95 in 1972 and $990.20 in 1973. Petitioner claimed an exemption deduction for her son in 1972 and 1973. The adjusted gross income of petitioner was less than $35,000.00 for each of the pertinent taxable years. 337 The community of acquets and gains existing between petitioner and her husband, Anthony J. Cash, Jr., was dissolved by a Louisiana court order in 1970. Under Louisiana law, the 1970 court order placed petitioner in the status of an unmarried individual regarding her property and income. However, petitioner was still married under Louisiana law. During the taxable years involved, petitioner was legally married to and living in the same household with Anthony J. Cash, Jr.For each of the taxable years, petitioner filed a Federal income tax return separate from her husband. Section 214 provides for the deduction of dependent care expenses for an individual maintaining a household for one or more other qualifying individuals. Petitioner maintains such a household and meets all the requirements of section 214 except the requirement that a married couple either must file a joint return (section 214(e)(1)) or be living apart from each other (section 214(e)(3)). Because married taxpayers living together are required by section 214(e)(1) to file a joint return while certain married taxpayers living apart are exempt from this requirement by section 214(e)(3), petitioner contends these38 two sections deny her due process of law under the Fifth Amendment by creating two classes of married taxpayers and treating each class differently. That section 214 treats certain married taxpayers living apart differently than other married taxpayers is admitted by respondent. Disparate treatment within the Internal Revenue Code is not unique. For example, single taxpayers pay a rate of tax different than the rate applicable to married taxpayers. This disparity in the rate structure is constitutional. Barter v. United States,550 F.2d 1239">550 F.2d 1239 (7th Cir. 1977), affg. per curiam 422 F. Supp. 958">422 F. Supp. 958 (N.D. Ind. 1976); Kellems v. Commissioner,58 T.C. 556">58 T.C. 556 (1972). For the reasons set forth below, the different treatment accorded married taxpayers by sections 214(e)(1) and 214(e)(3) is also constitutionally permissible. Section 214, originally enacted in 1954, was revised substantially by section 210 of the Revenue Act of 1971 (85 Stat. 518). The intent of Congress is set forth in the Report of the Committee on Finance accompanying that Act (S. Rept. No. 92-437, 92nd Cong., 1st Sess. 59-62), and in the Report of the Conference (H. Rept. 39 No. 92-708, 92nd Cong., 1st Sess. 42-43). In the Revenue Act of 1971, Congress expanded the definition of "unmarried" under section 214 to include a married taxpayer whose spouse lived outside the household during the entire taxable year. Additionally, the married taxpayer had to show she maintained for more than one-half of the taxable year a household for a dependent and that she furnished over one-half of the cost of maintaining the household. This revision allowed a married taxpayer living apart from her spouse to claim child care expenses without filing a joint return. Section 214(e)(3). Also as a result of the Revenue Act of 1971, the adjusted gross income allowed, before the amount of the deduction must be reduced, was increased to $18,000.00 (section 214(d)). This limitation was intended to apply to the income of the "household." Section 214(d) provided that "if the taxpayer is married during any period of the taxable year, there shall be taken into account the combined adjusted gross income of the taxpayer and his spouse for such period." The filing of a joint return by married taxpayers is the mechanism used to ensure that their income is combined in accordance with40 section 214(d). Congress could assume reasonably that where spouses are living together, the cost of maintaining the household is shared between them to the extent of their respective resources. That this assumption should prove erroneous in petitioner's situation is unfortunate, but immaterial to the constitutional validity of sections 214(e)(1) and 214(e)(3). Perfect equality between persons subject to the Internal Revenue Code is not a constitutional requirement. Barter v. United States,supra.Congress through section 214, as in effect during the years involved, intended to limit the child care deduction to households with an adjusted gross income below a prescribed level. The section defined which married taxpayers were to be treated as unmarried and eliminated the filing of a joint return for these individuals. This unmarried classification was based upon the absence of one spouse from the household. For the other class of married taxpayers, the section required the filing of a joint return to reflect both household income sources. The joint filing requirement was based upon the assumption that both spouses shared in the financial maintenance of41 the household. The Court, therefore, finds no invidious discrimination in the creation of two classes of married taxpayers to determine fairly the adjusted gross income of the household. 4Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated. Section 214↩ was repealed effective for taxable years beginning after 1975. For taxable years beginning after 1975, the deduction was converted into a credit (section 44A).2. In the petition, petitioner alleges that she was maintaining a household for one son. In the brief opposing respondent's motion for a judgment on the pleadings, petitioner alleges she totally supported "her two young sons." As the resolution of this factual question is inconsequential to the disposition of respondent's motion, the Court will assume the petition is accurate. ↩3. Although petitioner says that her adjusted gross income for each of the pertinent taxable years was less than $35,000.00, section 214(d) I.R.C. 1954, for taxable years beginning after December 31, 1971, and before March 30, 1975, sets the adjusted gross income limitation of the taxpayer at $18,000.00 for the taxable year. After March 29, 1975, and before taxable years beginning after 1975, the adjusted gross income limitation of section 214(d)↩ was increased to $35,000.00.4. A similar situation exists regarding the deduction of alimony where a husband and wife may be separated but are occupying the same household. Sydnes v. Commissioner,68 T.C. 170">68 T.C. 170↩ (1977).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621270/	ISABEL RICHARDSON MOLTER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Molter v. CommissionerDocket No. 47308.United States Board of Tax Appeals27 B.T.A. 442; 1932 BTA LEXIS 1066; December 28, 1932, Promulgated 1066 Held, that under the provisions of the testator's will petitioner received a vested remainder interest and that the date of acquisition of the property sold in the tax years was the date of death of the testator and not the date of distribution to petitioner. Donald V. Hunter, Esq., and Oscar A. Kropf, Esq., for the petitioner. J. M. Leinenkugel, Esq., for the respondent. LEECH442 The Commissioner has determined deficiencies in the amounts of $14,035.77 and $937.98 in this petitioner's income taxes for the years 1925 and 1926, respectively. The sole issue is the date of acquisition of certain stocks acquired by request, for the purpose of ascertaining the proper basis to be used in determining the gain derived upon their sale during the years in question. The facts have been stipulated. FINDINGS OF FACT. Petitioner is an individual, residing at Wilmette, Illinois. George P. Richardson, deceased, died testate, a resident of Chicago, on February 13, 1919. Surviving him as his only heirs at law were his widow, Isabel L. Richardson, and his daughter, Isabel M. Richardson, who subsequently married and appears in this proceeding1067 as Isabel Richardson Molter. The will of George P. Richardson, deceased, was proved and duly admitted to probate in the Probate Court of Cook County, Illinois, on March 18, 1919. The pertinent provisions of the will are as follows: Fourth. I give, devise and bequeath all the rest, residue and remainder of my property, real, personal and mixed, of whatever nature and wherever situated to the First Trust and Savings Bank of Chicago, Illinois, in trust, nevertheless, for the uses and purposes, and subject to the limitations hereinafter declared and expressed in this, my last Will and Testament. 443 Fifth. I will and direct that my said trustee shall take possession of my said estate and hold, manage and distribute the same. It shall, at all times, collect * * * all income of whatever kind arising from said estate. It shall, at all times, make all necessary repairs, * * * and make any and all other payments necessary and proper in and about the said estate and the management thereof. It shall have full power to sell and convey any or all of my real estate, * * * also, if it deems best for the interest of my estate, to sell, assign and dispose of any * * * personal1068 property of whatever name or nature, to my said estate belonging; provided, however, that no capital stocks of any corporation or corporations belonging to me at the time of my death shall be sold without the consent in writing of my daughter, Isabel M. Richardson, first had and obtained, if she is in the United States at the time of such sale, and if she is not in the United States at such time, such Trustee may sell the same without her consent in writing if deemed best; * * It shall have full power to invest or re-invest the principal arising from the sale of any of the real estate or personal property * * * except that no loans shall be made or bonds purchased on property used exclusively for dwelling house, flat or apartment building purposes. It is my intention hereby to give to my said trustee, full and absolute power to hold, manage and distribute my said estate, and any and all powers necessary for that purpose, whether such powers are substantially set forth or not, except as above limited, are hereby given to it. * * * Sixth. I will and direct that the net income derived from the control and management of my said estate be paid at the end of each quarter year to my1069 wife, Isabel L. Richardson, and to my daughter, Isabel M. Richardson, in equal parts, share and share alike, during the lifetime of my wife. In case of my daughter's death before my wife's death, I direct that the entire said net income be paid to my wife in quarterly installments during her life, unless, however, my daughter dies leaving lineal descendants, in which case, I direct that one-half of said net income be paid to my wife and one-half to the lineal descendants of my daughter, if any, share and share alike, in quarterly installments. At the death of my wife, in case she survives me, or at my death, in case she does not survive me, I will and direct that twenty-five per cent (25%) in value of my estate be turned over to my daughter, Isabel M. Richardson, and that twenty-five per cent (25%) thereof shall be turned over to her each second year thereafter until the whole is turned over to her in three additional installments and that the income received from the principal remaining in the hands of the trustee from time to time, be paid over to my said daughter in quarterly installments, provided, however, if my said daughter so elects, this trust may be continued for such time1070 not exceeding ten years from the date for final distribution for such time within that term as may be designated in writing by her. In case of the death of said Isabel M. Richardson before my death or before such distribution is made to her, I direct that the whole or remaining principal in the hands of such trustee and income hereinabove directed to be paid to her, be distributed and paid to her lineral descendants, if any, at the specified times and in the same manner, share and share alike. Seventh. In case of the death of my said daughter without leaving lineal descendants before distribution is made to her as directed and mentioned in the preceding paragraph, or in case of her death before my death, leaving no lineal descendants, I hereby direct my said trustee, upon the death of my wife, in case she survives me, or one year after my death, in case she does not survive me, to sell sufficient securities remaining in its hands to provide 444 for the following specific payments in cash, and to pay in cash to the following persons, respectively, the following sums: (Here follows a list of beneficiaries each of whom is bequeathed a specific sum, and the rest and residue1071 of the estate is bequeathed to the Old Peoples Home at Chicago.) Eighth. The provisions hereinabove made for my wife, Isabel L. Richardson, are in lieu of homestead, dower rights, widow's award and of all other rights, interests or claims which she may or might have, or claim in or to my estate, or any part thereof. Ninth. I direct that the income to be paid to the beneficiaries under this, my last Will and Testament, as well as the distributive share of my estate to be paid to them when the same is divided and distributed as hereinabove directed, shall be paid, distributed, assigned and conveyed to each of said beneficiaries in person, or to their lawfully appointed guardian or their representative, and that in no event shall any of said beneficiaries, or the creditors of any of them, have the right or power to anticipate the share of said estate or its income which my trustee is to pay over to such beneficiaries by any order on said trustee, assignment, conveyance or other voluntary transfer by such beneficiaries, or by operation of law, or by virtue of any attachment, garnishment, judgment, decree, or other legal proceedings, against said beneficiaries or my said trustee. 1072 The First Trust and Savings Bank of Chicago was appointed executor of the decedent's estate which, except for one piece of real property valued at $1,250, consisted of personal property valued at over $300,000 for estate tax purposes. The decedent's debts paid by the executor did not exceed $10,000. The executor's inventory of the estate, filed in the probate court on May 28, 1919, included among the assets listed, 40 shares of S. S. Kresge Company common stock and 1,265 shares of Belding Brothers & Company stock. The executor filed the Federal estate tax return for decedent's estate and paid the estate tax according to the value of the property included therein as finally determined by the Commissioner of Internal Revenue. Among the other properties were the following stocks, with their respective value for estate tax purposes: 40 shares S. S. Kresge Company, common, $4,480; 1,265 shares Belding Bros. & Company, common, $158,125. The First Trust & Savings Bank accepted and performed the duties of trustee as directed in the will and the property taken over by it consisted of practically the total estate of decedent, free from debts. Isabel L. Richardson, decedent's widow, 1073 did not renounce the will, but took under the provisions thereof until her death on April 25, 1923. She was survived by petitioner, daughter of George P. Richardson, deceased. On April 25, 1923, petitioner received 20 shares of S. S. Kresge Company common stock having a fair market value of $247.50 per share, as part of the first distribution by the trustee made under the will of George P. Richardson, deceased. 445 On March 19, 1925, petitioner received 10 shares of S. S. Kresge Company common stock as a stock dividend of 50 per cent on the 20 shares mentioned in the next preceding paragraph. On October 19, 1925, petitioner sold 10 shares of the said S. S. Kresge Company common stock and received therefor the net amount of $7,389.10. On January 26, 1926, petitioner sold the remaining 10 shares of the said S. S. Kresge Company common stock and the 10 shares received as a stock dividend on March 19, 1925, and received therefor the net amount of $17,580.20. On April 25, 1923, as part of the above mentioned first distribution made by the trustee, petitioner received 680 shares of Belding Bros. & Company common stock. On March 31, 1925, as part of the second distribution1074 by the trustee under the will of George P. Richardson, deceased, petitioner received 910 shares of Belding Bros. & Company common stock. On July 1, 1925, petitioner sold 750 of these same shares, for which she received $200 a share or a total of $150,000. Belding Bros. & Company common stock was not listed upon any stock exchange prior to July 15, 1925, but several sales were made by various persons during the two preceding years and it had a fair market value per share when received by her in 1925 equivalent to the price for which she sold it in that year. In making her income tax returns for the years in controversy, petitioner proceeded upon the theory that under her father's will she received a contingent remainder interest in his estate; that the time of acquisition by her of the stocks in question was her receipt thereof upon distribution by the trustee, and that the basis for determining gain or loss was the fair market value of the stocks on that date. The Commissioner in asserting the deficiencies in controversy, determined that petitioner took a vested remainder, that the time of acquisition was the date of her father's death and that the basis for ascertaining gain1075 or loss upon the sale of the stock was the value thereof on February 13, 1919, for estate tax purposes, reduced by stock dividends declared subsequent to that date. OPINION. LEECH: The parties have limited the issue to the question of whether petitioner took a vested or a contingent remainder under the provisions of her father's will. The applicable section of the Revenue Act of 1926 is as follows: SEC. 204. (a) The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that - * * 446 (5) If the property was acquired by bequest, devise, or inheritance, the basis shall be the fair market value of such property at the time of such acquisition. The provisions of this paragraph shall apply to the acquisition of such property interests as are specified in subdivision (c) or (e) of section 402 of the Revenue Act of 1921, or in subdivision (c) or (f) of section 302 of the Revenue Act of 1924, or in subdivision (c) or (f) of section 302 of this Act. Petitioner agrees that if she took a vested remainder the deficiencies as determined by the Commissioner are1076 correct. The Commissioner agrees that if petitioner took a contingent remainder the time of acquisition was the date of the distribution of the stock to her by the trustee; that no gain or loss was realized upon the sale of the Belding Bros. & Company stock, and that the gain realized upon the sale of the S. S. Kresge Company stock may be recomputed under Rule 50, pursuant to the foregoing findings of fact. In determining this issue we are bound by the rules of property established in Illinois, ; ; . The same general principles which regulate the vesting of devises of real estate apply to a considerable extent to personal legacies. The general rule in regard to the vesting of personal legacies, the payment of which is postponed to a period subsequent to the decease of the testator, is that where there is no general gift, but only a direction to pay in the future, the vesting will be postponed until the appointed time. But an exception to the general rule, constituting practically another general rule, is that although a gift1077 arises wholly out of directions to pay or distribute in futuro, if futurity is not annexed to the substance of the gift for reasons personal to the legatee, but merely for the convenience of the fund or property, because the testator desired to appropriate the subject matter of the legacy to the benefit of another for a certain period (such as a life estate) the legacy in remainder will vest instanter, the right of possession and enjoyment, only, being deferred. ; ; ; ; ; ; ; ; ; . A contingent remainder, by which no present interest passes, is where the estate in remainder is limited to take effect either to a dubious or uncertain person or upon the happening of a dubious or uncertain event, 1078 The status of such estate depends not upon the uncertainty of enjoyment, but upon the uncertainty of the right to enjoyment, ; . A vested remainder, by which a present interest passes to the remainderman instanter, though to be enjoyed in futuro, is where the estate is invariably fixed to remain to a determinate 447 person after the particular estate terminates, Although it may be uncertain whether the remainder will ever take effect in possession and enjoyment, it will nevertheless be vested if the interest is fixed, ; . If survivorship or other conditional element be incorporated into the description of the gift or the designation of the remainderman, such as to the children surviving the life tenant, as a condition precedent, the remainder will be contingent and the vesting deferred, 1079 ;But if the remainderman be designated by name accompanied by words giving a vested remainder interest, a subsequent provision disposing of the same estate in the event he dies before payment or distribution merely creates a condition subsequent, and the estate will vest instanter, subject to being divested upon the remainderman's death prior to the falling in of the particular estate or the arrival of the appointed time for payment or distribution. ; ; ; ; ;;The controlling consideration in deciding whether a remainder is vested or contingent upon the beneficiary being alive at the time of distribution is to discover the intention of the testator, which must be given effect, 1080 However, the law not only favors vested remainders, ;, and in cases of doubt or ambiguity in the language employed, will determine the remainder to be vested, , but will presume that words of postponement relate to enjoyment and possession. The testator's intent to postpone the vesting of the interest must be clear and manifest. A spendthrift trust is the term commonly used to designate a trust created to provide a fund for the maintenance of the beneficiary and at the same time to secure the enjoyment of it to the object of the testator's or grantor's bounty by providing that it shall not be alienable by the beneficiary or be taken by his creditors, ; . The limits of such provisions depend upon the law of the jurisdiction wherein the real property is situate, or, as to personalty, the law of the jurisdiction wherein the trust was created and is to be administered, and, where permitted, 1081 such provisions are a valid restriction even upon a vested property interest, ; The Illinois rule of law is that there is one exception to the rule that any limitation is bad which restrains an owner in fee simple from alienating his property, and this exception is that property may be 448 devised in fee, subject to a spendthrift trust which effects only a deferment of possession or enjoyment. ; ; ;In the case at bar, paragraph sixth of the will provides for a particular estate for the lifetime of the testator's widow, and then provides "at the death of my wife, in case she survives me, or at my death, in case she does not survive me, I will and direct that twenty-five per cent (25%) in value of my estate be turned over to my daughter, Isabel M. Richardson, and that twenty-five per cent (25%) thereof shall be turned over to her each second year thereafter * ." The last sentence of paragraph sixth provides that, 1082 in case of the death of Isabel M. Richardson before the testator's death or distribution to her, the whole or remaining principal be distributed to her lineal descendants, if any. Paragraph seventh provides that, in the event of the death of testator's daughter without leaving lineal descendants before distribution is made to her as directed in paragraph sixth, or before the testator's death, the trustees are directed, upon death of testator's widow or if she predecease him within one year after his death, to make several specific payments in cash and turn over the residue to the Old Peoples Home. Paragraph ninth of the will is a spendthrift clause applying to both the income and the corpus of the testator's estate. The will makes a specific gift of the remainder of the testator's estate to his daughter by name and at the date of death of the testator she was in esse and then answered fully the description by which she was to take. She had a present fixed right to future enjoyment. There was no intervening circumstance in the nature of a condition precedent which had to happen before she received the right to take in possession, under the terms of the will. Survivorship1083 was not included in the description of the remainderman, but, instead, the words employed created a vested interest, subject to being divested upon her death prior to the falling in of the particular estate or the periods appointed for distribution to her. Had the testator's wife predeceased him, petitioner would have taken possession of 25 per cent of the remainder immediately upon the death of the testator. The obvious reason for postponing enjoyment of this portion of the remainder was "for the convenience of the fund or property" by providing for the life estate of the widow - not for any reasons personal to the legatee. Certainly then, petitioner took a vested interest in the first 25 per cent of the remainder of testator's estate. There is nothing in the will to denote an intention by the testator that she was to take a vested interest as to 25 per cent of his remainder estate and a contingent interest as to the other 75 per cent. The words of 449 postponement are presumed to relate to enjoyment and possession, for there is no clear and manifest intent expressed by the testator to postpone the vesting of the whole or any part of the remainder interest in his daughter*1084 at the date of his death. The spendthrift clause was a valid limitation upon the right which vested in petitioner at date of testator's death and effected only a postponement of enjoyment. We conclude that petitioner acquired a vested remainder interest. The date of acquisition of the property disposed of in these tax years was the date of death of the testator, namely, February 13, 1919, and the basis for determining gain or loss is the fair market value of such property on that date. . Also, cf. ; ; ; ; . The Commissioner has used, as the basis for determining gain, the value for estate tax purposes of the shares of stock in question on the date of the testator's death, reduced by dividends declared subsequent to that date. No issue has been raised as to those values. Judgment will be entered for respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621272/	GROVER B. KELSAY and LOIS E. KELSAY, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Kelsay v. CommissionerDocket Nos. 1471-71, 1472-71, 1473-71, 1474-71, 1475-71, 1476-71, 1477-71.United States Tax CourtT.C. Memo 1972-249; 1972 Tax Ct. Memo LEXIS 7; 31 T.C.M. (CCH) 1232; T.C.M. (RIA) 72249; December 21, 1972, Filed Charles P. Duffy and Joyle C. Dahl, for the petitioners. Lee A. Kamp, for the respondent. QUEALYMEMORANDUM FINDINGS OF FACT AND OPINION QUEALY, Judge: The respondent has determined deficiencies in the Federal income tax returns of the petitioners as follows: Docket No.PetitionersYearAmount1471-71Grover B. and Lois E. Kelsay1965$ 3,929.00196612,661.001472-71Robert A. and Barbara K. Graham19667,158.001473-71Dan A. and Marilyn B. Graham1965973.0019666,780.001474-71Raymond F. and Ida D. Hills19653,724.00196612,678.001475-71Lloyd A. and Shirley K. Leabo19651,036.0019667,588.001476-71Frank A. and Mildred J. Graham19651,048.0019662,986.001477-71John H. and Velva M. Leabo19652,390.5519662,994.008 The above-entitled proceedings were consolidated for purposes of trial and opinion. Concessions and agreements having been made by the parties, the sole issue for decision in this case is whether petitioners owned, or had a contract right to cut certain timber on the lands of Weyerhaeuser Timber Co., within the meaning of section 631(a), 2 for a period of more than 6 months prior to the taxable year in which the timber was cut. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Petitionrs Grover B. Kelsay and Lois E. Kelsay are husband and wife who filed their joint Federal income tax returns for the calendar years 1965 and 1966 with the district director of internal revenue for the District of Oregon. At the time of the filing of the petition herein, they legally resided in Pleasant Hill, Oregon. Petitioners Robert A. Graham and Barbara K. Graham are husband and wife who filed their joint Federal income tax return for the calendar year 1966 with the district9 director of internal revenue for the District of Oregon. At the time of the filing of the petition herein, they legally resided in Pleasant Hill, Oregon. Petitioners Dan A. Graham and Marilyn B. Graham are husband and wife who filed their joint Federal income tax returns for the calendar years 1965 and 1966 with the district director of internal revenue for the District of Oregon. At the time of the filing of the petition herein, they legally resided in Pleasant Hill, Orgeon. Petitioners Raymond F. Hills and Ida D. Hills are husband and wife who filed their joint Federal income tax returns for the calendar years 1965 and 1966 with the district director of internal revenue for the District of Oregon. At the time of the filing of the petition herein, they legally resided in Pleasant Hill, Oregon. Petitioners Loyd A. Leabo and Shirley K. Leabo are husband and wife who filed their joint Federal income tax returns for the calendar years 1965 and 1966 with the district director of internal revenue for the District of Oregon. At the time of the filing of the petition herein, they legally resided in Sparks, Nevada. Petitioners Frank A. Graham and Mildred J. Graham are husband and wife10 who filed their joint Federal income tax returns for the calendar years 1965 and 1966 with the district director of internal revenue for the District of Oregon. At the time of the filing of the petition herein, they legally resided in Jasper, Oregon. Petitioners John H. Leabo and Velva M. Leabo are husband and wife who filed their joint Federal income tax returns for the calendar years 1965 and 1966 with the district director of internal revenue for the District of Oregon. At the time of the filing of the petition herein, they legally resided in Pleasant Hill, Oregon. At all times during the years 1965 and 1966, Grover B. Kelsay, Robert A. Graham, Dan A. Graham, Raymond F. Hills, Lloyd A. Leabo, Frank A. Graham, Mildred J. Graham, and John H. Leabo were the partners in Hills Creek Lumber Co., wich was engaged in logging timber and manufacturing lumber at its mill located in Jasper, Oregon. During the years 1965 and 1966, respectively, the partnership interests were as follows: 19651966Grover B. Kelsay22 %22 %Robert A. Graham5 %15-1/3%Dan A. Graham9-1/2%15-1/3%Raymond F. Hills22 %22 %Lloyd A. Leabo9-1/2%15-1/3%Frank A. Graham7-1/2%2-1/2%Mildred J. Graham7-1/2%2-1/2%John H. Leabo17 %5 %11 Prior to 1965, the partnership had duly elected to treat the cutting of timber by it under the provisions of section 631(a) of the Internal Revenue Code. Any timber cut by the partnership during the years 1965 and 1966, which otherwise qualified for treatment under section 631(a), was cut for sale on its own account or to use such cut timber in the partnership's trade or business. Beginning sometime in 1955, Hills Creek Lumber Co. (hereinafter referred to as "Hills Creek") entered into negotiations with Weyerhaeuser Timber Co. (hereinafter referred to as "Weyerhaeuser") for the exchange of certain cutover timberland in Lane County, Oregon, owned by Hills Creek. It was ultimately agreed by the parties that, in consideration for the conveyance by Hills Creek of its cutover land to Weyerhaeuser, Hills Creek would receive conveyance of a certain tract believed to have standing 6,500,000 board feet of quality old-growth Douglas fir timber, together with the right to cut an additional 8,500,000 board feet of such timber on nearby lands owned by Weyerhaeuser. As a result of such negotiations, on August 27, 1957, Hills Creek conveyed the 3,877.25 acres of its cutover12 timberland in Lane County, Oregon, to Weyerhaeuser. At about the same time, Weyerhaeuser conveyed to Hills Creek 78.96 acres of its timberland located in Section 14, Township 15 South, Range 1 East, in Lane and Linn Counties, Oregon. In addition, as part of the consideration of the conveyance of the 3,877.25 acres, on January 27, 1958, Weyerhaeuser also granted Hills Creek an exclusive and irrevocable option for a term ending on December 31, 1965, to acquire timber located on a certain 107.75 acres of land located in Section 14, Township 15 South, Range 1 East, in Lane and Linn Counties, Oregon, at a price of $60 per thousand board feet. The option did not specify the estimated board feet of Douglas fir timber contained in the 107.75 acres, but the parties assumed that the acreage would contain 8,500,000 feet of quality Douglas fir timber. As a result of miscalculations on the part of Weyerhaeuser, it developed that the land conveyed to Hills Creek did not contain the requisite 6,500,000 board feet of quality Douglas fir. In recognition of this, Weyerhaeuser granted additional rights to Hills Creek, which were exercised and are not involved in this proceeding. There was also some13 question whether the designated acreage covered by the option of January 27, 1958, would yield the agreed upon volume of timber. Accordingly, it was agreed that Hills Creek would relinquish its option and be permitted to select a different tract. In exchange for the option of January 27, 1958, Weyerhaeuser granted an exclusive and irrevocable option to Hills Creek, dated November 23, 1964, to be exercised by December 31, 1966, to cut Douglas fir timber located in Sections 19 and 20, Township 17 South, Range 2 East of the Willamette Meridian. This option agreement was identical to the January 27, 1958 option agreement, except that the legal description of the land from which the timber was to be removed was different, and the date by which the option had to be exercised was extended from December 31, 1965 to December 31, 1966. On July 28, 1965, Hills Creek advised Weyerhaeuser by letter that: We hold an option to buy timber from your firm, as is evidenced by such a paper in our hands. This option was signed by your Mr. George H. Weyerhaeuser for your company, under date of November 23rd, 1964. In an amendment to this agreement, we may exercise option rights any time this year14 on 30 days notice to your firm; and we may invoke option privileges more than the once, as specified in error in the agreement. Pursuant to such understanding, we wish to invoke our option privilege for 4,000,000' at this time, and this letter is to constitute the 30 days notice of our such intent. * * It is presently our intention to invoke our option on the remaining 4,500,000' at a later date of this year; and as a result, be prepared to log out all of the option timber prior the end of the year of 1966, at which time our rights expire. During August 1965, Weyerhaeuser prepared the (1) "Pay as Cut Timber Sales Contract" for the removal of 4,000,000 board feet of Douglas fir timber from Sections 19 and 20, Township 17 South and (2) service logging contract for the delivery of hemlock, cedar and Douglas fir culls from the same area. The aforementioned contracts were transmitted to Hills Creek by letter, dated August 30, 1965, for the signatures of officials of Hills Creek. The "Pay as Cut Timber Sales Contract," dated August 25, 1965, provided in part as follows: (1) Hills Creek to remove approximately 4,000,000 feet of timber by December 31, 1966. (2) The timber to15 be removed from Sections 19 and 20 of Township 17 South, Range 2 East of the Willamette Meridian. (3) Title to the timber to pass to Hills Creek when the timber is removed from the contract area. (4) Notwithstanding the time of passage of title, operator shall bear risk of loss or damage to covered products other than loss or damage caused by fault of owner. (5) The timber, its grade to be No. 3 sawmill log or better, to be paid at the rate of $60 per thousand board feet. On January 26, 1966, Hills Creek entered into a supplemental agreement with Weyerhaeuser to provide for an additional 4,500,000 board feet of Douglas fir timber to be covered by the "Pay as Cut Timber Contract," dated August 25, 1965. On April 7, 1966, the cutting area from which the Douglas fir timber was to be removed, was increased by adding other parts of Sections 19 and 20, Township 17 South, Range 2 East of the Willamette Meridian. Hills Creek cut the 8,500,000 board feet of Douglas fir timber as follows: YearFootage19653,086,1201966 5,425,820Total 8,511,940 OPINION Section 631(a) grants to the taxpayer the election to treat the cutting of timber for sale or for16 use in the taxpayer's trade or business as a sale or exchange of a capital asset providing that the taxpayer either has owned such timber or has held "a contract right to cut" such timber for a period of more than 6 months before the beginning of the taxable year. 3 The sole question presented is whether Hills Creek held "a contract right to cut" the 8,500,000 board feet of Douglas fir timber for a period of more than 6 months before the beginning of the taxable year in which Hills Creek cut such timber. In other words, when did Hills Creek acquire from Weyerhaeuser the right to cut 8,500,000 board feet of timber? 17 In the sequence of events, Hills Creek and Weyerhaeuser entered into an agreement for the exchange by petitioner of certain cutover acreage for a plot of lesser acreage believed to have 6,500,000 board feet of matured timber, together with the right to cut an additional 8,500,000 board feet of timber at a price of $60 per thousand. The terms for the exchange were agreed upon verbally not later than July 1956. Pursuant to that agreement, on August 27, 1957, Hills Creek conveyed to Weyerhaeuser its cutover land and received a conveyance from Weyerhaeuser of the smaller tract which was supposed to have 6,500,000 board feet of timber. It subsequently developed that the tract would not yield timber of the quantity and quality agreed upon by the parties, so that Hills Creek was given the right to cut elsewhere up to the total of 6,500,000 board feet. As a part of the same transaction, on January 27, 1958, Weyerhaeuser also granted Hills Creek the exclusive sive and irrevocable option for a term ending December 31, 1965, to cut the timber on certain designated acreage believed to yield 8,500,000 board feet of Douglas fir at a price of $60 per thousand board feet. Subsequently, the petitioner18 went on said lands and concluded that the tract would not yield the quantity and quality of timber agreed upon by the parties. As a result, in exchange for the earlier option, on November 23, 1964, Weyerhaeuser granted an option to Hills Creek to cut timber on a different tract. Except for the description of the property, the terms and conditions were identical with the earlier option. Hills Creek duly exercised its rights under the option cutting therefrom a total of 3,086,120 board feet during the taxable year 1965 and 5,425,820 board feet during the taxable year 1966. Before undertaking to cut such timber, the option provided for the fulfillment of certain conditions by Hills Creek. These terms and conditions, to which Hills Creek was obligated to agree before being permitted to enter upon the lands of Weyerhaeuser to cut timber, were embodied in a standard form of contract used by Weyerhaeuser entitled a "Pay as Cut Timber Sales Contract." Relying on this, respondent argues that all Hills Creek had prior to the entitled contract was an option to obtain a contract right to cut rather than the contract right itself. The respondent would commence the running of the 6-month period19 required in the statute from the date of the contract to cut rather than the date of the option to cut. Accordingly, respondent contends that the 6 months did not begin to run until the date of the "pay as cut" contract. In taking this position, the respondent fails to give effect to the distinction between "a contract right to cut" as used in section 631(a) and "a contract to cut." 4The characterization of the initial right to cut granted to Hills Creek as an "option" was adopted by Weyerhaeuser to distinguish the initial contract or agreement from the cutting contract which Weyerhaeuser required before permitting a logger to cut timber on its lands. The intention of Weyerhaeuser as described by Mr. Daniel C. Smith, its vice president and general counsel, was as follows: Q Why did you call it an option agreement? A I thought that of it I guess, less artfully than now appears to have been the case, it is just an agreement. They had a right to cut that timber at any time and we called it an option agreement because we were concerned about--well, we had two considerations. One, we wanted some notice to make sure that if we had logging operations20 going on anywhere in the vicinity we could schedule--well, we could avoid any congestion on the roads. We could ask them to schedule their logging or we could reschedule our logging so as to avoid two shows going on in the same area. They are very inadequate roads. Secondly, whenever we, and we had other instances, when we grant to somebody the right of this sort we want to make sure that when they go in and start operating that they had an operating agreement that fairly clearly sets forth their obligations with respect to fire prevention, with respect to insurance, and usually these operating agreements have the provision for either a bond or a security deposit. A right to cut is nothing more than an "option." It implies no obligation on the part of the holder of such right. Section 631(a) does not require that the taxpayer seeking to claim its benefits have a binding contract to cut timber which is in effect for a period of 6 months prior to the taxable year. All the statute requires is that the taxpayer have an enforceable right, exercisable at its option, to cut such timber. Hills Creek clearly had that right with respect to the 8,500,000 board feet either at the time it furnished*21 the consideration which formed a part of the original agreement, namely, August 27, 1957, or in any event not later than January 27, 1958, when Weyerhaeuser granted the petitioner an option to elect to go upon a designated tract believed to yield 8,500,000 board feet of timber and to cut such timber upon appropriate notice to Weyerhaeuser and the assumption of the customary obligations of any logger permitted to cut timber on Weyerhaeuser's land. The contract by which the petitioner obtained the right to cut such timber came into being at that time. What transpired subsequent thereto was merely the implementation of that right. Decisions will be entered Under Rule 50. Footnotes1. Cases of the following petitioners are consolidated herewith: Robert A. Graham and Barbara K. Graham, docket No. 1472-71; Dan A. Graham and Marilyn B. Graham, docket No. 1473-71; Raymond F. Hills and Ida D. Hills, docket N. 1474-71; Lloyd A. Leabo and Shirley K. Leabo, docket No. 1475-71; Frank A. Graham and Mildred J. Graham, docket No. 1476-71; and John H. Leabo and Velva M. Leabo, docket No. 1477-71.↩2. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩3. SEC. 631. GAIN OR LOSS IN THE CASE OF TIMBER, COAL, OR DOMESTIC IRON ORE.(a) Election to Consider Cutting as Sale or Exchange.--If the taxpayer so elects on his return for a taxable year, the cutting of timber (for sale or for use in the taxpayer's trade or business) during such year by the taxpayer who owns, or has a contract right to cut, such timber (providing he has owned such timber or has held such contract right for a period of more than 6 months before the beginning of such year) shall be considered as a sale or exchange of such timber cut during such year. If such election has been made, gain or loss to the taxpayer shall be recognized in an amount equal to the difference between the fair market value of such timber, and the adjusted basis for depletion of such timber in the hands of the taxpayer. Such fair market value shall be the fair market value as of the first day of the taxable year in which such timber is cut, and shall thereafter be considered as the cost of such cut timber to the taxpayer for all purposes for which such cost is a necessary factor. If a taxpayer makes an election under this subsection, such election shall apply with respect to all timber which is owned by the taxpayer or which the taxpayer has a contract right to cut and shall be binding on the taxpayer for the taxable year for which the election is made and for all subsequent years, unless the Secretary or his delegate, on showing of undue hardship, permits the taxpayer to revoke his election; such revocation, however, shall preclude any further elections under this subsection except with the consent of the Secretary or his delegate. For purposes of this subsection and subsection (b), the term "timber" includes evergreen trees which are hore than 6 years old at the time severed from the roots and are sold for ornamental purposes.↩4. For example, see sec. 631(b)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621273/	Aaron Kraut and Iris Kraut, Petitioners v. Commissioner of Internal Revenue, Respondent; Harry Kraut and Marian Kraut, Petitioners v. Commissioner of Internal Revenue, RespondentKraut v. CommissionerDocket Nos. 7663-70, 7664-70United States Tax Court62 T.C. 420; 1974 U.S. Tax Ct. LEXIS 83; 62 T.C. No. 48; June 27, 1974, Filed 83 Decisions will be entered under Rule 155. In 1965 petitioners organized and became the sole stockholders of Nassau Plastic & Wire Corp. (Nassau) to manufacture wire to be used in Christmas decorations. Less than 1 year later, petitioners entered into an agreement to sell their Nassau stock to Cathedral of Tomorrow, a federally tax-exempt religious organization, which simultaneously agreed to liquidate Nassau. Nassau's assets consisted almost entirely of a secondhand automobile, $ 50,000 of receivables, and a 5-year lease of its single piece of machinery -- all subject to liabilities in excess of $ 36,000. The stated sales price was a flexible amount ranging from a minimum of $ 500,000 to a maximum of $ 3,500,000, and was payable primarily out of 75 percent of the business' net income for the ensuing 10 years. As employees, petitioners remained in control of the operation of the business. In the event of default, petitioners' sole recourse was the enforcement of a lien upon the business' assets. The lease agreement for the machine entitled the lessor, a corporation wholly owned by petitioners, to terminate the lease unilaterally after the expiration of its initial term. 84 Held, this transaction amounted merely to the payment of a fee to Cathedral in return for lending its tax exemption to Nassau's earnings rather than the actual transfer of the business to Cathedral, and it therefore did not constitute a bona fide sale of a capital asset within the meaning of sec. 1222(3). Sidney N. Solomon, Frederic Scheinfeld, and O. John Rogge, for the petitioners.87 Stanley J. Goldberg and Walter C. Welsh, for the respondent. Raum, Judge. RAUM421 The Commissioner determined deficiencies in petitioners' 1967 income tax as follows:Docket No.PetitionersAmount7663-70Aaron and Iris Kraut$ 254,437.127664-70Harry and Marian Kraut258,544.82The cases were consolidated for trial. At issue is whether an agreement by which two of petitioners purported to transfer the stock of their wholly owned corporation to a tax-exempt charitable organization in exchange primarily for a portion of the business' profits for a period of 10 years constituted a bona fide sale within the meaning of section 1222(3), I.R.C. 1954, thereby entitling petitioners to capital gains treatment in respect of the proceeds. In the event such a sale did occur, there is the further question whether those proceeds in excess of approximately $ 168,000 were capital gains.FINDINGS OF FACTThe parties have filed a stipulation of facts which, together with its accompanying exhibits, is incorporated herein by this reference.Petitioners Iris Kraut and her husband Aaron Kraut resided in Oceanside, N.Y., at the time they filed their petition herein; petitioners88 Marian Kraut and her husband Harry Kraut resided in Flushing, N.Y., at the time they filed their petition herein. Both pairs of petitioners timely filed joint Federal income tax returns for the year 1967 with the district director of internal revenue at Brooklyn, N.Y.Aaron Kraut and his brother Harry together were in the business of developing and manufacturing electric wire of various types. For at least 20 years they had owned and acted as president and vice president, respectively, of Trio Wire & Cable Corp. (Trio), which was primarily concerned with the production of assorted types of wires and cables encased in plastic insulation. In addition to and as an offshoot of that business the Kraut brothers in or around 1960 formed a separate corporation, Christmas Wire Manufacturing Corp. (Christmas Wire), through which they hoped to penetrate the more specialized and very competitive market for wiring used in the manufacture of Christmas decorations. Although Trio itself did not produce such 422 wire, it owned the necessary machine, an extruder, which Christmas Wire made use of. The extruder was housed in a leased building, one of three separate but interconnected buildings89 on Meserole Avenue in Brooklyn in which Trio carried on its business. That machine appears to have been the only item of equipment used in the production of the Christmas wire, and the record fails to show that any appreciable number of employees was engaged in its operation.The heart of the manufacturing process for Christmas wire consisted of extruding a coat of plastic insulation around light gage wire. The Christmas decoration manufacturers who purchased the wire then attached light bulb sockets to it by means of small brass spurs on the sockets which punctured the plastic jacket and made contact with the electric wire inside. A major problem for manufacturers of such wire was the normally tough consistency of the plastic used which created difficulty in attaching the sockets and thus led to a high "rejection rate" in the decoration assembly process. As a result of various problems, primarily the rejection rate, the Kraut brothers brought production under Christmas Wire's name to an end sometime in the spring of 1965. Although the Krauts "sold" the Christmas Wire corporation at that time at a price not satisfactorily shown in the record, the purchaser never conducted operations90 at the Meserole Avenue location. The Krauts retained the use of Christmas Wire's premises as well as Trio's extruder which remained there. Within a very short time thereafter, possibly as little as several weeks and certainly no more than a few months, Harry and Aaron Kraut formed another corporation, Nassau Plastic & Wire Corp. (Nassau), which they intended would operate as an adjunct to Trio similar in fashion to Christmas Wire. As a matter of convenience, Nassau issued all of its stock, 200 shares, in equal amounts to Iris and Marian Kraut in return for their contributions to its capital of $ 100 apiece. Although neither Aaron nor Harry contributed to Nassau's capital, they nonetheless were the dominant figures in its activities, while their wives provided no services at all to it. Nassau occupied the same premises which Christmas Wire had previously used, and its only equipment was the extruder belonging to Trio which Trio had in the past supplied to Christmas Wire. Nassau required the extruder to manufacture Christmas wire with a new insulating material which, due to its easily penetrable consistency, promised to minimize the rejection problem associated with conventional91 plastic insulation. This new material was, however, "an unknown quantity," and its resistance to wear and decay over a period of several years was as yet unproven. Despite the new material's alleged superiority to the insulating material commonly in 423 use at the time, the Krauts did not obtain, nor apparently did they apply for, a patent on it.On its Federal income tax return for the fiscal year ended June 30, 1966, Nassau reported gross income of $ 26,189.84, which represented the difference between its sales of $ 492,305.16 and its cost of goods sold, $ 466,115.32. The cost of goods sold consisted entirely of merchandise bought for manufacture or sale; Nassau reported no expense for salaries and wages other than $ 2,600 paid to the Krauts, no expense for use of the extruder, nor any expense for the building in which it was kept. As of June 30, 1966, Nassau maintained no inventory whatsoever. After deducting the Krauts' salaries, taxes, depreciation on a car, and $ 5,913.40 of operating expenses, Nassau reported a taxable income of $ 15,831.56 and a resultant tax liability of $ 3,482.94.At some time in the early part of 1966, Management Methods, an investment counseling92 and legal firm located in New York City, brought to Rev. Rex T. Humbard, its client, a proposal for the purchase of Nassau. Reverend Humbard was the pastor of the Cathedral of Tomorrow (Cathedral), a federally tax-exempt religious organization in Akron, Ohio. Its activities included conducting Sunday services, a Sunday school, and youth groups, as well as sponsoring the worldwide telecast of its church services and supporting an extensive missionary program. Among its assets, Cathedral owned two businesses, at least one of which it had acquired in an entirely debt-financed transaction. After expressing his preliminary interest in the proposal concerning Nassau, Reverend Humbard with his associates undertook to examine Nassau's business more closely.Before the parties had entered a binding agreement, however, Iris and Marian Kraut executed an agreement with a party identified only as Wilson Mold & Die Corp. (Wilson), on May 31, 1966, purporting to sell to it their entire interest in Nassau, payments to commence on September 1, 1966. Beyond its participation in this contract, the record contains no evidence as to any and all particulars in respect of Wilson and its principals. 93 On the following day, June 1, 1966, Trio and Nassau executed an agreement whereby Trio leased to Nassau the extruder which Nassau had theretofore been using along with its accompanying apparatus. The lease was to run for a term of 5 years, to continue indefinitely thereafter but subject to termination by either party upon 60 days' written notice. Nassau agreed to pay Trio $ 500 per month. The lease further provided that:The Lessor [Trio] shall at all times have free access to the machines for the purpose of inspection or observation, or to make alterations, repairs, improvements, or additions, or to determine the nature or extent of use of the machines.424 Furthermore:The machines shall be used only by operators in the direct employ of the Lessee [Nassau], and only in the factory now occupied by it at its principal place of business, and shall be used only for the purpose of insulating and spooling copper wire, made by or for the Lessee.Iris and Marian Kraut signed on behalf of Nassau.Shortly thereafter, before the time of its performance had arrived, Nassau and Wilson abandoned their purported contract of sale. In a separate three-cornered agreement dated June94 15, 1966, only 15 days after the initial contract, Wilson assigned all of its rights and delegated all of its duties arising under the May 31, 1966, agreement to Cathedral; Iris and Marian Kraut agreed to release Wilson from the prior contract; and Cathedral convenanted to purchase Nassau's stock according to the following terms:The Buyer [Cathedral] shall take all such action as may be required so that on or as of June 25, 1966 Nassau Plastic shall be liquidated and all of its assets distributed to the Buyer. Simultaneously with the execution of this Agreement, the Buyer, with the consent of the stockholders and directors of the Sellers [Iris and Marian Kraut], shall take steps forthwith to accomplish the following:(a) Create a separate operating-manufacturing unit, owned by the Buyer, to be denominated and known as Nassau Plastic (hereinafter sometimes interchangeably referred to as "Nassau Plastic & Wire Co." * * ); the Buyer to file such documents with the proper governmental authorities as may be necessary to effectuate the same.(b) The name of Nassau Plastic & Wire Corp. shall be changed forthwith, to such name as the Buyer may designate. * * The purchase price for 95 all of the stock sold under this Agreement shall be not less than $ 500,000 (hereinafter called the "Minimum Price") nor more than $ 3 1/2 million (hereinafter called the "Maximum Price"). The purchase price shall be paid by the Purchaser to the Sellers at the following time in the following manner and to the extent set forth below:(a) For the period from June 25, 1966 to July 1, 1966, 100% of the net income of the Corporation shall belong to the Sellers; the Purchasers shall receive credit for said amount toward the purchase price.(b) $ 50,000 on or before August 1, 1966.(c) For the balance of the year 1966 and in each of the years 1967 through 1976 terminating however on June 30, 1976 inclusive, unless the Maximum Price be paid in full prior thereto; commencing with the 15th day of October 1966 and on the 15th day of each January, April, July and October thereafter in respect to each preceding quarterly period from July 1, 1966 through June 30, 1976, an amount equal to 75% of the Corporations [sic] net income before Federal income taxes for each of such next preceding fiscal periods. In the event a loss occurs in any quarterly period, said loss shall be utilized as an offset96 in each of the succeeding quarterly periods (until said loss has been recouped) before payments to the Sellers are resumed.425 (d) In any event and notwithstanding any provision in this Agreement with respect to the contingent deferral of installment payments of the Purchase Price, the full Minimum Price referred to above and any portion of the Maximum Price referred to above which Sellers may become entitled to receive shall be paid in full on or before July 15, 1976.(e) The Purchaser may prepay at any time all or any part of the unpaid amount of the Maximum Price.The terms of payment agreed to by Cathedral largely reflected the substance of Wilson's antecedent commitment, the one notable difference being that Wilson had agreed to pay 75 percent of its pretax earnings only through June 30, 1971, thereafter applying the same percentage to its after-tax income for the duration of the 10-year period.The ultimate transaction did not contemplate any cash outlay by Cathedral, either at the outset or in the event of default. Although the terms of the contract provided for an initial $ 50,000 payment on August 1 irrespective of Nassau's profits, Nassau's assets at the time of97 the purported sale included $ 50,089.75 of notes and accounts receivable plus $ 2,323.36 in cash. In point of fact, petitioners permitted Cathedral to postpone that payment until mid-October 1966, by which time Nassau had generated sufficient cash flow from which Cathedral could pay petitioners. Even though Iris and Marian Kraut retained a security interest in all of the assets, business, and goodwill of Nassau, their interest was subject not only to prior liens, but to "the rights of present and future general creditors for obligations arising in the regular course of business, and liens, collateral or security for the loan or loans advanced or to be advanced by any bank." Moreover, it was stipulated that, in the event of Cathedral's default in payments or otherwise, enforcement of the security agreement would constitute the seller's exclusive remedy "and in no event shall the Sellers seek any deficiency judgment or other judgment for damages against the Buyer." In addition thereto, Cathedral agreed to employ both Harry and Aaron Kraut as its chief executive officers, Aaron in the capacity of production manager and internal office manager and Harry as sales manager. As such, Cathedral98 granted them full authority and responsibility to direct the business of Nassau in every respect. For such services, Cathedral agreed to pay them each $ 5,200 yearly, their employment to terminate on the day following the date of Cathedral's final payment to Iris and Marian.At the time of this agreement, Nassau owned neither the building in which it operated nor the single piece of machinery with which it produced wire. Its interest in the machine consisted of the 5-year lease 426 from Trio described above. On its tax returns for the year ending June 30, 1966, it listed total assets in the amount of $ 53,867.56, of which notes and accounts receivable amounted to $ 50,089.75; the remaining assets consisted of cash and an automobile. In the same return, it reported $ 36,575.99 in accounts payable while its capital account showed $ 200 in respect of its common stock.Following the disposition of the stock, Nassau's operations continued at the same location with the same personnel using the same equipment, and apparently under the same or a very similar name. Harry and Aaron Kraut, as "Cathedral's employees," still managed the business. Under this arrangement the business99 met with early and quite remarkable success. Although on August 1 the business' cash flow apparently had been insufficient to provide Cathedral with the funds necessary to make the downpayment then due, on October 12 Harry Kraut drew two checks of $ 25,000 each on Nassau's account in favor of Cathedral which Reverend Humbard then endorsed as payable to Iris and Marian Kraut individually. During the remainder of 1966 Cathedral paid Iris and Marian an additional $ 97,500; in 1967 Cathedral paid them a total of $ 1,332,500, 1 which raised the overall level of payments to $ 1,480,000. After 1967, though, the business rapidly became unprofitable, and in 1969 it ceased operating altogether. The sudden turnabout in the business' fortunes was attributable, at least in part, to its competitors' ability to reduce the rejection rate of their Christmas wire through improved techniques and production quality. Ownership of Nassau's then-remaining assets, which were of negligible value, reverted to the original owners.100 In each of their respective joint income tax returns for 1967, petitioners reported the receipt of $ 666,250 from Cathedral, of which they treated $ 27,720.83 as interest and from which they deducted collection expenses of $ 32,112.50, primarily brokers' commissions. They then listed the net amount of $ 606,416.67 in each return as long-term capital gains and computed their tax liability according to the alternative tax provided in section 1201(b). In each of his deficiency notices, the Commissioner determined:that $ 595,776.09 of the amount collected in 1967 pursuant to the sale of your shares of stock in Nassau Plastics & Wire Corp. to the Cathedral of Tomorrow, Inc. in 1966, payments to be made out of the profits of the company sold, constitutes ordinary income to you in 1967. * In arriving at this amount, the Commissioner assigned to the stock of Nassau a selling price of $ 168,445.60, a value equal to 10 times the taxable 427 income of Nassau for the taxable year ended June 30, 1966. 2 He then made the following computation:Amount received in 1966 and 1967$ 1,480,000.00Less interest as reported56,904.161,423,095.84Amount deemed applicable to selling price of shares168,445.60Balance1,254,650.24Less expenses incurred in 196763,098.07Increase in ordinary income for 19671,191,552.1750% applicable to each shareholder595,776.09101 OPINIONThis case presents a factual variation of a common transaction, the heart of which is the debt-financed acquisition of a going business by a tax-exempt organization. Prior to the Tax Reform Act of 1969, churches described in section 501(c)(3), I.R.C. 1954, which were exempt from ordinary taxation were also singled out in section 511(a)(2)(A) for relief from taxation on so-called unrelated business taxable income. 3103 This provision enabled a qualified church to receive the income from the operation of a trade or business, itself unrelated to the church's exempt purpose, without incurring tax liability on the proceeds, provided the102 business was not conducted as a separate corporate entity. 4 Arrangements of this type held out to businessmen the prospect of relieving the tax burden on otherwise 428 taxable business profits by "selling" the business to a church, which could then pass on a substantial portion of those untaxed profits to the seller as deferred payment of the purchase price, ultimately resulting in tax liability of the seller only for long-term capital gains.In the case before us, the events of which transpired prior in time to the amendment of section 511(a)(2)(A), the Commissioner has challenged petitioners' decision to treat the payments received from Cathedral as long-term capital gains. He proposes two bases for this conclusion: First, that the totality of the dealings between the parties did not amount to a bona fide sale, without which long-term capital gain does not arise; 5 second, that in the event we find this transaction to exhibit the substance of a sale, the value of Nassau's stock was nevertheless limited to $ 168,445.60, and the payments which petitioners received in excess thereof were thus not "from the sale or exchange of a capital asset." To these contentions petitioners respond simply that there was a bona fide common law sale, that the agreed-upon price for Nassau's stock resulted from arm's-length negotiations between the parties and fell well within a reasonable range of values in light of Nassau's alleged potential sales volume. We, however, are not persuaded by the evidence before104 us that the Commissioner has erred.It is a cardinal rule that, in characterizing a transaction for purposes of taxation, we are obliged to look beyond the form in which the parties have chosen to cast it and to draw our conclusions from that which we perceive to be the substance of the matter. Griffiths v. Commissioner, 308 U.S. 355">308 U.S. 355, 357-358; Higgins v. Smith, 308 U.S. 473">308 U.S. 473, 476; Jack E. Golsen, 54 T.C. 742">54 T.C. 742, 754, affirmed 445 F. 2d 985 (C.A. 10). In particular here we must determine whether the parties effected a true sale of Nassau's stock. In its benchmark105 decision in this area, Commissioner v. Brown, 380 U.S. 563">380 U.S. 563, the Supreme Court addressed itself to the relevant characteristics of a sale, stating (380 U.S. at 571):"A sale, in the ordinary sense of the word, is a transfer of property for a fixed price in money or its equivalent," Iowa v. McFarland, 110 U.S. 471">110 U.S. 471, 478; it is a contract "to pass rights of property for money, -- which the buyer pays or promises to pay to the seller * * ," Williamson v. Berry, 8 How. 495">8 How. 495, 544. * Inherent in the Court's understanding of a sale is the notion of movement through exchange, the idea that, at the conclusion of the sale, the buyer possess that which was the object of the sale. And, indeed, 429 this comports well with the "common and ordinary meaning" of a sale. Commissioner v. Brown, supra at 571. On the strength of this definition, the Supreme Court characterized the transaction before it as a sale, and in so doing it underscored a variety of detail which impresses us as highly significant in analyzing the facts106 before us.At the outset, the Court recognized the necessity of construing the term "sale" in a manner consistent with the purpose of the capital gains provisions of the Code. That purpose is (380 U.S. at 572) --to afford capital gains treatment only in situations "typically involving the realization of appreciation in value accrued over a substantial period of time, and thus to ameliorate the hardship of taxation of the entire gain in one year." Commissioner v. Gillette Motor Co., 364 U.S. 130">364 U.S. 130, 134.Unlike the facts in Brown, in which the transferred business had an adjusted net worth of $ 619,457.63 which included $ 448.471.63 of accumulated earnings, at the time of the present transaction Nassau's balance sheet showed total assets of $ 53,867.56, accumulated earnings of $ 12,348.62, and a net worth of only $ 12,548.62. Yet the purported sales price was a flexible figure between $ 500,000 and $ 3,500,000 as opposed to the correspondingly more realistic price of $ 1,300,000 in Brown. While the absence of accrued value is not conclusive with regard to the existence of a sale, it quite clearly demonstrates 107 that the consideration here reflected whatever future income Nassau might produce rather than the typical capital gains situation "involving the realization of appreciation in value accrued over a substantial period of time" as was the case in Brown. 6 We think that such a transaction may most accurately be described as a retained proprietary interest by the shareholders in the business' future earnings rather than the creation of a creditor's interest in future earnings born of past accrued value of a capital asset. To treat such as a sale is at odds with the very purposes of the Code in allowing capital gains treatment for realization of the enhanced value of a capital asset.The Court in Brown further108 stressed the express finding of the Tax Court that the price paid was within reasonable limits based on the earnings and net worth of the company. 380 U.S. at 572-574. In the context of a purchase to be financed entirely and exclusively from the earnings of the business acquired, this factor properly focuses attention upon what Justice Harlan referred to as the purchaser's "residual interest." Commissioner v. Brown, supra at 581 (concurring opinion). While Justice Harlan agreed with the majority's conclusion that a 430 sale had occurred, he offered the following analysis which we deem to be especially helpful in the case before us:the Government might more profitably have broken the transaction into components and attempted to distinguish between the interest which [the taxpayers] retained and the interest which they exchanged. The worth of a business depends upon its ability to produce income over time. What [the taxpayers] gave up was not the entire business, but only their interest in the business' ability to produce income in excess of that which was necessary to pay them off under the terms of the transaction. 109 The value of such a residual interest is a function of the risk element of the business and the amount of income it is capable of producing per year, and will necessarily be substantially less than the value of the total business. Had the Government argued that it was that interest which [the taxpayers] exchanged, and only to that extent should they have received capital gains treatment, we would perhaps have had a different case.It follows therefrom that to the extent the so-called sales price is excessive, albeit agreed upon, the purchaser's residual interest is correspondingly diminished. Despite inadequacies in the record before us, there is sufficient evidence to create serious doubt in our minds that Nassau's expected earnings even approximated, no less exceeded, the level necessary to render payments to the Krauts of $ 3,500,000. And to the extent the clouded record precludes us from making any specific finding with reasonable confidence in this respect, we find that petitioners have failed to sustain their burden of proving that the facts were otherwise.In urging upon us the reasonableness of the contract price, petitioners have relied heavily upon Aaron Kraut's projection110 of Nassau's earnings from its new Christmas wire, which valuation is supported, they argue, by the fact that Wilson Mold & Die Corp., an allegedly nonexempt corporation subject to the constraints of taxation, agreed to substantially the same terms as did Cathedral in a contract to purchase Nassau. At trial, Aaron Kraut testified that, based upon the customer acceptance of Nassau's new wire and the growing backlog of unfilled orders in the first half of 1966, he expected Nassau to yield gross profits of $ 10 million during the ensuing 10 years. We, however, simply do not believe this evidence. Petitioners introduced neither documentary nor other specific evidence of Nassau's allegedly skyrocketing business of early 1966. And Aaron Kraut's narrowly selective and seemingly self-serving memory rendered his testimony wholly unsatisfactory. On the one hand, he repeatedly professed his complete ignorance even of Trio's and Nassau's most general financial concerns, such as the information in tax returns which he himself had signed, explaining that his brother Harry handled all financial matters while he was engaged exclusively in the production end of the business. 7431 Yet, 111 with respect to the central question of the case, Nassau's earning capacity over a period of 10 years, he presumed to ask the Court to rest content entirely on the strength of his knowledge of that matter. The valuation of a business is a delicate and sophisticated calculation, the more so with only 1 year's operation from which to extrapolate, and we are hardly inclined to credit Aaron Kraut with the necessary knowledge or ability to lend the slightest probative value to his testimony.112 Insofar as Wilson is concerned, we are faced with unexplained silence. The record is barren of evidence with respect to Wilson. We do not know what business, if any, it conducted, who its principals were and what relationship, if any, existed between them and Cathedral or other persons involved in these transactions, and what negotiations, if any, preceded the signing of the contract. All we do know is that a party referred to as Wilson Mold & Die Corp. signed a contract to purchase Nassau's stock and 15 days later assigned the entirety of its interest in the contract to Cathedral. In the absence of any explanatory evidence (which was peculiarly within the control of petitioners) and in view of the two contracts' all too convenient timing, it is strongly suggestive the initial Wilson contract was merely a bootstrap effort to bolster petitioners' contention as to Nassau's fair market value, and we consequently must discount its evidentiary value.In addition to petitioners' failure to produce credible evidence supporting the value they have tried to attach to Nassau, what evidence the record does provide in respect of this issue compels us to conclude that petitioners have failed113 to show that the contract price of as much as $ 3,500,000 was not grossly excessive. Nassau was a company which, in its 1 year of existence, had managed to generate profits of less than $ 16,000 before taxes, with total assets amounting to slightly more than $ 50,000 and a net worth of $ 12,548.62. Its only fixed asset was an automobile. Its sole product was still experimental in June of 432 1966, untested in actual use over a period of time. Most significantly, though, was the fact that the Krauts neither obtained, nor apparently did they apply for, a patent on the new wire of such allegedly explosive sales potential, nor was it shown that production depended on a trade secret. Petitioners offered no explanation for such omission. Even assuming, arguendo, that this wire possessed the marketing potential urged by petitioners, without the protection afforded by a patent (and without any convincing evidence showing that production of the wire was based on a secret process) Nassau's competitors could have appropriated such a valuable process and a corresponding share of the market for such wire.The decision in Brown rested as well upon a finding that the transaction 114 had effected a real change of economic benefit, that the tax-exempt organization involved there was motivated by the genuine prospect of owning outright the substantial assets of a business after paying the purchase price in full. The record does not support a similar conclusion in the instant case.Cathedral had no prospect of ending up with the substantial assets of an active business simply because Nassau owned no manufacturing assets at the time of the purported sale. Nassau's only fixed asset was an automobile; it owned no manufacturing equipment, no building, no inventory. The single piece of machinery employed in production was the extruder which it leased from Trio. By the terms of that lease, Trio had the right to determine the nature or extent of use of the machine and Nassau could make no additions or alterations to the extruder without the permission of Trio. After the initial 5-year period ending on May 31, 1971, either party could unilaterally cancel the lease. In effect, the Kraut brothers, through their wholly owned corporation, Trio, had reserved the power to terminate the lease and to repossess Nassau's sole source of income at any time after May 31, 1971. 115 In that event, there would have been small likelihood that Nassau's two key employees, Aaron and Harry Kraut, would have remained with Nassau and applied their skills to rebuilding the business around a new extruder, even if one were available. 8 Reduced to its essentials, this arrangement in substance would have permitted petitioners, after 5 years, to deprive Cathedral of its newly acquired business, the value of which would have been obvious had the enterprise been sufficiently profitable to permit Cathedral to pay the Krauts in full.433 On the other hand, although in Brown the Supreme Court rejected the argument that risk-shifting was an essential element of a bona fide sale, the transaction there nevertheless contemplated the payment by the exempt organization of a fixed price that was deemed116 to have a reasonable relationship to the subject matter of the sale. In the present case, however, the wholly unrealistic sales price coupled with the so-called sellers' remedy in the event of Cathedral's default makes it obvious that what we have here is a transaction designed, on the one hand, to insure Cathedral against any expense in the event Nassau failed to generate sufficient sales and, on the other hand, to provide the Krauts with the practical opportunity of recapturing the substance of Nassau's business in the event it proved profitable beyond the unrealistic level fixed in the contract. Our difficulty in discerning a sale in this arrangement is not that risk-shifting is absent; it is that nothing of substance has shifted other than a portion of the business' profits to Cathedral for a limited period of time. And the latter was merely the price that the Krauts paid for the opportunity of claiming capital gains treatment in respect to future speculative profits that might be realized by the enterprise. Petitioners have thus failed entirely to demonstrate that their arrangement with Cathedral contemplated the prospect of Cathedral retaining any residual interest in Nassau. 117 It follows therefrom that the transaction lacked the essentials of an exchange upon the basis of which a sale might be founded.In a recent decision of this Court, Louis Berenson, 59 T.C. 412">59 T.C. 412, appeal pending (C.A. 2), the majority refused to recognize the bona fides of a purported sale of a business to a tax-exempt organization. In distinguishing the holding in Brown, the Court found that the agreed-upon price was "grossly excessive," bearing no relationship to the value of the assets sold or to the earnings history of the business. The Court concluded therefrom that the sale was merely a sham. In the present case the facts are even stronger than those relied upon in Berenson. Not only have petitioners here failed to demonstrate that the agreed-upon price was not grossly excessive, but moreover they have not shown by satisfying evidence that Cathedral entertained even a remote prospect of actually acquiring anything of value. Cathedral's residual interest in Nassau was purely nominal, and we think the facts therefore fall within the rule of Kolkey v. Commissioner, 254 F. 2d 51 (C.A. 7), affirming 27 T.C. 37">27 T.C. 37.118 The Seventh Circuit there decided that when, in a debt-financed acquisition by an exempt organization, the sales price is so grossly inflated that the purchaser's prospect of finally owning the business outright is at best remote, the transaction does not amount to a sale. Likewise in the 434 instant case, we are not persuaded that petitioners formulated the terms of payment for any purpose other than to secure this right to receive 75 percent of Nassau's profits throughout the specified period. It is our opinion that the transaction never contemplated the actual transfer to Cathedral of a going business in fact. Far from comprising a sale, this was quite plainly an agreement to pay Cathedral a fee in return for lending its exemption to Nassau's earnings. This is not to say that every debt-financed acquisition of a business by a charitable organization which is payable exclusively from its future earnings is a tainted sale. But the sweep of Commissioner v. Brown, 380 U.S. 563">380 U.S. 563, is not unlimited, and we do not believe that either the logic or the intent of the Court's decision there compels a finding for the petitioners before us. The Supreme119 Court itself in Brown recognized the appropriateness of a contrary result in cases like Kolkey, 380 U.S. at 574 fn. 7, and, in our view, there was here similarly lacking a bona fide sale.Although our finding that petitioners have failed to prove the existence of a bona fide sale to Cathedral is conceptually sufficient to render the entire net proceeds of the transaction taxable as ordinary income to Iris and Marian Kraut, the decisions to be entered herein will necessarily be limited by the Commissioner's computation in the deficiency notices. The Commissioner there determined an amount, $ 168,445.60, applicable to the selling price of the stock of Nassau (on the theory that there was a bona fide sale only to the extent of that amount), and only the proceeds in excess thereof, after deducting collection expenses of $ 63,098.07, and interest of $ 56,904.16, were deemed to be ordinary income to each of the shareholders. In the proceedings in this Court, the Commissioner contended alternatively that the entire transaction was lacking in bona fides -- a conclusion which we have found to be valid and which would justify charging petitioners with the120 entire net proceeds undiminished by any so-called true selling price of $ 168,445.60. 9However, the Commissioner has not sought to amend the pleadings to ask for increased deficiencies, and 435 in the circumstances the redetermination of deficiencies herein will be limited accordingly. Sec. 6214(a); Rule 41(a) and (b), Tax Court Rules of Practice and Procedure. Cf. Commissioner v. Long's Estate, 304 F. 2d 136, 141-142 (C.A. 9), affirming an unreported Tax Court Opinion. We wish to add that in neither Commissioner v. Brown, 380 U.S. 563">380 U.S. 563, nor in Louis Berenson, 59 T.C. 412">59 T.C. 412, did the respective Courts have before them an allocation by the Commissioner to the purchase prices therein, and our conclusion in these proceedings that the entire transaction lacked bona fides should not be interpreted as being inconsistent with the propriety of making an allocation if the facts in a particular case are thought to justify such action.121 Due to concessions in another respect made prior to trial,Decisions will be entered under Rule 155. Footnotes1. This is a gross amount against which there should be charged $ 64,225, the related expenses of collection, leaving a net amount of $ 1,268,275.↩2. Nassau's Federal income tax return for the year ended June 30, 1966, indicated taxable income of $ 15,831.56, which, multiplied by 10, equals only $ 158,315.60. The Commissioner, on brief, noted the discrepancy between this amount and the figure used in computing the deficiencies, but he does not now contend that the value of Nassau's stock should be limited to the lower figure.↩3. Part III of subch. F of ch. 1 of the Income Tax Subtitle of the Internal Revenue Code, consisting of secs. 511 through 515, extends taxation to the business income of certain exempt organizations. The critical language therein is "unrelated business taxable income," a defined term denoting income from a trade or business carried on by the exempt organization but which trade or business is not substantially related to the organization's exempt purpose. Sec. 511(a)(1) contains the operative language of part III, imposing a tax on the unrelated business taxable income "of every organization described in paragraph (2)." Sec. 511(a)(2), as effective in 1967, provided in relevant part:(2) Organizations subject to tax. -- (A) Organizations described in section 501(c) (2), (3), (5), (6), (14) (B) or (C), and (17), and section 401(a). -- The taxes imposed by paragraph (1) shall apply in the case of any organization (other than a church, a convention or association of churches, or a trust described in subsection (b)) which is exempt, except as provided in this part, from taxation under this subtitle by reason of section 401(a) or of paragraph (3), (5), (6), (14) (B) or (C), or (17) of section 501(c). Such taxes shall also apply in the case of a corporation described in section 501(c)(2) if the income is payable to an organization which, itself is subject to the taxes imposed by paragraph (1) or to a church or to a convention or association of churches. [Emphasis supplied.]The Tax Reform Act of 1969, sec. 121(a)(1), repealed the preferred status of churches in respect of unrelated business income by deleting the parenthetical exception in sec. 511(a)(2)(A).↩4. Sec. 1.511-2(a)(3)(ii), Income Tax Regs.↩5. SEC. 1222. OTHER TERMS RELATING TO CAPITAL GAINS AND LOSSES.For purposes of this subtitle -- * * * *(3) Long-term capital gain. -- The term "long-term capital gain" means gain from the sale or exchange of a capital asset held for more than 6 months, if and to the extent↩such gain is taken into account in computing gross income.6. In this respect, we regard the $ 3 million range within which the purchase price was allowed to vary as incompatible with a sale of Nassau's past accrued value and goodwill. Rather, it is highly suggestive of an arrangement by which the Krauts retained a most substantial interest in Nassau's future profits.↩7. Another instance of Aaron Kraut's remarkably inconsistent memory arose in respect of the sale of Christmas Wire, an event no more than 8 years past at the time of trial. He at first professed to have no recollection whatever of the purchase price, but after persistent questioning by the Court, prompted by the witness' startling total lapse of recall, he finally testified that the price was somewhere between $ 100,000 and $ 1 million. We did not find him a credible witness and are unwilling to ground our findings on what is so obviously contrived testimony.We also mention that, although the Government had subpoenaed Harry Kraut to appear at trial, the Government's attorney explained that he had not sought to enforce the subpoena. Inasmuch as it was represented that Harry was scheduled to appear at a trial elsewhere at the same time, the Government attorney relied upon petitioners' counsel's assurance that Aaron was every bit as knowledgeable as Harry with respect to the details of Nassau's business. At trial, petitioners' counsel did not contest the accuracy of such representation, and we simply note that petitioners must bear the consequences of their failure to adduce credible evidence of Nassau's value.↩8. The extruder here under discussion had been specially tooled for the production of this wire, and the record leaves in doubt whether an extruder adapted as such might be readily available for purchase or rental.↩9. As noted above, pp. 426-427, the Commissioner attempted to fix a selling price in terms of 10 times indicated taxable income. But, as pointed out in fn. 2, supra, such taxable income was $ 15,831.56, and 10 times that amount would be $ 158,315.60. Moreover, the usual method of computing value in terms of a multiple of earnings is to use an after-tax↩ earnings figure, and if Nassau's $ 3,482.94 tax liability is subtracted from $ 15,831.56, there would remain net earnings of only $ 12,348.62. Accordingly, the 10 times earnings formula would yield a value of $ 123,486.20. It seems hardly likely that any greater multiple than 10 would be justified in the light of the fact that the stock was closely held, that the company's net assets were very modest in amount, that its only physical asset of any consequence was a secondhand automobile, that its successful operation obviously depended upon the continued management of the enterprise by the Krauts, that it had such a brief history, and that its sole product was untested over a sufficiently lengthy period.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621274/	Herzog Building Corporation, Petitioner, v. Commissioner of Internal Revenue, RespondentHerzog Bldg. Corp. v. CommissionerDocket No. 92607United States Tax Court44 T.C. 694; 1965 U.S. Tax Ct. LEXIS 43; August 2, 1965, Filed 43 Decision will be entered under Rule 50. 1. Before approving petitioner's subdivision plan or issuing building permits, the village required provision for an adequate sewerage system. To make possible the development of its property, petitioner agreed to buy sewerage revenue bonds, so that the village could build such a system. Petitioner did not desire to invest in sewerage revenue bonds. Held, the amount which petitioner agreed to pay for the bonds was properly allocated to the cost basis of land.2. An amount which petitioner estimated it would become obligated to pay under an agreement to reimburse a related company for the additional costs incurred in making certain changes in the sewerage system held not properly allocable to the cost basis of land.3. Profit on the May 1956 sale of part of the Forke Farm held ordinary income.4. Profit on the sale of 6.014 acres of the Haverly Farm held ordinary income. Henry J. Jostock, for the petitioner.Seymour I. Sherman, for the respondent. Forrester, Judge45 . FORRESTER694 The respondent has determined deficiencies in petitioner's income taxes for the calendar years 1955 and 1956 in the respective amounts of $ 63,821.98 and $ 117,233.44. The issues to be decided are (1) whether petitioner may deduct any part of an amount it agreed to pay for sewerage revenue bonds by allocating a part of such amount to its cost of lots sold to home buyers in 1955 and 1956; (2) whether petitioner may, by a similar procedure, deduct part of an amount it estimated it would become obligated to pay, under an oral agreement, as reimbursement to a related company for additional expenses incurred in the construction of a sewerage system; (3) whether petitioner is entitled to treat as a capital gain its profit on the sale of 53.12 acres of the Forke Farm in 1956; and (4) whether petitioner is entitled to treat as a capital gain its profit on the sale of 6.014 acres of the Haverly Farm in 1956. A fifth issue was raised by the petition; but in view of petitioner's failure to present evidence or argument relating to such issue, we deem it to have been abandoned.FINDINGS OF FACTSome of the facts have been stipulated and are so found.Petitioner is a corporation46 organized in 1951 under the laws of the State of Illinois; its principal office in 1955 and 1956 was in Des Plaines, Ill. Petitioner filed its corporate income tax returns for the calendar years 1955 and 1956 on an accrual basis with the district 695 director of internal revenue, Chicago, Ill. During 1955 and 1956, and for several years prior thereto, petitioner was engaged in the business of acquiring unimproved land, subdividing the land, building houses thereon, and selling the houses. At all material times, E. A. Herzog (hereinafter sometimes referred to as Herzog) owned, directly or through nominees, all of petitioner's outstanding capital stock.On November 30, 1954, petitioner acquired approximately 100 acres of land near the village of Wheeling, Ill. (hereinafter sometimes referred to as the village or Wheeling), for the purpose of subdivision and construction and sale of houses. Upon acquiring the property, known as the Forke Farm, petitioner caused it to be rezoned from farming to residential. In January 1955, petitioner acquired a 262-acre parcel of land known as the Techny Farm. The Techny Farm was about one-half to three-quarters of a mile west of the Forke47 Farm. At some undisclosed time it was annexed to the village of Wheeling. On May 23, 1955, petitioner acquired a 69-acre tract, known as the Haverly Farm, situated directly west of the Techny Farm.In 1955, Wheeling had a population of about 900. It then had no sewers or sewerage disposal facilities and no funds available to provide a sewerage system. Early in 1955, petitioner applied to the village for approval of its subdivision plan for the Techny Farm and for the issuance of appropriate building permits. At a meeting of the trustees of the village in January 1955, Herzog, who was petitioner's president, was told that the subdivision would not be approved and building permits would not be issued until provision was made for an adequate sewerage system. Herzog was also told that the village had no funds for building such a system, that the only way to raise the money was by issuing bonds, and that no one had been willing to buy sewerage revenue bonds of the village. It was suggested that petitioner could buy the bonds, and at a subsequent meeting in January or February 1955, Herzog notified the village that petitioner would do so. Engineers employed by the village drew up48 plans for a sewerage system and estimated the cost thereof at $ 542,000. The plans and estimate were dated February 1955. By agreement dated April 11, 1955, petitioner agreed to purchase $ 542,000 of sewerage revenue bonds from the village. Petitioner's primary purpose for agreeing to buy such bonds was to enable it to develop its land. Subsequently, petitioner proceeded to subdivide and develop the Techny Farm for residential construction.In or about June 1955, Wheeling's board of trustees passed an ordinance authorizing the issuance of 5-percent sewerage revenue 696 bonds 1 in the amount of $ 542,000. Between June 30, 1955, and December 31, 1955, petitioner purchased a total of $ 282,000 of such bonds. Petitioner bought an additional $ 57,000 of bonds in 1956 and $ 59,000 in 1957, raising the total amount of bonds purchased to $ 398,000. Bonds in the amount of $ 144,000 were unissued as of July 13, 1957.49 The ordinance authorizing issuance of the Wheeling sewerage revenue bonds provided that 14 bonds per year would be redeemed from 1960 to 1990, 22 bonds per year from 1991 to 1994, and 20 bonds in 1995, and that all bonds could be redeemed on any interest date after December 31, 1959. It was further provided that additional sewerage revenue bonds could be issued, and if issued, such bonds would share ratably in the earnings of the sewerage system. Because the foregoing provisions were deemed unacceptable by many purchasers of and dealers in municipal bonds, and because in June 1955 there were not enough customers of the sewerage system to assure payment of principal or interest on the bonds, and because there was no convenient way to force sewerage system customers to pay their bills, the bonds issued by Wheeling were not considered marketable. The bonds were not worthless in 1955, but they were worth substantially less than face value. Whether or not they would become more valuable was largely dependent upon petitioner's success in selling houses in its subdivision project.In October 1956, petitioner engaged the services of Paul D. Speer (hereinafter referred to as Speer), a 50 municipal finance consultant, for the purpose of finding a way to liquidate its interest in the Wheeling sewerage revenue bonds. It was ultimately arranged for petitioner to sell its bonds, subject to the obligation to purchase the balance of the issue, to McDougal & Condon, Inc., a corporation which dealt in municipal bonds, and for the issue then to be refunded by the village through the issuance of $ 650,000 of water and sewerage revenue bonds under an acceptable ordinance. The agreement between petitioner and McDougal & Condon, Inc., was executed by May 16, 1957. On or about July 12, 1957, petitioner sold to McDougal & Condon, Inc., $ 398,000 face amount of village of Wheeling sewerage revenue bonds together with petitioner's right to purchase the remaining $ 144,000 of such bonds still unissued. McDougal & Condon, Inc., paid petitioner in respect of this transaction $ 289,000 and agreed to assume 697 petitioner's responsibility with respect to said unissued bonds in the amount of $ 144,000.In June 1955, E. A. Herzog Construction Co. (hereinafter referred to as Construction) contracted with the village of Wheeling to build the sewerage system previously referred to. 51 At all material times, E. A. Herzog owned, directly or through nominees, all of the outstanding capital stock of Construction. Construction was to be paid by Wheeling with the funds derived from the sale of its sewerage revenue bonds. After the ordinance authorizing the bonds had been passed, and after work on the sewerage system had commenced, the village requested certain changes in the depth, location, and directional flow of some of the sewer trunklines. The additional expense necessitated by such requested changes was estimated at $ 75,000. This amount was not covered by the original bond issue, and the village did not have other available funds sufficient to meet the increased cost. Authorization of an additional bond issue would have entailed considerable delay.Petitioner had by this time sold a number of houses in the subdivision; its schedule of promised delivery dates made no allowance for delays. Under these circumstances, petitioner's president orally agreed that petitioner would reimburse Construction for the additional cost of incorporating the requested changes into the sewerage system.As of December 31, 1956, petitioner estimated that Construction would incur52 costs of $ 75,000 in addition to the $ 542,000 originally estimated as the cost of building the Wheeling sewerage system. The sewerage system was completed sometime in 1957. On October 27, 1957, Wheeling and Construction canceled their contract respecting the sewerage system. During petitioner's fiscal year 2 ending March 31, 1958, the precise amount of such additional costs was ascertained, and such amount was then paid or credited by petitioner to Construction. The amount so paid or credited was about $ 74,000.Despite the fact that, when petitioner acquired the Forke Farm in November 1954, it was for the purpose of subdivision and development, petitioner neither subdivided nor improved the Forke Farm. Petitioner made the following sales out of the Forke Farm to an53 unrelated homebuilder:DateAcreagePriceMay 3, 195512.23$ 30,575.00Sept. 1, 195533.0982,725.00May 195653.12132,790.37698 Of the 69 acres comprising the Haverly Farm, 59 were subdivided and developed as residential land and 10 acres were reserved for a shopping center. On October 1, 1956, 6.014 out of the 10 acres reserved for a shopping center were sold to an unrelated party, which constructed a shopping center thereon. Under the terms of the sale, petitioner was required to extend adequate water mains and sewers to the property sold.Petitioner added $ 542,000, representing the entire amount of Wheeling sewerage revenue bonds it had agreed to purchase, to its cost of land. Portions of such amount were allocated to the cost of lots sold, and in this manner petitioner charged off as such costs $ 120,482.01 in 1955 and $ 267,312.83 in 1956. On its 1956 return, petitioner reduced the $ 267,312.83 by tax-exempt interest it received on the bonds during 1956 in the amount of $ 19,187.50, so that the amount actually included in cost of goods sold in 1956 was $ 248,125.33. In the statutory notice of deficiency, respondent determined that petitioner 54 had overstated its cost of goods sold to the extent it had included therein any part of the cost of purchasing the Wheeling sewerage revenue bonds.As of December 31, 1956, petitioner allocated the $ 75,000, by which it estimated the cost to Construction of completing the sewerage system would exceed the original estimate of $ 542,000, on its books in the following manner: $ 53,661.65 was included as part of cost of homes sold during 1956; the balance, $ 21,338.35, was added to the cost of unsold property. In the statutory notice of deficiency, respondent determined that petitioner was not entitled to include the foregoing amount of $ 53,661.65 in its cost of homes sold.On its return for 1955, petitioner reported as ordinary income the gain from the two sales out of the Forke Farm made during the year. Petitioner reported no sales of capital assets on its 1955 return. On its return for 1956, petitioner reported as long-term capital gain the profit from the May 1956 sale of the final 53.12 acres of the Forke Farm. Petitioner also reported as long-term capital gain on its 1956 return the profit from the sale of 6.014 acres of the 10 acres of Haverly Farm reserved for a shopping 55 center. Respondent determined that the gains from the 1956 sales of both the 53.12 acres and the 6.014 acres were ordinary income from sales in the ordinary course of petitioner's real estate business.OPINIONThe first issue concerns the correctness of respondent's determination that petitioner improperly included in its 1955 and 1956 cost of lots sold certain portions of the amount it had agreed to pay for Wheeling sewerage revenue bonds.We must first dispose of a preliminary matter. During the course of the trial we allowed petitioner's chief accountant to testify as to what transpired at certain meetings of the board of trustees of the 699 village of Wheeling. Both the witness and petitioner's president were present at these meetings, which took place early in 1955. Respondent objected to the admissibility of such evidence on the ground that it was not the best evidence. Respondent argued that minutes are frequently taken at such meetings, and the minutes would be the best evidence of what took place at the meetings. According to respondent, oral testimony concerning the meetings was not admissible in the absence of a showing by petitioner either that no minutes were56 kept or that the nonproduction of the minutes was not due to any fault or neglect of petitioner. Respondent's objection is without merit.The so-called best evidence rule is stated by McCormick, Evidence, sec. 196, p. 409, as follows:in proving the terms of a writing, where such terms are material, the original writing must be produced, unless it is shown to be unavailable for some reason other than the serious fault of the proponent. * This rule has no applicability to evidence of events or happenings which took place at such a meeting as is here in issue (as opposed to the end result or product, accomplished at such meeting) even where there happens to be a written or electronic transcription. McCormick, Evidence, sec. 198, p. 410. Petitioner is not trying to prove the contents of any minutes as such, but only the general tenor of what transpired at the meetings. 3 It may perhaps be true that minutes, if any, would provide a more accurate and reliable account of the events in question, but our system of evidence has no general rule requiring that the most accurate and reliable evidence in existence is the only evidence admissible to prove a fact. See Allen v. W. H. O. Alfalfa Milling Co., 272 F. 2d 9857 (C.A. 10, 1959); McCormick, Evidence, secs. 195-198; 4 Wigmore, Evidence, secs. 1173, 1174, 1179-1180, 1242 (3d ed. 1940).As to the merits, it is firmly established that the costs of streets, sidewalks, public parks, and recreation areas are properly considered part of a subdivider's cost of lots sold. See Country Club Estates, Inc., 22 T.C. 1283">22 T.C. 1283, 1293 (1954). Also, payments to utility companies to extend services to a new development are allocable to the cost of lots sold, even though the developer receives contingent rights to partial or complete reimbursement. Albert Gersten, 28 T.C. 756">28 T.C. 756, 766 (1957),58 another issue modified 267 F. 2d 195 (C.A. 9, 1959); Colony, Inc., 26 T.C. 30">26 T.C. 30, 44 (1956), affirmed on other grounds 244 F. 2d 75 (C.A. 6, 1957), reversed on other grounds 357 U.S. 28">357 U.S. 28 (1958); Rev. Rul. 60-3, 1 C.B. 284">1960-1 C.B. 284. See also Hallcraft Homes, Inc., 40 T.C. 199">40 T.C. 199 (1963), affd. 336 F. 2d 701 (C.A. 9, 1964). Finally, it has consistently been 700 held that the cost of constructing a water or sewerage system for a new development may be added to the cost of lots sold, although the developer retains title to the facility, so long as the project was undertaken primarily to further the sale of lots or houses and the rights retained do not amount to "full ownership and control" of the facility constructed. Willow Terrace Development Co. v. Commissioner, 345 F. 2d 933 (C.A. 5, 1965), affirming 40 T.C. 689">40 T.C. 689 (1963); Commissioner v. Offutt, 336 F. 2d 483 (1964), affirming a Memorandum59 Opinion of this Court; Estate of M. A. Collins, 31 T.C. 238">31 T.C. 238 (1958). On the other hand, where a developer retained full ownership and control over the assets comprising a water supply system built in order to make its lots salable, it was held that the costs of the system could not be allocated to the cost of lots sold. Colony, Inc., supra at 46.It is respondent's position that, because petitioner agreed to and did buy sewerage revenue bonds rather than build the sewerage system itself, and because petitioner at all times during the taxable years exercised full ownership and control over the bonds, petitioner may not, under Colony, Inc., supra, allocate the agreed price of the bonds to its cost of lots sold. We disagree, for the reasons hereinafter stated.The evidence in the instant case convincingly establishes that the village of Wheeling would not have approved petitioner's subdivision plans, nor would it have issued building permits, until it was certain that an adequate sewerage system would be provided for the new area. We are satisfied that petitioner's purpose in agreeing to buy60 the Wheeling sewerage revenue bonds was to make possible the construction and sale of houses in the proposed subdivision, and was not to make an investment in the bonds. Considering this state of facts, we believe the soundest analysis of the case at bar will result from treating petitioner as having agreed to pay directly the costs of building the sewerage system. In this manner, the bundle of rights represented by the sewerage revenue bonds received by petitioner may be viewed in the most realistic perspective.We are of the opinion that the instant case is in all material respects indistinguishable from Albert Gersten, supra. In Gersten, four corporations contracted with a water company to pay the water company's costs of extending its lines to subdivisions being developed by the corporations. The water company agreed in return to extend its lines, and also agreed to make payments to the corporations of approximately one-third of the gross receipts from the sale of water to houses in the particular subdivisions. Such payments were to be made for a maximum period of 10 years, but in no event were the corporations to receive more than the amounts61 they had originally paid. The corporations did not hold title to the facilities. The contracts were fully 701 transferable by the corporations; similar contracts were bought and sold; and the Court found that, 1 to 3 years after they were entered into, the contracts had fair market values at least equal to 50 percent of the maximum unpaid amounts. We held, for the petitioners, that the payments by the corporations to the water company were properly added to the cost of the subdivision property sold. The controlling facts were stated to be "that the corporations made unconditional payments to provide utility service for the subdivisions, and such payments were directly related to the property sold." 28 T.C. at 767. See also Rev. Rul. 60-3, supra.Respondent, in emphasizing that petitioner in the instant case exercised full ownership and control of the sewerage revenue bonds, seeks to gloss over the fact that petitioner's only interest in the sewerage facility itself was a debt security, giving petitioner the right to be paid principal and interest out of the revenues of the system. The payments made62 by petitioner, in exchange for which it received certain rights (represented in this case by sewerage revenue bonds), were made to enable petitioner to build and sell houses on its land. The payments in Gersten were of the same nature, except that the rights received by the corporations there were embodied in contracts of a different form.We do not deem it a material distinction that the contracts in the instant case provided for interest, for repayment according to a schedule, and for complete repayment out of revenues without a time limit, whereas the contracts in Gersten did not contain such provisions. These differences did not prevent the bonds received by petitioner from having value at time of issue substantially below the amounts paid by petitioner. 4 Nor did they guarantee that petitioner would be repaid a larger proportion of its payments or at a faster rate than the corporations in Gersten. In both cases, such factors were largely dependent upon the success of the subdivisions, a fact which further emphasizes the close relationship between the payments in question and the sale of the properties. Petitioner's income from the sale of lots will be more clearly63 reflected if a proportionate part of the amount it agreed to pay for the bonds is included in the basis of each lot sold. Cf. Willow Terrace Development Co. v. Commissioner, supra;Colony, Inc., supra at 48.Respondent contends that, in any event, it is improper to permit petitioner to 64 allocate $ 542,000, the amount petitioner agreed to pay to 702 the village, to the cost of lots prior to the time the full amount was paid. It is clear that petitioner was obligated to pay the entire amount, and that the amount was related to all the lots in the subdivision. Under circumstances like these, where a builder is committed to making an expenditure for the benefit of a real estate development, it is well settled that the estimated expense may be added to the basis of the land prior to actual payment. Colony, Inc., supra at 44; Cambria Development Co., 34 B.T.A. 1155 (1936). 5 Such treatment permits the income from the sale of each lot accurately to reflect a portion of all related costs.The fact that petitioner eventually paid less than the full amount it had agreed to pay for the bonds does not, under the circumstances, affect the result. Respondent does not contend65 that as of the end of 1955 it was probable that petitioner would not have to buy the entire bond issue. Petitioner did not engage Speer, the municipal finance expert who was to find a way for petitioner to liquidate its interest in the bonds, until October 1956; the agreement to sell the bonds to McDougal & Condon, Inc., was not executed until May 1957. Petitioner's sale of its interest in the bonds was a separate, subsequent transaction which should not affect the allocation to basis in 1955. Cf. Willow Terrace Development Co. v. Commissioner, supra;Cambria Development Co., supra.Although the taxable period during which petitioner disposed of its interest in the bonds is not before us, petitioner on brief seems to concede that the amounts received for the bonds constituted ordinary income. See Hallcraft Homes, Inc., supra.We hold on this first issue for petitioner.The second issue is whether petitioner is entitled to allocate to its cost of lots, as of December 31, 1956, an amount which it estimated it would have to pay Construction as reimbursement for the additional cost of incorporating66 into the sewerage system certain changes desired by the village of Wheeling. Petitioner claims it is entitled to include this amount as an estimated development expense. See Colony, Inc., supra at 44; Cambria Development Co., supra.We are of the opinion, however, that the item here in question is not an estimated expenditure of the type which, under the rule of Cambria Development Co., supra, 6 may be allocated to basis prior to accrual or payment. A careful reading of the cases discloses the following rationale for allowing allocation to basis: Where a developer is bound by contract to make certain improvements for the benefit of the property sold, the fact that the expenditure required to install the improvement is not made during the taxable period within which part of the 703 property is sold should not prevent an aliquot portion of the cost from being offset against the profit from the sale of the property. See Milton A. Mackay, supra.67 The evidence shows that, after construction of the sewerage system had begun, the village decided that certain changes were desirable. We do not know whether, if the changes had not been agreed to, the village could legally have interfered with the construction of the sewerage system or with the construction and delivery of petitioner's houses. Nevertheless, petitioner's president, fearing the adverse consequences of possible delays, orally agreed that petitioner would reimburse Construction for the additional cost of effecting the desired changes in the sewerage system. Even if we assume that the oral agreement constituted a contract enforceable against petitioner, it does not appear that such contract was entered into to satisfy any preexisting obligation of petitioner. We are of the opinion that, whatever the nature of the obligation incurred by petitioner, it was not one for the benefit of lots previously or subsequently sold and hence properly allocable to the cost thereof. Rather, the obligation apparently was undertaken to benefit petitioner's operations generally, by avoiding the costs and embarrassments which delay might have produced. Thus, the estimated expenditure68 was not so closely related to specific property as to make an allocation to basis necessary to reflect clearly the income from the sale of property. Whether the amount later paid by petitioner to Construction would be deductible as an ordinary and necessary business expense in the year of payment is a question not now before us. 7 In any event, we are satisfied that petitioner was not entitled in 1955 or 1956 to allocate to cost of lots its estimated liability to Construction. We hold for respondent on this issue.The third issue is whether respondent erred in determining that petitioner's gain from the sale of 53.12 acres of the Forke Farm in May 1956 constituted ordinary income, rather than capital gain as reported by petitioner.Petitioner69 acquired the Forke Farm on November 30, 1954, for the purpose of subdividing it, building houses on the lots, and selling the houses. In furtherance of this purpose, petitioner caused the Forke Farm to be rezoned from a farming to residential classification. However, petitioner neither subdivided nor improved the Forke Farm, although petitioner did subdivide and develop two subsequently acquired nearby tracts, the Techny Farm and the Haverly Farm.On May 3 and September 1, 1955, petitioner sold 12.23 and 33.09 704 acres, respectively, of the Forke Farm. Petitioner reported the gain from these sales as ordinary income. The only issue is raised by petitioner's assertion that it properly treated as capital gain its profit from the sale of the remaining 53.12 acres in May 1956. Petitioner relies upon Eline Realty Co., 35 T.C. 1 (1960), Charles E. Mieg, 32 T.C. 1314 (1959), and Carl Marks & Co., 12 T.C. 1196">12 T.C. 1196 (1949).That petitioner acquired the Forke Farm for the purpose of development and sale to customers in the ordinary course of its business does not, ipso facto, prevent petitioner70 from prevailing on this issue. To do so, however, petitioner must prove sufficient facts to satisfy us that at the time of sale its purpose for holding the property had changed to an investment purpose. Eline Realty Co., supra;Alice E. Cohn, 21 T.C. 90">21 T.C. 90, 99-100 (1953), affd. 226 F. 2d 22 (C.A. 9, 1955).Aside from the bare fact that petitioner reported the item in question as a capital gain, the only evidence supporting petitioner's claim of a change in its purpose for holding the Forke Farm from one of sale to customers to one of investment is the following testimony of James R. Jackson (hereinafter referred to as Jackson), petitioner's assistant secretary and chief accountant during the period 1953-56:A. Well, the reason the Forke Farm wasn't subdivided by us was that we were -- the petitioner at the time was developing the Techny Farm, he had acquired additional acreage around the Techny Farm. Houses were selling very very fast in the Techny Farm area, and the petitioner knew from his previous experience that land nearby where there was tremendous construction activity always did rise in value71 so he held onto it as an investment for speculation. 8Opposed to this evidence is petitioner's treatment of the gain from the first two sales out of the Forke Farm as ordinary income; the short period of time between acquisition of the property and the sales; and the lack of contemporaneous evidence, such as book entries, to corroborate the claim that there was a change in the purpose for which the property was held and to indicate the time when such a change might have taken place. Compare Donald J. Lawrie, 36 T.C. 1117">36 T.C. 1117 (1961).After carefully weighing the evidence, we are of the opinion that petitioner herein has failed to carry its burden of proof on this question. It then follows from sections 1201, 1221, 1222, and 1231 of the 1954 Code that respondent's determination must be sustained. The cases relied upon by petitioner are distinguishable, since in those cases there was72 satisfactory evidence that the properties in issue were held for investment purposes.The final issue is whether respondent erred in determining that petitioner's gain from the sale of 6.014 acres of the Haverly Farm on 705 October 1, 1956, was ordinary income, rather than capital gain as reported by petitioner.Petitioner purchased the Haverly Farm, a tract consisting of 69 acres, on May 23, 1955. Petitioner subdivided 59 acres for residential development and reserved 10 acres for a shopping center. Petitioner claims, and Jackson testified, that petitioner had originally intended to build and own the shopping center itself and, in furtherance of this plan, had engaged an architect, who prepared plans for a shopping center for the site. Petitioner claims further that its failure to get enough lease commitments from prospective tenants for the shopping center prevented it from obtaining financing for the project, which was then abandoned.In support of its claim that it intended to build and own the shopping center, petitioner introduced in evidence copies of an artist's conception of the proposed shopping center and a plan of the shopping center. The shopping center plan, 73 however, lists "Herzog Realty Company" as the owner, and the same name appears on the artist's drawing. These are the only references to Herzog Realty Co. we have been able to find in the record. The existence of Construction as an entity separate from petitioner establishes that E. A. Herzog conducted his affairs through more than one controlled company. If Herzog intended petitioner to build the shopping center, then sell it to another company, it seems clear that petitioner held the 10-acre tract for sale to customers in the ordinary course of its business. Jackson's testimony does not foreclose this possibility, since Jackson made no reference to Herzog Realty Co. Furthermore, Jackson, in his testimony, frequently failed to draw a distinction between Herzog and petitioner. That Herzog might have intended another of his companies to own the shopping center is of no help to petitioner.Since petitioner has failed to carry its burden of proving that the 10-acre tract of the Haverly Farm was not held for sale to customers in the ordinary course of business, respondent must prevail on this issue.Decision will be entered under Rule 50. Footnotes1. Revenue bonds differ from general obligation bonds in that principal and interest payments on the former may be made only out of the revenues of the facility with respect to which they are issued. Principal and interest on general obligation bonds are payable out of the general funds and tax revenues of the issuing authority.↩2. Petitioner changed its tax accounting period from a calendar year to a fiscal year ending Mar. 31 by filing a return for the short period Jan. 1, 1957, to Mar. 31, 1957, and by thereafter filing a return for the fiscal year ending Mar. 31, 1958.↩3. In the instant case the evidence (testimony) was not offered as tending to prove the end result of the meetings, which was stipulated, but as tending to prove that petitioner's motive and purpose (acting through its executive officer) in purchasing sewerage revenue bonds was to enable petitioner to subdivide and develop its land, rather than to simply make an investment.↩4. We do not consider such technical defects as the unorthodox maturity schedule of the bonds and the failure to limit the issuance of additional bonds as important causes of the low value of the bonds in 1955. We are satisfied that such defects, once recognized, could and would have been corrected with relative ease. Nor do we consider the lack of a convenient way to coerce customers of a sewerage system to pay their bills as an important factor, since the evidence indicates that sewerage revenue bonds with this characteristic are not uncommon. Whether the bonds would become valuable was primarily dependent upon whether petitioner's subdivision project was successful.↩5. See also the discussion, infra↩, with respect to the second issue.6. See also Birdneck Realty Corporation, 25 B.T.A. 1084">25 B.T.A. 1084 (1932); Milton A. Mackay, 11 B.T.A. 569">11 B.T.A. 569 (1928); O.D. 567, 3 C.B. 108. Cf. Fairfield Plaza, Inc., 39 T.C. 706">39 T.C. 706, 713↩ (1963).7. Petitioner does not claim the amount so paid had accrued during the taxable years. Since it does not appear that the work was completed by Construction or that the amount to be paid was ascertained before the end of 1956, such a claim probably would have to be rejected.↩8. It is clear that the witness was referring to petitioner's president, E. A. Herzog, as the petitioner.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621275/	ELIZABETH EWELL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; DOUGLAS W. EWELL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEwell v. CommissionerDocket Nos. 8853-85; 10137-85.United States Tax CourtT.C. Memo 1988-265; 1988 Tax Ct. Memo LEXIS 291; 55 T.C.M. (CCH) 1107; T.C.M. (RIA) 88265; June 21, 1988. 291 H and W, husband and wife, received wages and other income in 1976 through 1980, and filed Federal income tax returns for such years. In preparing each year's return, H summarized the information relating to W's income on a worksheet. He did not include the wages and other income earned by him individually and the income earned jointly by the couple on such worksheet. He presented such worksheet to W for her review, along with a blank Form 1040 for her to sign. After W signed such Form and returned it to H, H completed the Form by adding certain personal information. He then signed and filed such Form as a joint return. H and W failed to report the wages and other income received by H during the years in issue. In separate notices of deficiency, the Commissioner determined that H and W are liable for deficiencies and additions to tax with respect to the omitted income. H has conceded that he is liable for such deficiencies and additions. Held, W does no qualify as an income spouse under sec. 6013(e), I.R.C. 1954, because, under the facts and circumstances, it is not inequitable to hold her liable for the deficiencies in tax determined by the Commissioner; 292 held, further, W lacked the intent to evade tax owed on the omitted income; therefore, she is not liable for the addition to tax for fraud under sec. 6653(b), I.R.C. 1954. George E. Krouse, for the petitioners. Lawrence M. Hill, for the respondent. SIMPSONMEMORANDUM FINDINGS OF FACT AND OPINION SIMPSON, Judge: The Commissioner determined deficiencies in, and additions to, the petitioners' Federal income tax as follows: Addition to TaxSec. 6653(b)PetitionerYearDeficiencyI.R.C. 1954 1Elizabeth Ewell1976$ 13,672.00$ 6,836.00197712,000.006,000.00197813,246.006,623.00197914,113.007,057.0019809,470.004,735.00Douglas W. Ewell197613,672.006,836.00197712,000.006,000.00197813,246.006,623.00197914,113.007,057.0019809,470.004,735.00After concessions, the issues for our decision are: (1) Whether petitioner Elizabeth Ewell is liable for deficiencies in Federal income taxes, resulting294 from unreported income from wages, dividends, and other sources, received by her husband in 1976 through 1980, in the amounts determined by the Commissioner; (2) whether Mrs. Ewell qualifies as a so-called "innocent spouse" under section 6013(e); and (3) whether Mrs. Ewell is liable for the addition to tax for fraud under section 6653(b) for 1976 through 1980. FINDINGS OF FACT Some of the facts have been stipulated, and those facts are so found. The petitioners, Douglas W. and Elizabeth Ewell, husband and wife, resided in Rockville, Maryland, at the time they filed their petitions in this case. They filed their joint Federal income tax returns for 1976 through 1980 with the Internal Revenue Service Center, in Philadelphia, Pennsylvania. Mr. Ewell attended Benjamin Franklin University in Washington, D.C., from 1963 through 1967. He took courses in accounting and finance, but he never received a degree from such university. Mrs. Ewell attended the University of Maryland in college Park, Maryland. She graduated with a bachelor of arts degree in English during the early 1970s. The Ewells were married in May 1972, and they remained husband and wife at the time of trial. 295 Upon graduation from college, Mrs. Ewell accepted a job at Suburban Trust Company (Suburban Trust) in Hyattsville, Maryland. Over the years, she held various positions at Suburban Trust. During 1976 through 1980, she was employed as a customer service representative at such company. As a customer service representative, Mrs. Ewell advised customers of the various types of accounts offered by Suburban Trust and assisted customers in opening checking and savings accounts and in purchasing certificates of deposit. In 1970, Mr. Ewell accepted a position as a senior accountant for 101 Enterprises, which owned the franchise rights to operate Ponderosa Steak House restaurants in Maryland, the District of Columbia, and northern Virginia. For convenience, we shall refer to 101 Enterprises as Ponderosa. In June 1973, Mr. Ewell was promoted to comptroller of Ponderosa. He served in such position until April 1978, when he was promoted to vice president of purchasing at Ponderosa. From 1976 through 1980, Mr. Ewell received a yearly salary from Pondersoa, payable in payroll checks issued to him every 2 weeks. Mr. Ewell deposited many of such checks into a joint bank account maintained296 by the petitioners at Suburban Trust. Mr. Ewell earned a salary from Ponderosa of $ 39,606.03 in 1976, $ 34,326.95 in 1977, $ 36,299.91 in 1978, $ 39,715.34 in 1979, and $ 33,461.59 in 1980. At the end of each year, Ponderosa furnished him with a Wage and Tax Statement (Form W-2) which reported such wages. During 1977 through 1980, Mr. Ewell was a beneficiary of a trust established under the will of his maternal grandfather, Charles C. Scherer (the Scherer trust). Mr. Ewell received dividends and other income from such trust of $ 1,310.23 in 1977, $ 1,397.91 in 1978, $ 1,621.01 in 1979, and $ 1,866.17 in 1980. A Form K-1 reporting such income from the Scherer trust from 1977 through 1980 was mailed to Mr. Ewell during each of the years in issue. From 1972 to 1978, Mrs. Ewell took a number of business courses that were related to the banking industry, including Introduction to Accounting, Principles of Bank Operations, and Negotiable Instruments. However, she never took any courses relating to income tax preparation, and she never prepared an income tax return. Before her marriage, her father prepared most of her income tax returns. During Mr. and Mrs. Ewell's courtship, 297 Mr. Ewell prepared her 1971 income tax return. After they were married, Mr. Ewell prepared all of their income tax returns. Before preparing the couple's income tax returns, Mr. Ewell accumulated all the information relating to Mrs. Ewell's income, including her Forms W-2 and 1099. He summarized such information on a worksheet and presented the worksheet to Mrs. Ewell for her review. A blank Form 1040 was attached to the worksheet with a paper clip. After reviewing the worksheet to insure that it reflected all her income, Mrs. Ewell signed the blank return. On the Federal income tax returns for 1977 and 1978, Mrs. Ewell signed in the block designated for the spouse's signature. On the 1976 and 1980 returns, she signed in the block designed for the taxpayer's signature. The Ewells' Federal income tax return for 1979 is not contained in the record. After Mrs. Ewell reviewed the worksheet and signed the blank return, they were given back to Mr. Ewell. He transferred the information on the worksheet onto the blank return. He then completed the return by inserting the filing status as married, filing jointly, claiming two exemptions, filling in his occupation and social security298 number, and signing his name. Mrs. Ewell earned wages from Suburban Trust of $ 8,173.79 in 1976, $ 8,538.48 in 1977, $ 9,026.90 in 1978, $ 9,865.35 in 1979, and $ 10,938.41 in 1980. She also received a lump-sum distribution of $ 861.16 from Suburban Trust's profit-sharing plan in 1977. All of Mrs. Ewell's income from Suburban Trust was reported on the returns filed by the Ewells. In addition, all of the interest earned on the Ewells' joint bank account at Suburban was reported on such returns. Finally, the returns reported interest income earned by Mr. Ewell from an individual account maintained by him at Perpetual Bank (Perpetual). However, the Ewells failed to report the wages earned by Mr. Ewell from Ponderosa in 1976 through 1980 or the dividend and other income received by him from the Scherer trust in 1977 through 1980. Mrs. Ewell was aware that Mr. Ewell worked for Ponderosa. She was also aware that he received payroll checks from Ponderosa every 2 weeks. After she noticed that his wages from Ponderosa were not included on the worksheets, she asked him whether such wages were subject to Federal income tax. He replied that he was an independent contractor for Ponderosa299 and that his wages were taxed in a "different way" than hers. Mrs. Ewell never asked her husband if he filed a separate Federal income tax return for the years in issue. 2Mrs. Ewell's father was a somewhat strict man who demanded obedience from her. At trial, he described his daughter as "not worldly." After her marriage, Mr. Ewell dominated the couple's financial and household affairs. He never physically or mentally intimidated or abused his wife. However, Mrs. Ewell testified that he was "firm" with her, and she clearly deferred to his wishes. The Ewells did not enjoy a lavish or extravagant lifestyle. During the first years of their marriage, they lived in an apartment in College Park, Maryland. In February 1980, they moved to a condominium in Rockville, Maryland. The purchase price of such condominium was $ 150,000. By the time300 of closing, the Ewells paid $ 45,000 in cash toward the price of the condominium and took out a mortgage of $ 105,000 for the balance. They obtained the downpayment for the condominium by cashing in some certificates of deposit purchased by them. In 1976, the Ewells purchased a 1976 Lincoln Continental for approximately $ 10,000. In 1977, they purchased a 1977 Mercury Cougar RX-7 for approximately $ 8,000. Title to such car was held in Mrs. Ewell's name. In 1980, the Ewells purchased Mr. Ewell's company car from Ponderosa for approximately $ 4,500. In addition, the Ewells purchased a 24-foot boat for approximately $ 6,000 in 1979. Mr. Ewell's failure to report his wages from Ponderosa eventually came to the attention of the Internal Revenue Service. After an investigation by the IRS's criminal investigation division, he was indicted by a Federal grand jury on four counts of income tax evasion for the years 1977 through 1980. On October 12, 1984, he pled guilty to one count of the indictment relating to 1978. He served 180 days in jail and received a fine of $ 5,000. The Commissioner issued separate identical notices of deficiency to Mr. and Mrs. Ewell, in which he301 determined that they failed to report compensation received by Mr. Ewell from Ponderosa in 1976 through 1980 on their Federal income tax returns for such years. He also determined that they failed to report dividends and income from the Scherer trust received in such years. Finally, he determined that they were liable for the addition to tax for fraud under section 6653(b) for 1976 through 1980. OPINION The petitioners concede on brief that Mr. Ewell failed to report the income that he received from Ponderosa and from the Scherer trust during the years in issue. Therefore, they concede that he is liable for the deficiencies and for additions to tax determined by the Commissioner. However, the petitioners continue to challenge the deficiencies and additions to tax determined with respect to Mrs. Ewell. Thus, the first issue remaining for our decision is whether she is liable for such deficiencies. As a general rule, a husband and wife are jointly and severally liable for any tax or deficiency owed on a joint return. Sec. 6013(d)(3); Davenport v. Commissioner,48 T.C. 921">48 T.C. 921, 926 (1967).302 Therefore, the entire tax liability on a joint return may be assessed against either spouse. Davenport v. Commissioner, supra.However, one spouse may avoid liability for the tax owed by showing that a joint return was not made ( Calhoun v. Commissioner,23 T.C. 4">23 T.C. 4 (1954)), 3 or that her signature was obtained through duress or deception ( Brown v. Commissioner,51 T.C. 116">51 T.C. 116 (1968)), or by qualifying for relief under the innocent spouse provisions (section 6013(e)). The petitioners first claim that the Federal income tax returns filed by them for the years in issue were not joint returns. However, in the stipulation of facts submitted to the Court at trial, the petitioners admitted that the documents filed by them for such years with the Internal Revenue Service were "their joint U.S. Individual Income Tax Returns." They further stipulated that they both reviewed and signed such returns before they were filed. 303 In general, a stipulation entered into by the parties is treated as a conclusive admission by such parties as to the facts involved in such stipulation. Rule 91(e), Tax Court Rules of Practice and Procedure.4 Accordingly, statements of fact contained in a stipulation are controlling, and we hold that the petitioners are bound by their admission that the returns filed by them were joint returns. The petitioners next claim that Mr. Ewell misrepresented the nature of the returns presented to Mrs. Ewell for her signature and that she was deceived into signing such returns. They both testified at trial that Mrs. Ewell signed blank Forms 1040 which were represented to be her separate returns, and that such returns were converted to the couple's joint returns at a later time by Mr. Ewell. For such reason, they argue that Mrs. Ewell lacked the intent to file joint returns for the years in issue. Whether or not a joint return has been filed is a question of intent. Whitmore v. Commissioner,25 T.C. 293">25 T.C. 293, 298 (1955).304 The presence or absence of a spouse's signature on a return, by itself, does not conclusively establish an intent to file or not to file a joint return. Cf. Federbush v. Commissioner,34 T.C. 740">34 T.C. 740 (1960), affd. 325 F.2d 1">325 F.2d 1 (2d Cir. 1963). The petitioners bear the burden of proving that Mrs. Ewell was deceived into signing the returns and that she intended to file only separate returns for the years in issue. Rule 142(a). The petitioners both testified that Mr. Ewell represented such returns to be Mrs. Ewell's separate returns. However, a review of the objective documentary evidence in the record supports a conclusion that the petitioners fully intended to file their returns as joint returns. Mrs. Ewell signed at least two of the returns in issue in the block designated for the spouse's signature. Thus, she left the space designated for the taxpayer's signature blank on such returns, thereby allowing Mr. Ewell to file the returns as joint returns by filling in his signature. In our judgment, such conduct is inconsistent with her testimony that she intended to file only separate returns. In addition, Mr. Ewell admitted at trial that all of the Ewells' 305 interest income from their joint bank account was reported on the returns filed for the years in issue. We also have found as a fact that the interest income earned on Mr. Ewell's individual account at Perpetual was reported in such returns. The fact that the returns report income earned not only by Mrs. Ewell alone, but also by Mr. Ewell or by the couple jointly, is inconsistent with the petitioners' claim that such returns were Mrs. Ewell's separate returns. Federbush v. Commissioner, supra;Cecere v. Commissioner,T.C. Memo. 1975-371, affd. without published opinion 547 F.2d 1159">547 F.2d 1159 (3d Cir. 1976). For such reasons, we discount the petitioners' testimony and hold that the Federal income tax returns filed by them for 1976 through 1980 were intended to be the couple's joint returns for such years. Finally, the petitioners argue in the alternative that Mrs. Ewell is not liable for the deficiencies because she qualifies as an innocent spouse under section 6013(e). Section 6013(e), as amended by the Tax Reform Act of 1984, Pub. L. 98-369, sec. 424(a), 98 Stat. 801-802, provides that 306 in order to obtain innocent spouse relief, the taxpayer must show (1) that a joint return has been made for a taxable year; (2) on such return, there is a substantial understatement of tax attributable to grossly erroneous items of the other spouse; (3) that she did not know and had no reason to know of such substantial understatement when she signed the return; and (4) after considering all the facts and circumstances, it would be inequitable to hold her liable for the deficiency in income tax attributable to such substantial understatement. See sec. 6013(e)(1); Purcell v. Commissioner,86 T.C. 228">86 T.C. 228, 235 (1986), affd. 826 F.2d 470">826 F.2d 470 (6th Cir. 1987). Grossly erroneous items are defined to include "any item of gross income attributable to [the spouse not claiming innocent spouse status] which is omitted from gross income." Sec. 6013(e)(2)(A). Substantial understatement, for purposes of the innocent spouse provisions, "means any understatement * * which exceeds $ 500." Sec. 6013(e)(3). It is undisputed that Mr. Ewell failed to report his wages from Ponderosa and his income from the Scherer trust on the returns filed for the years in issue. It is307 also undisputed that such omission is a grossly erroneous item attributable to Mr. Ewell and produced a substantial understatement in tax. However, the Commissioner argues that the petitioners failed to establish that Mrs. Ewell did not know or did not have reason to know of the omitted income when she signed the returns. In determining whether Mrs. Ewell knew or had reason to know of the omitted income, we must consider whether a reasonable person in her circumstances could be expected to know of the omissions at the time of the signing of the returns. Terzian v. Commissioner,72 T.C. 1164">72 T.C. 1164, 1170 (1979). We have found as a fact that the Ewells intended to file joint returns for the years in issue. We have also found that the worksheets which Mrs. Ewell reviewed contained only summaries of her individual income, and not summaries of income earned by Mr. Ewell alone or by the couple jointly. Mrs. Ewell may have assumed that her husband would include his own income on the returns before filing them. Once Mrs. Ewell signed the returns and gave them back to Mr. Ewell, she had no way of knowing that he did not report all of his income on such returns. For such reason, 308 we are unwilling to conclude that Mrs. Ewell had reason to know of the omissions from income during the years in issue. The Commissioner finally argues that it would not be inequitable to hold Mrs. Ewell liable for the deficiencies in tax resulting from the omissions from income. Mrs. Ewell again has the budget of proving that such a holding would be inequitable. Rule 142(a). Whether it is inequitable to hold Mrs. Ewell liable for the deficiency in tax is to be determined by an examination of all the facts and circumstances in the case. Sec. 1.6013-4(b), Income Tax Regs. The record shows that, during each of the years in issue, she signed a blank Form 1040 which she intended to serve as the Ewells' joint return for such year. The record also shows that Mrs. Ewell failed to review the return after it was completed and before it was mailed to the IRS. For an individual to sign a blank return and fail to review such return before it is filed raises a risk that the return will be altered or that, as in this case, not all the income earned in the tax year will be reported. We believe that it was unreasonable for Mrs. Ewell to allow the returns signed309 by her to be filed without further review. Moreover, the Ewells purchased automobiles, a boat, and a condominium, all of which could not have been purchased with Mrs. Ewell's income alone. Thus, she shared in the benefits derived by the Ewells from the unreported income. 5Adams v. Commissioner,60 T.C. 300">60 T.C. 300, 303-304 (1973); see also Blinderman v. Commissioner,T.C. Memo 1986-536">T.C. Memo. 1986-536. Under such circumstances, it is not inequitable to hold her liable for the resulting deficiencies in tax. For such reasons, we hold that Mrs. Ewell is not an innocent spouse within the meaning of section 6013(e). The final issue for our decision is whether Mrs. Ewell is liable for the additions to tax for fraud, as determined by the Commissioner. 310 We have held Mrs. Ewell liable for the deficiencies in tax resulting from the omitted income, because she filed joint returns along with Mr. Ewell for 1976 through 1980 and because she does not qualify as an innocent spouse. However, the fact that Mrs. Ewell filed joint returns for such years does not in itself create liability for the fraud addition. Sec. 6653(b); Stone v. Commissioner,56 T.C. 213">56 T.C. 213, 227 (1971). Section 6653(b)(3) provides that the fraud addition only applies with respect to a spouse who signed a joint return if some part of the underpayment in tax is due to that spouse's fraudulent conduct. The Commissioner has the burden of proving such fraudulent conduct by clear and convincing evidence. Sec. 7454(a); Rule 142(b). To establish fraud, the Commissioner must show that Mrs. Ewell intended to evade taxes which she knew or believed to be owed by conduct intended to conceal, mislead, or otherwise prevent the collection of such taxes. Stoltzfus v. United States,398 F.2d 1002">398 F.2d 1002, 1004 (3d Cir. 1968).311 The existence of fraud is a question of fact to be resolved upon consideration of the entire record. Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181, 199 (1976), affd. without published opinion 578 F.2d 1383">578 F.2d 1383 (8th Cir. 1978). Fraud is never presumed, but rather must be established by affirmative evidence. Beaver v. Commissioner,55 T.C. 85">55 T.C. 85, 92 (1970). Since direct evidence of fraud is rarely available, circumstantial evidence may be considered. Spies v. United States,317 U.S. 492">317 U.S. 492, 499 (1943); Rowlee v. Commissioner,80 T.C. 1111">80 T.C. 1111, 1123 (1983). Fraud may properly be inferred where an entire course of conduct establishes the requisite intent. Rowlee v. Commissioner, supra.Our conclusion must be reached not on isolated pieces of testimony, but on the entire record. Kellett v. Commissioner,5 T.C. 608">5 T.C. 608, 616 (1945). We have concluded that Mrs. Ewell does not qualify as an innocent spouse because, in our judgment, it would not be inequitable to hold her liable for the deficiencies in income tax determined by the Commissioner. However, a finding of fraud requires a showing312 by the Commissioner that Mrs. Ewell acted with an intent to evade taxes. Liability for the addition to tax for fraud requires that the Commissioner prove that she knew of the income omitted from the returns by Mr. Ewell. See Sheckles v. Commissioner,T.C. Memo. 1984-289. The petitioners have conceded that Mr. Ewell was involved in a scheme intended to evade the payment of income tax owed for the years in issue. In our judgment, the Commissioner has not established that Mrs. Ewell was a participant in such scheme. It is true that Mrs. Ewell knew that her husband received wages from Ponderosa during the years in issue and that he often deposited his payroll checks from Ponderosa into their joint bank account at Suburban Trust. She also knew that such wages were not reflected on the worksheets presented to her for her review. She failed to review the returns she signed before they were filed, and failed to insure that Mr. Ewell included his wages from Ponderosa on such returns or that he filed his own separate returns so as to properly report his income. Through her inaction, she facilitated Mr. Ewell's scheme to evade the payment of income taxes. However, *313 these facts are insufficient to support a finding of fraud on the part of Mrs. Ewell. The record shows that she deferred to her husband on household and financial matters. Among other things, she relied on him to prepare and file the couple's tax returns. He took advantage of her trust by altering the returns she signed. While Mrs. Ewell perhaps did not act prudently and consequently failed to learn of his conduct in altering such returns, we do not think that she acted with the intent of defraud. For such reason, we conclude that she is not liable for the addition to tax for fraud under section 6653(b). In docket No. 8853-85, decision will be entered for the respondent with respect to the deficiencies and for the petitioner with respect to the addition to tax. In docket No. 10137-85, decision will be entered for the respondent.Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect during the years in issue. ↩2. Mr. Ewell testified that Mrs. Ewell did in fact ask him whether he filed separate returns reflecting his wages from Ponderosa. He also testified that he told her that he did and that he kept such returns in his office. However, we do not find Mr. Ewell to be a credible witness and decline to accept his testimony on this point. ↩3. See also Wiener v. Commissioner,T.C. Memo 1971-56">T.C. Memo 1971-56; Wills Corp. v. Commissioner,T.C. Memo. 1969-36↩. 4. Any reference to a Rule is to the Tax Court Rules of Practice and Procedure. ↩5. Although sec. 6013(e) as amended in 1984 no longer requires an assessment of whether a spouse benefitted from an erroneous item, Congress intended that benefits received should continue to be taken into account. H. Rept. 98-432 (Part 2), on H.R. 4170 (Tax Reform Act of 1984), at 1502 (1984). See also Purcell v. Commissioner,86 T.C. 228">86 T.C. 228, 241 (1986), affd. 826 F.2d 470">826 F.2d 470↩ (6th Cir. 1987).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621277/	Crossett Western Company, Petitioner, v. Commissioner of Internal Revenue, RespondentCrossett Western Co. v. CommissionerDocket No. 3054United States Tax Court4 T.C. 783; 1945 U.S. Tax Ct. LEXIS 229; February 13, 1945, Promulgated 229 Decision will be entered under Rule 50. 1. Held, section 718 (b) (3), Internal Revenue Code, being clear and unambiguous, does not justify resort to Congressional reports for interpretation.2. Held, further, application of the section requiring the deduction of the amount of earnings and profits of another corporation which previously at any time were included in the accumulated earnings and profits of a corporation by reason of a tax-free reorganization is mandatory, irrespective of the fact that because of operating losses in the intervening years taxpayer had no accumulated earnings and profits at the beginning of the taxable years. Carl E. Davidson, Esq., for the petitioner.Wilford H. Payne, Esq., for the respondent. Van Fossan, Judge. Smith230 and Disney, JJ., concur only in the result. Murdock, J., concurring. Hill, J., agrees with the concurring opinion. VAN FOSSAN 783 The respondent determined deficiencies against Crossett Western Co. in income and excess profits taxes for the years 1940 and 1941, as follows:19401941Income tax$ 7,789.14Excess profits tax266.98$ 86,807.49The petitioner concedes that the deficiency in income tax for 1940 was correctly determined and the full amount thereof has been assessed and paid since the filing of the petition herein. Of the total deficiency in excess profits tax for 1941, the petitioner admits that $ 51,679.31 was properly asserted, and that amount has been assessed, with the consent of the petitioner, since the deficiency notice was issued. The deficiency in excess profits tax for 1940 is in dispute in its entirety.The single issue for our determination is whether, in determining the petitioner's equity invested capital for excess profits tax for the years 1940 and 1941, the earnings and profits which the petitioner acquired from other corporations in 1923 in connection with a nontaxable reorganization and which were subsequently eliminated231 by operating losses prior to the taxable years here involved, should be 784 applied pursuant to the provisions of section 718 (b) (3) of the Internal Revenue Code in reduction of the amounts included in equity invested capital under the provisions of section 718 (a) of the code.FINDINGS OF FACT.The facts are all stipulated. In so far as material to the issue herein, they are as follows:The petitioner is a corporation organized November 19, 1923, under the laws of the State of Delaware, with principal office at 1024 American Bank Building, Portland, Oregon. Its corporation income, declared value excess profits and defense tax return for the year 1940, its corporation excess profits tax return for the taxable year 1940, and its corporation excess profits tax return for the taxable year 1941 were filed with the collector of internal revenue for the district of Delaware.The authorized capital stock of the petitioner at the time of its organization was as follows: Preferred stock - 10,000 shares of a par value of $ 100 per share.Common stock - 90,000 shares of a par value of $ 100 per share.On November 23, 1923, a plan of reorganization was adopted by petitioner and232 three other corporations, namely: Big Creek Logging Co., Crossett Western Lumber Co., and Crossett Timber Co., whereby the latter three corporations were to be consolidated into the petitioner by conveying all of their net assets, except certain cash which was to be distributed to their respective stockholders, to the petitioner solely in exchange for the petitioner's stock. The plan of reorganization was consummated in accordance with its terms as of December 31, 1923. The stock of the petitioner which was received by the three corporations above named upon the consolidation was exchanged by them with their respective stockholders in redemption of all the stock of the corporations, which were thereupon duly dissolved.The assets received by the petitioner from its transferors upon the exchange, pursuant to the plan of reorganization, were received without recognition of gain or loss under the internal revenue laws and the bases of the assets in the hands of the petitioner were the same as the bases of the assets in the hands of the petitioner's transferors.Crossett Timber Co. was a corporation organized November 16, 1906. On December 31, 1923, the par value of its capital stock233 issued and outstanding, its paid-in surplus, and its undistributed earnings and profits were as follows:Capital stock issued and outstanding$ 1,738,250.00Paid-in surplus550,000.00Undistributed earnings and profits599,022.22785 On December 31, 1923, Crossett Timber Co. distributed $ 769,086.25 to its stockholders, of which $ 599,022.22 was from earnings and profits. Thereafter, and on the same day, Crossett Timber Co. transferred all of its remaining assets to the petitioner in exchange for shares of petitioner's stock, pursuant to the plan of reorganization referred to above.The net unadjusted basis for determining loss upon sale or exchange of the assets transferred to the petitioner on December 31, 1923, by Crossett Timber Co. in exchange for stock of the petitioner, after deducting liabilities of Crossett Timber Co. assumed by the petitioner, was $ 2,118,185.97. Crossett Timber Co. had no earnings and profits at the time of transfer of its assets to the petitioner, and there was no deficit in its earnings and profits at that time.Big Creek Logging Co. was a corporation organized on May 17, 1912. On December 31, 1923, the par value of its capital stock234 issued and outstanding, its paid-in surplus, and its undistributed earnings and profits were as follows:Capital stock issued and outstanding$ 250,000.00Paid-in surplus22,500.00Undistributed earnings and profits862,902.46On December 21, 1923, Big Creek Logging Co. distributed $ 70,000 to its stockholders out of its earnings and profits, and thereafter, and on the same day, transferred all of its remaining assets to the petitioner in exchange for shares of the petitioner's stock, pursuant to the plan of reorganization referred to above.The net unadjusted basis for determining loss upon sale or exchange of the assets transferred to the petitioner on December 31, 1923, by Big Creek Logging Co. in exchange for stock of the petitioner, after deducting liabilities assumed by the petitioner, was $ 1,065,402.46. The earnings and profits of Big Creek Logging Co. which, under the rule of Commissioner v. Sansome, 60 Fed. (2d) 931, became earnings and profits of the petitioner upon transfer of the assets of Big Creek Logging Co. to it, amounted to $ 792,902.46.Crossett Western Lumber Co. was a corporation organized on December 31, 1912. 235 On December 31, 1923, the par value of its capital stock issued and outstanding was $ 439,700. Prior thereto distributions in such stock had been made from capital in the amount of $ 72,077. On the same date, December 31, 1923, the undistributed earnings and profits of Crossett Western Lumber Co., prior to payments on that date in redemption of a part of its stock for cash and the distribution of other cash to its stockholders, were $ 154,078.05.On December 31, 1923, Crossett Western Lumber Co. redeemed $ 37,100 par value, of its stock for cash and distributed $ 23,800 in 786 cash to its stockholders. Thereafter, and on the same day, Crossett Western Lumber Co. transferred all of its remaining assets to the petitioner in exchange for shares of the petitioner's stock, pursuant to the plan of reorganization referred to above.The net unadjusted basis for determining loss upon sale or exchange of the assets transferred to the petitioner on December 31, 1923, by Crossett Western Lumber Co. in exchange for stock of the petitioner, after deducting liabilities assumed by the petitioner, was $ 460,801.05.The earnings and profits of Crossett Western Lumber Co. which, under the rule236 of Commissioner v. Sansome, supra, became earnings and profits of the petitioner upon transfer of the assets of Crossett Western Lumber Co. to it, amounted to $ 130,278.05.The net aggregate investment of the old stockholders in the capital stock of the three transferor corporations, parties to the reorganization referred to above, amounted to $ 2,721,208.97. The aggregate accumulated earnings and profits of said transferor corporations remaining as of December 31, 1923, the date the reorganization was effected, amounted to $ 923,180.51, which, under the rule of Commissioner v. Sansome, supra, became the earnings and profits of the petitioner at the time of its organization. The total net assets received by the petitioner from the three transferor corporations in exchange for the capital stock of the petitioner, in connection with the plan of reorganization, amounted to the sum of $ 3,644,389.48.On or about December 31, 1923, the petitioner issued shares of its own common stock of a par value of $ 8,411,800 and preferred stock of a par value of $ 164,600 to Crossett Timber Co., Big Creek Logging Co., and Crossett237 Western Lumber Co. in exchange for the net value of assets of said transferor corporations transferred to the petitioner in connection with the aforesaid reorganization.The operations of the petitioner commenced on January 1, 1924, and from that date to and including December 31, 1939, the petitioner's operations resulted in an aggregate loss in excess of $ 923,180.51. The petitioner had no accumulated earnings and profits either from its own operations or transferred to it by a predecessor corporation under the rule of Commissioner v. Sansome, supra, as of the beginning of either of the taxable years 1940 or 1941.The corrected excess profits net income of petitioner for the year 1940 is $ 119,020.32.The excess profits tax net income of petitioner for the year 1941 is $ 460,990.49. Petitioner was in existence for 351 days of the year 1941.In computing its equity invested capital for excess profits tax for the years involved, the petitioner made no deductions in respect to the earnings and profits it had acquired from its transferor corporations. 787 The respondent determined that such deductions were necessary under the provisions of238 section 718 (b) (3) and determined the deficiencies accordingly.OPINION.The sole question for our determination is whether, in computing the petitioner's equity invested capital for 1940 and 1941, there must be deducted, under section 718 (b) (3) of the Internal Revenue Code, the amount of the earnings and profits of other corporations which the petitioner received in a tax-free reorganization, where because of operating losses in the intervening years the taxpayer had no accumulated earnings and profits at the beginning of either of the taxable years in question.The facts are not in dispute. The petitioner was organized to take over the assets of three transferor corporations. These assets, for which the petitioner issued its capital stock, had a net value at the time of the reorganization of $ 3,644,389.48, which value was used by respondent as the adjusted basis of the assets in his computations. Included in this amount was the sum of $ 923,180.51 representing the accumulated earnings and profits of the transferor corporations which, under the rule of Commissioner v. Sansome, supra, became earnings and profits of the petitioner for tax purposes. 239 In the years subsequent to the reorganization, the petitioner suffered operating losses and it had no accumulated earnings and profits at the beginning of either of the taxable years here in question.The controversy between the parties centers about the application of section 718 (b) (3), which section was enacted as a part of the Second Revenue Act of 1940.The petitioner contends that the committee reports show the true purpose of the section to be to avoid a duplicate inclusion of the earnings and profits so transferred; that in the instant case there is no duplication, since the petitioner had no accumulated earnings and profits at the beginning of either of the taxable years involved; and that consequently no amount should be deducted under section 718 (b) (3).The respondent contends that resort may not be had to the committee reports for construction of the statute; that, standing by itself, the staute is clear and unambiguous; and that if any ambiguity exists it is caused by reference to the reports. He contends that the statute is mandatory in requiring the deduction of the earnings and profits of another corporation "which previously at any time" were included in the petitioner's240 accumulated earnings and profits and that, since the earnings and profits of the transferor corporations were "included" in the petitioner's earnings and profits at the time of the reorganization, 788 the requirements of the statute have been fulfilled and the deduction must be made.We have concluded that the respondent should be sustained. Section 718 is a directive measure, specifically indicating which items shall be included in, and which excluded from, equity invested capital. It provides, with appropriate definitions and limitations, that equity invested capital shall be the sum of: The money paid in; property paid in; distributions in stock; accumulated earnings and profits as of the beginning of the year; and any income on account of gain on tax-free liquidation -- reduced by distributions not made out of accumulated earnings and profits; earnings and profits of another corporation; and loss on account of tax-free liquidation. The specific subsection of section 718 here in question is (b) (3) which, as far as pertinent, reads as follows:(b) Reduction in Equity Invested Capital. -- The amount by which the equity invested capital for any day shall be reduced as provided241 in subsection (a) shall be the sum of the following amounts -- * * (3) Earnings and profits of another corporation. -- The earnings and profits of another corporation which previously at any time were included in accumulated earnings and profits by reason of a transaction described in section 112 (b) to (e), both inclusive, or in the corresponding provision of a price, revenue law, * The quoted language is clear and unambiguous. If the earnings and profits of another corporation were at any time previously included in the accumulated earnings and profits of the taxpayer by reason of a nontaxable reorganization under section 112 (b) to (e) both inclusive, then the aggregate of the items listed in section 718 (a) shall be reduced by the amount of such earnings and profits.It is stipulated that as a result of a nontaxable reorganization the taxpayer took over the assets of other corporations, including accumulated earnings and profits, and under the rule of Commissioner v. Sansome, supra, these earnings and profits became taxpayer's earnings and profits. It seems too clear to require demonstration that petitioner taxpayer fits precisely 242 in the statutory picture. The words "previously" and "at any time" require no definition if they are accorded their everyday meaning. Petitioner, in effect, asks us to delete these words. This can not be done. Clearly the taxpayer comes within the ambit of section 718 (b) (3). Any other interpretation would be a distortion of the statutory language.Petitioner's insistence that the Congressional reports demonstrate that Congress intended, in enacting section 718 (b) (3), to prevent duplication of assets and that, since it had no accumulated earnings and profits at the beginning of the year, there is no duplication calling for the application to it of section (b) (3), can not be entertained. 789 In short, the taxpayer asks to be exempted from the application of the cited section. While resort may be had in some circumstances to the legislative history to find the Congressional intent, when Congress has spoken in clear and unambiguous language the normal and reasonable meaning of an act is not to be argued to one side in favor of a construction made possible only by the distortion or disregard of such plain language. Here we find no support for petitioner's argument in 243 the law or in the facts. The language used in the act is so plain as to be impossible of misconstruction and to admit of no farfetched interpretation or distortion. The respondent has followed the statute explicitly. While it is true that petitioner had no accumulated earnings and profits in the taxable years, the statute makes no exception to cover such a case. There is no suggestion that the deduction depends on the fact or the amount of the taxpayer's earnings and profits in the taxable year. This is a case where, of a certainty, nothing should be added to, nor substituted for, the plain and obvious meaning of the statute by a forced construction.We sustain the action of the respondent.Decision will be entered under Rule 50. MURDOCK Murdock, J., concurring: Equity invested capital, as defined in the statute, includes property paid in for stock. That property goes into the computation under certain circumstances at its unadjusted basis for determining loss. See sec. 718 (a) (1) and (2), I. R. C. Properties of the transferor were paid in for the stock of the petitioner. There was no gain or loss recognized on that transfer. The amount to be included in equity invested244 capital as property paid in for stock is the unadjusted basis of the transferred property in the hands of the transferor corporations. Equity invested capital also includes accumulated earnings and profits of a taxpayer as of the beginning of the year. The earnings and profits of the transferors, under the principle of the Sansome case, become the earnings and profits of the transferee. The assets of the transferor corporations at their book basis already reflect the earnings of those corporations. If both the assets and the earnings of the transferors go into equity invested capital of the transferee corporation, there is a duplication equivalent to the amount of the earnings and profits of the transferor corporations taken over by the transferee. Such a duplication must be eliminated. Sec. 718 (b) (3). The duplication continues even though the transferee corporation loses the earnings of the transferor corporations. Because of the duplication above described, the loss 790 of earnings works a double reduction of what makes up equity invested capital. Not only do the earnings disappear, but the asset account is correspondingly reduced. In other words, the transferee*245 corporation, in the loss of the earnings of the transferor corporation, has lost a corresponding amount of the assets paid in for its stock which supported those earnings in the example above, so there is still necessity for an elimination.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621278/	Joe Goldstein and Lillian Goldstein v. Commissioner.Goldstein v. CommissionerDocket No. 71831.United States Tax CourtT.C. Memo 1960-276; 1960 Tax Ct. Memo LEXIS 14; 19 T.C.M. (CCH) 1531; T.C.M. (RIA) 60276; December 27, 196014 Petitioners, owning over 50 per cent of the stock of a family corporation, acquired real estate, on which the corporation held a very favorable long-term lease and on which it operated a market, for $35,000 and immediately resold it to the corporation for $75,000, offsetting the short-term gain against a capital loss carryover on their personal return. Held, the $40,000 profit realized by petitioners was a disguised dividend from the corporation and taxable to petitioners as ordinary income. Walter M. Campbell, Esq., Subway Terminal Building, Los Angeles, Calif., for the petitioners. Thomas F. Greaves, Esq., for the respondent. DRENNENMemorandum Findings of Fact and Opinion DRENNEN, Judge: Respondent determined a deficiency15 in petitioners' income tax for the calendar year 1953 in the amount of $28,404.13. The only issue is whether a gain of $40,000, realized by petitioners on the sale of real estate, which they had purchased for $35,000 on December 8, 1953, to their family corporation for $75,000 on December 31, 1953, was taxable as ordinary income or as gain on the sale of a capital asset. Petitioners reported the gain as a short-term capital gain and offset it against a $112,944.77 capital loss carryover. Respondent determined that the gain was in the nature of a dividend and taxable as ordinary income. Findings of Fact Some of the facts were stipulated and are so found. Petitioners are husband and wife living in Los Angeles, California. They filed a joint income tax return for the calendar year 1953 with the district director of internal revenue for the district of Los Angeles. Joe Goldstein, the oldest of five brothers, the others being Max, Edward, Bernard, and Albert, started a retail grocery business as a sole proprietorship in 1925 when he was 17 years old. Joe gave each of his brothers his start in business by employing them in his expanding marketing business. On or before September 27, 1945, this16 business became a limited partnership with Joe as the sole general partner, and Edward and Joe, as trustee for Max, as limited partners. The partnership operated under the name the Boys' Market. The Boys' Market, Inc., a California corporation, and hereafter referred to as the corporation, was incorporated in 1936 but was inactive until January 1, 1946, at which time all the assets of the limited partnership were transferred to it in exchange for capital stock of the corporation. On September 27, 1945, the limited partnership leased a parcel of land situate on the corner of a major intersection in San Gabriel, California, from Torley Land Company for a term of 50 years beginning November 1, 1945. Joe had previously attempted to buy the land for a market site but had been unable to agree with Torley on terms. The lease provided for rental of $40,000 payable in installments of $800 per year during the term thereof, and contained no provision for renegotiation. Among other things the lease required the lessee to construct on the property at its own expense a commercial business building costing at least $20,000. The building was to be completed by November 1, 1946; otherwise lessee17 was required to post bond as security for completion of the building. All buildings constructed on the premises during the term of the lease were to become a part of the realty, to be delivered to the lessor upon termination of the lease. Lessee was required to pay all taxes, insurance, and other charges against the property. Lessee was entitled to assign the lease, provided that if the lease was assigned prior to completion of and payment for the original building, the lessee was to remain liable for the performance of all covenants of the lease as though no assignment had been made; if assigned after completion of the building the lessee would not, without the written consent of the lessor, be released or discharged from any obligations thereafter accruing. This lease was assigned to the corporation, along with the other assets of the partnership, in 1946. The lessor was notified of the assignment and its attorney acknowledged receipt of the notice by letter dated March 28, 1946, which also advised the partnership that it was not exonerated from its obligations under the lease and that lessor was not releasing the partnership. A market building was constructed on the leased premises18 by the corporation sometime in 1947 or 1948 and was thereafter occupied by the corporation as one of its eight retail stores. From time to time after the lease was executed Joe unsuccessfully sought to purchase the fee in this land for the business. The minutes of a meeting of the board of directors of the corporation held on January 27, 1953, state that the president (Joe) reported that it might be possible to purchase the land on which the corporation built the San Gabriel market, and that the purchase of the land would enable "us" to procure a loan on the property and increase "our" working capital. The president and secretary were thereupon authorized to "make such purchase, if the price was satisfactory, and to arrange a loan on terms and conditions they deemed proper considering our loan agreement." The minutes of a subsequent meeting of the board of directors of the corporation held on April 28, 1953, after referring to the previous discussion about the possibility of purchasing the San Garbriel property, stated: "It has now been decided that Joe Goldstein and Lillian Goldstein would buy this land as their private property, and they may at some time in the future, sell it19 to The Boy's Market." All of the directors were recorded as being present at this meeting. As a result of further negotiations with Torley Land Company sometime before June 22, 1953, Joe entered into an agreement with Torley whereby petitioners would buy a lot in Las Vegas, Nevada, where Torley's president lived, and build an apartment house thereon for a total cost to petitioners of $35,000, and upon completion of the construction petitioners would trade the Las Vegas property to Torley for the San Gabriel property with no cash involved. Escrows to carry out this agreement were executed on June 22, 1953, and Joe and Lillian put up $35,000 of their own money to carry it out. The transaction was completed on December 8, 1953, on which date Joe and Lillian conveyed the Las Vegas property to Torley Land Company, and received in exchange a deed for the fee to the San Gabriel property, subject to the lease held by the corporation. The transaction was worked out this way at the request of Torley Land Company which had a tax basis of a little over $10,000 in the San Gabriel property. On December 31, 1953, Joe and Lillian conveyed the San Gabriel real estate to "The Boy's Market, Inc. 20 ," by quitclaim deed, for the sum of $75,000 in cash, thus receiving $40,000 in excess of the cost to them of said property. There were no minutes recorded in the corporation's minute book which showed a consideration of or authorization for the consummation of this transaction by the board of directors of the corporation. During the year 1953 the corporation had issued and outstanding 5,500 shares of capital stock, which were held as follows: NumberNameof sharesJoe Goldstein2,720Joe and Lillian Goldstein as jointtenants150Lillian Goldstein as trustee for minorchildren36Edward Goldstein (brother of Joe)1,294Max Goldstein (brother of Joe)1,271Dorothy Goldstein (wife of BernardGoldstein, brother of Joe) as trusteefor her minor children24Everett Eddy5Total5,500 The officers of the corporation were: Joe GoldsteinPresidentEdward GoldsteinVice presidentAlbert GoldsteinVice presidentMax GoldsteinVice presidentEverett EddySecretary-treasurerBernard GoldsteinAsst. secretary-treasurer The directors of the corporation were: Joe GoldsteinEdward GoldsteinLillian GoldsteinAlbert GoldsteinMax GoldsteinBernard GoldsteinEverett Eddy21 The five brothers worked in various supervisory capacities in the business, with Joe as the principal executive officer and general manager. The brothers received salaries from the corporation, and bonuses when profits justified them. Max, Edward, and Bernard obtained their stock in the company by investing their bonuses in the business from time to time. Albert, the youngest brother, never owned any stock. Everett Eddy was first employed as bookkeeper for the business in 1936. He acquired his shares of stock by gift from Max. As secretary-treasurer and a director of the corporation in 1953 Eddy was responsible for keeping the books and records of the company and for preparing minutes of the directors meetings. Some of the directors meetings were held informally as the brothers discussed matters among themselves in the offices of the corporation, and minutes of such meetings were not always recorded. At the more formal meetings of the directors Eddy took notes during the meeting from which he wrote up formal minutes within a few days to a month thereafter. The corporation was successful and had a "triple A" rating with Dunn & Bradstreet. It did not pay regular dividends and, 22 although it had net earnings for 1953, it did not formally pay a dividend that year. The corporation had accumulated earnings and profits and available cash in excess of $75,000 during the year 1953 and on December 31, 1953. The corporation entered into a loan agreement with Provident Mutual Life Insurance Company of Philadelphia in 1950 under which it borrowed $400,000, secured by a mortgage on all of its real estate and fixed property including the company office and the store in San Gabriel. The note agreement and mortgage contained certain restrictive covenants which, among other things, limited the corporation's borrowing and dividend activities to some extent. The transaction whereby petitioners acquired the San Gabriel property from Torley Land Company and immediately sold it to the corporation for a cash profit of $40,000 was not an arm's-length transaction. Of the $75,000 paid to petitioners by the Boys' Market, Inc., for the property in 1953, $40,000 was not in fact consideration for the sale or exchange of a capital asset; it represented a distribution of corporate earnings. Opinion The question is whether the $40,000 profit realized by petitioners on their sale23 of the San Gabriel business property to their family corporation is taxable to petitioners as gain on the sale of a capital asset, or as ordinary income in the form of a disguised dividend. This is a question of fact and this case must be decided on its own particular facts. The fact that the transaction was not at arm's length is not in itself a basis for disregarding the form of the transaction but it invites careful scrutiny as to whether all phases of the transaction were in fact what they purport to be in form; and this is particularly true here where the principal stockholders of a family corporation resell property to the corporation at a profit of over 100 per cent a few days after they acquired it. Petitioners attempt to explain why the property was first acquired by petitioners and then sold to the corporation, rather than being acquired directly by the corporation, by evidence to the effect that Torley would not sell the property for cash but would only trade it for investment property in Las Vegas; that the brothers, as directors, would not permit the corporation to enter into such a transaction because, by reason of their own personal unpleasant experiences in Las24 Vegas, they would have nothing to do with anything in Las Vegas; that it was against company policy to own the property on which its markets were located; that for some unexplained reason Eddy thought such a transaction might violate the corporation's loan agreement with Provident Mutual Life Insurance Company of Philadelphia; and that entering into this transaction might involve the corporation in interstate commerce which for some unexplained reason might affect the wages and hours of its employees. Petitioners further attempt to explain why they were so anxious to acquire this particular property, which the corporation held under a very favorable long-term lease, on the grounds that Joe was anxious to be relieved of the personal liability for performance of the lease which he had assumed as the general partner of the original lessee under the lease, and that the corporation was anxious to acquire the fee in the property so it could borrow money on it and could also use it for a sale and leaseback agreement with other parties. No effort was made by petitioners to justify the profit of over 100 per cent petitioners made by reselling this property to their controlled corporation25 in the same month they acquired it, except to attempt to show that the property itself was worth $75,000 at the time. The only evidence of this value was the testimony of Eddy that he made some inquiry of the Bank of America as to the value of the property for loan purposes, and the testimony of an experienced independent appraiser who appraised the property a few days before the trial and gave his opinion that the value of the property as of 1953 was about $79,000. This witness gave no satisfactory explanation of the effect on this value of the lease which still had 42 years to run at an annual rental of $800, particularly to a prospective purchaser who held the lease. The evidence indicates that Joe himself would not pay more than $35,000 for the property because of the favorable lease. The corporation, as holder of the lease, should have been in a better position to bargain for the property than anyone else. It requires little analysis of the various reasons given to conclude that many of them are not only inconsistent with each other and implausible, but even if accepted as a whole would not reasonably explain why the corporation would refuse to enter into this transaction directly26 with Torley but would be willing to let its president and principal stockholder buy the property for $35,000 and immediately resell it to the corporation for $75,000. Based on our examination of all the evidence and our observation of the witnesses on the witness stand, we are convinced that Joe Goldstein was the dominant character in the corporation, that he had control of its policies and made the executive and administrative decisions, that the other stockholders and directors owed their livelihoods to Joe and would have agreed that the corporation do anything legitimate that Joe suggested, and that the real reason the transaction here involved was carried out in the manner and on the terms described was to permit the corporation to acquire a higher tax basis in the San Gabriel property and at the same time permit Joe to withdraw $40,000 from the accumulated earnings of the corporation at a time when it could be offset against Joe's capital loss carryover and thus result in no tax to Joe. It is quite apparent that the objective of all concerned with the corporation was to get the title to the San Gabriel property in the corporation and that this could easily have been accomplished27 in behalf of the corporation for $35,000, by use of an agent or someone acting for the corporation if necessary, without exposure of either the corporation or its stockholders to any of the alleged problems which worried them, and that a direct acquisition by the corporation would just as well accomplish the objectives of all parties as would the indirect transaction. We do not believe the corporation, with its favorable lease, would have paid $75,000 for this property to an outsider. This is supported by the fact that its president and principal stockholder, Joe, had refused to pay more than $35,000 for the property when negotiating in behalf of the corporation. We do not think the corporation would have paid more than $35,000 for the fee to this property. Consequently, we have found as a fact that only $35,000 of the $75,000 paid by the corporation to petitioners was consideration for the property, and that the remaining $40,000 was a disguised dividend to petitioners. It will be taxed accordingly. Albert E. Crabtree, 22 T.C. 61">22 T.C. 61, affirmed per curiam 221 F. 2d 807 (C.A. 2, 1955); Sidney V. LeVine, 24 T.C. 147">24 T.C. 147; H.K.L. Castle, 9 B.T.A. 931">9 B.T.A. 931;28 secs. 22(a) and 115(a), I.R.C. 1939. Cf. Palmer v. Commissioner, 302 U.S. 63">302 U.S. 63. Sun Properties v. United States, 220 F. 2d 171 (C.A. 5, 1955), is heavily relied on by petitioners but is clearly distinguishable on the facts. The question there was whether the transfer of depreciable property to a wholly owned corporation was a sale or a contribution of capital. Here the question is whether a part of the sum paid by the corporation to the principal stockholder ostensibly as part of the purchase price of the land was in fact a disguised dividend. Accepting all the legal principles set forth in the Sun Properties case and applying those that are pertinent to the facts here would not, in our opinion, require a different conclusion than we have reached. The same is true of Warren H. Brown, 27 T.C. 27">27 T.C. 27, also cited by petitioners. See Aqualane Shores, Inc. v. Commissioner, 269 F. 2d 116 (C.A. 5, 1959), affirming 30 T.C. 519">30 T.C. 519, wherein the Court of Appeals for the Fifth Circuit distinguished its own Sun Properties case on the facts. It follows that respondent's determination of the amount of medical expense deductible is also29 correct. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621279/	The Toledo Newspaper Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. San Diego Sun Publishing Company, Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent. The E. W. Scripps Company, Transferee of San Diego Sun Publishing Company, Ltd., Petitioner, v. Commissioner of Internal Revenue, RespondentToledo Newspaper Co. v. CommissionerDocket Nos. 110076, 110077, 110078United States Tax Court2 T.C. 794; 1943 U.S. Tax Ct. LEXIS 48; September 30, 1943, Promulgated 48 Decisions will be entered under Rule 50. Where during the taxable year a taxpayer corporation engaged in the publication of a newspaper entered into a contract to sell all of its intangible assets for a specified consideration but no tangible assets, and in the same contract agreed for a separate specified consideration that it would discontinue publication of its newspaper on a given date, that it would not resume publication of any newspaper in the city of publication for a period of ten years, and that it would not permit its plant or equipment to be used for the publication of any newspaper in said city for a like period, held, the entire consideration received by the taxpayer in the sale should be treated as a whole and taxpayer's gain from the transaction should be determined by subtracting the March 1, 1913, value of its intangibles, including good will, from the total consideration received. The March 1, 1913, value of taxpayer's intangibles, including good will, determined from the evidence. Paul Patterson, Esq., and W. H. Bemis, Esq., for the petitioners.John H. Pigg, Esq., for the respondent. Black, Judge. BLACK 795 These proceedings were49 consolidated.In Docket No. 110076 the respondent determined deficiencies in income and excess profits taxes against the Toledo Newspaper Co. for the calendar year 1938 in the amounts of $ 93,240.95 and $ 59,898.69, respectively.In Docket No. 110077 the respondent determined deficiencies in income and excess profits taxes against San Diego Sun Publishing Co., Ltd., for the calendar year 1939 in the amounts of $ 62,776.98 and $ 45,655.99, respectively.In Docket No. 110078 the respondent determined that the E. W. Scripps Co. is liable as transferee for deficiencies in income and excess profits taxes in the respective amounts of $ 62,776.98 and $ 45,655.99 and for interest thereon due from San Diego Sun Publishing Co., Ltd., for the calendar year 1939. Transferee liability is admitted for any tax and interest, if any, owed by the transferorIn a statement attached to the deficiency notice in Docket No. 110076, the respondent made adjustments to net income and explanations thereof, as follows:Net loss disclosed by return$ 213,393.62Unallowable deductions and additional income:(a) Income received under sales agreement with The ToledoBlade Company, dated August 1, 1938713,554.16Total$ 500,160.54Nontaxable income and additional deductions:(b) Contributions423.00Net income adjusted$ 499,737.5450 Explanation of Adjustments to Net Income(a) Your taxable income for the year 1938 has been increased by the following amounts, representing consideration received by you under a sales agreement with The Toledo Blade Company, dated August 1, 1938:(1) Gain on sale of the name, "The Toledo News-Bee," thecirculation, route, subscription, dealer and carrier$ 100,000.00lists, etc(2) Income received for discontinuing publication of yournewspaper and refraining from competition613,554.16Total$ 713,554.16(b) * * *796 By appropriate assignments of error the petitioner in Docket No. 110076 contests adjustment (a).In a statement attached to the deficiency notice in Docket No. 110077, the respondent made adjustments to net income and explanations thereof, as follows:Net loss disclosed by return$ 101,965.57Unallowable deductions and additional income:(a) Income received under a sales agreement with TheUnion-Tribune Publishing Company, dated November 17, 1939483,180.46Total$ 381,214.89Nontaxable income and additional deductions:(b) Contributions595.32Net income adjusted$ 380,619.57Explanation of Adjustments51 to Net Income(a) Your taxable income for the year 1939 has been increased by the following amounts, representing consideration received by you under a sales agreement with The Union-Tribune Publishing Company, dated November 17, 1939:(1) Gain on sale of the name, "The San Diego Sun," and thecirculation, route, subscription, dealer and carrier lists,etc$ 120,000.00(2) Income received for discontinuing publication of yournewspaper and refraining from competition363,180.46Total$ 483,180.46(b) * * By appropriate assignments of error the petitioners in Docket Nos. 110077 and 110078 contest adjustment (a).FINDINGS OF FACT.Facts Concerning the Toledo Newspaper Co.The Toledo Newspaper Co., hereinafter sometimes referred to as "Toledo," is an Ohio corporation, with its principal office at Cincinnati, Ohio. It filed its corporation income and excess profits tax return for the calendar year 1938 with the collector for the first district of Ohio. Its books are kept on the cash receipts and disbursements basis.The business of Toledo was the publication of the daily newspaper "The Toledo News-Bee" in the city of Toledo, Ohio, from 1903 to August52 2, 1938, inclusive.On August 1, 1938, the Toledo Blade Co., an Ohio corporation, hereinafter sometimes referred to as "the Blade," entered into a written contract as first party with Toledo as second party and the E. W. Scripps Co., an Ohio corporation, as third party. The contract provided in part as follows:797 Whereas, The Toledo Blade Company is the owner and publisher of an evening newspaper in the City of Toledo, Ohio, known as The Toledo Blade, and The Toledo Newspaper Company is the owner and publisher of an evening newspaper in the said city of Toledo, Ohio, known as the Toledo News-Bee, and First Party desires to obtain from Second Party the discontinuance of The Toledo News-Bee and the agreement of Second Party that it shall not permit its plant and equipment in Toledo to be used during the period hereinafter stated for the publication of any newspaper in Toledo; andWhereas, First Party also desires to purchase the name, "The Toledo News-Bee" and the circulation, route, subscription, dealer and carrier lists and other assets hereinafter referred to, all upon the terms and conditions hereinafter set forth;Now, therefore, the parties hereto mutually agree as follows: 53 I-(a) For and in consideration of the payment by First Party to Second Party of the sum of Seven Hundred and Eighty Thousand ($ 780,000) Dollars as hereinafter set forth, Second Party agrees that for the period of ten (10) years from and after the closing date hereinafter named, it will discontinue publication of The Toledo News-Bee from and after the publication of its regular editions on Tuesday, August 2, 1938 (hereinafter referred to as the closing date), and Second Party further agrees that it will not resume publication of any newspaper in the City of Toledo, Ohio, during the period of ten (10) years from and after said closing date; and Second Party further agrees that it will not, without the written consent of First Party, permit its plant or equipment to be used for the publication of any newspaper in the City of Toledo, Ohio, during the said ten (10) year period.Paragraph I (b) of the contract provided that the consideration of $ 780,000 was payable in 20 quarterly installments of $ 12,500 each, beginning February 1, 1939, without interest, and 20 quarterly installments of $ 26,500 each, beginning February 1, 1944, without interest; that all the payments were to be represented54 by 40 noninterest-bearing promissory notes dated August 1, 1938, payable to the order of Toledo; and that the notes "shall be jointly and severally and unconditionally guaranteed by Paul Block and Associates, Inc., a corporation * * and by Paul Block, an individual, which guarantees First Party hereby agrees to obtain." The contract then continued in part as follows:II. - Provided there shall be no default by First Party in making prompt payment of the notes to be given to Second Party under paragraph I hereof, The E. W. Scripps Company, Third Party hereto, covenants and agrees that for the period of ten (10) years from and after the closing date, August 2, 1938, it will not, directly or indirectly, without the prior written consent of First Party, commence or become financially interested in any way in the establishment or publication in the City of Toledo, Ohio and Lucas County, Ohio, of any newspaper not in existence at the present time. It is understood and agreed by and between the parties hereto that this agreement by The E. W. Scripps Company is made by it as an inducement to The Toledo Blade Company to enter into this agreement with the Toledo Newspaper Company, in which55 The E. W. Scripps Company owns and holds a majority of the Class A (voting) stock.III. - (a) First Party hereby agrees to and does hereby purchase from Second Party, and Second Party hereby agrees to and does hereby sell, assign 798 and transfer to First Party, the name and title of the newspaper "The Toledo News-Bee" now owned by Second Party, together with all rights and privileges necessarily connected therewith, including any and all trade-marks or copyrights of said name, provided however that it is understood and agreed that the name and/or emblem of Scripps-Howard are not included hereunder; and also all circulation, route, subscription, dealer and carrier lists, copies of all statements of account and copies of all records relating to or concerned with the sale, distribution, delivery and returns of said newspaper "The Toledo News-Bee" in the territory in which it circulates on the closing date, it being expressly understood that no other assets of Second Party are sold or transferred to First Party hereunder. Second Party agrees that the assets to be sold to First Party shall be free and clear of all liens and encumbrances.(b) For and in consideration of the sale56 and transfer of the aforesaid assets to First Party by Second Party, First Party further agrees to pay Second Party the total sum of One Hundred Thousand ($ 100,000) Dollars, payable at the rate of Two Thousand Five Hundred ($ 2,500) Dollars quarterly beginning February 1, 1939, all such payments to be represented by a series of forty (40) promissory notes (to be known as Series B) of First Party payable to the order of The Toledo Newspaper Company, which notes shall be substantially in the form hereto attached marked Exhibit B and shall be jointly and severally and unconditionally guaranteed by Paul Block and Associates, Inc., and by Paul Block, an individual, which guarantees First Party also agrees to obtain. Each of said forty (40) notes shall be dated August 1, 1938, and shall bear no interest.Paragraph III (c) of the contract provided that "In further consideration of the sale and transfer by Second Party to First Party of the assets sold and transferred to First Party under this Paragraph III" the Blade would pay to Toledo 50 percent of the tax savings realized by it through amortization of any part of the $ 780,000 to be paid under paragraph I of the contract. The Blade57 was to be entitled to a tax saving of $ 25,000 before any payments were required to be made to Toledo. Thereafter Toledo was to be entitled to one-half of the tax savings up to a maximum of $ 50,000.On March 1, 1913, Toledo's business was expanding and profitable; on August 1, 1938, it was declining and unprofitable.For the five years preceding 1913 Toledo's net income after payment of taxes, average daily net paid circulation and dividends paid were as follows:Net incomeAverage dailyDividendsYearafter taxesnet paidpaidcirculation1908$ 60,522.7946,281$ 36,000190961,416.2453,84841,250191096,531.2158,741105,0001911156,856.3363,64145,0001912107,904.7667,224202,500Total483,231.33289,735429,750Average96,646.2657,94785,950799 Toledo's balance sheets as of December 31 for the years 1908 to 1912, inclusive, were as follows:190819091910ASSETSCash and notes receivable$ 137,467.99$ 167,298.60$ 152,845.70Accounts receivable26,426.7531,895.1935,341.10Paper assets2,875.33SecuritiesInvestments in landBuilding less depreciationEquipment less depreciation62,949.0056,654.1050,359.20Toledo Times purchase150,000.00150,000.00150,000.00Total376,843.74405,847.89391,421.33LIABILITIES AND CAPITALAccounts payable17,950.0016,896.7513,209.41Notes payable35,000.00Paper liabilityCapital stock300,000.00300,000.00300,000.00Surplus58,893.7488,951.1443,211.92Total376,843.74405,847.89391,421.3358 19111912ASSETSCash and notes receivable$ 262,873.90$ 97,583.97Accounts receivable34,618.8244,088.62Paper assets4,842.81909.73Securities60,000.00Investments in land35,000.00Building less depreciation78,400.00Equipment less depreciation44,064.30101,484.00Toledo Times purchaseTotal406,399.83357,466.32LIABILITIES AND CAPITALAccounts payable10,361.4211,239.20Notes payable20,000.0010,000.00Paper liability16,017.009,262.98Capital stock300,000.00300,000.00Surplus60,021.4126,964.14Total406,399.83357,466.32Toledo's average tangible assets for the five-year period prior to December 31, 1912, were $ 387,595.82.The circulation and income of Toledo continued to rise until 1916 and 1917, respectively. The average daily net paid circulation rose from 46,281 in 1908 to 91,332 in 1916. The net income after taxes rose from $ 60,552.79 in 1908 to $ 245,574.02 in 1917. From the period of the first World War through 1929 circulation fluctuated between 70,864 and 96,704, and the net income after taxes ranged between $ 109,000 and $ 232,000. In 1930 the income dropped to $ 23,002.88, and since that59 time Toledo has never had any net income. The circulation also declined steadily after 1929, except for a slight rise in 1934 and 1935, until it reached 47,816 in 1938, which was only slightly larger than the circulation in 1908. During the period from 1908 to 1932, inclusive, Toledo paid total dividends of $ 3,204,301.19.For the period of five years and seven months preceding August 2, 1938, Toledo paid no dividends and instead of realizing a net income it had a net loss for each year. Its net losses and average daily net paid circulation for this period were as follows:Net lossesAverage dailyYearafter taxesnet paidcirculation1933$ 98,058.8659,1871934113,070.6061,5101935120,263.3866,379193647,769.4654,666193713,541.0750,884To Aug. 2, 1938213,393.6247,816800 No tangible assets were sold to the Blade under the above mentioned contract dated August 1, 1938. Toledo suspended publication of "The Toledo News-Bee" with the publication of the regular editions on August 2, 1938, and transferred to the Blade all of its intangible assets in accordance with the contract dated August 1, 1938. Toledo has not published a newspaper60 in Toledo, Ohio, since August 2, 1938. All of the notes of the Blade delivered to Toledo which have matured since August 1, 1938, have been paid when due.The fair market value on March 1, 1913, of the intangible assets, including good will, transferred to the Blade in accordance with the contract dated August 1, 1938, was $ 437,590.60. There is no evidence as to the cost to Toledo of such intangible assets.Facts Concerning San Diego Sun Publishing Co., Ltd.San Diego Sun Publishing Co., Ltd., hereinafter sometimes referred to as "San Diego," is a California corporation, with its principal office at Cincinnati, Ohio. It filed its corporation income and excess profits tax return for the calendar year 1939 with the collector for the first district of Ohio. Its books were kept on a cash receipts and disbursements basis.The business of San Diego was the publication of the daily newspaper "The San Diego Sun" in the city of San Diego, California, from November 2, 1914, until November 25, 1939. Prior to November 2, 1914, "The San Diego Sun" was owned and published by the San Diegan Sun Co. San Diego acquired all the assets of the San Diegan Sun Co. on November 2, 1914, as the61 result of a tax-free exchange, within the meaning of sections 112 (b) (4) and 113 (a) (6) of the Revenue Act of 1938. The books of the San Diegan Sun Co. were also kept on a cash receipts and disbursements basis.On November 17, 1939, the Union-Tribune Publishing Co., a California corporation, hereinafter sometimes referred to as "the Union-Tribune," entered into a written contract as first party with San Diego as second party and the E. W. Scripps Co. as third party.The contract contained provisions substantially the same as those contained in the Toledo contract. The period for which San Diego had to suspend publication was seven years and six months. Under paragraph I of the contract, corresponding to paragraph I of the Toledo contract, the Union-Tribune agreed to pay San Diego $ 30,000 in cash and $ 30,000 on the first day of June and December of the years 1940 to 1946, inclusive. The debt was to be evidenced by a series of fourteen notes bearing no interest. The consideration specified in paragraph III of the San Diego contract for the transfer of the name "The San Diego Sun" and the circulation route, subscription, dealer, and carrier lists was $ 120,000 payable in cash62 upon execution of the 801 contract. The San Diego contract did not contain a provision such as that by which the Blade was to share its tax savings with Toledo.On March 1, 1913, the business of the San Diegan Sun Co. was stable and profitable; on November 17, 1939, the business of San Diego was declining and unprofitable.For the five years preceding 1913, the San Diegan Sun Co.'s net income after payment of taxes, average daily net paid circulation, and dividends paid were as follows:Net incomeAverage dailyDividendsYearafter taxnet paidpaidcirculation1908$ 11,638.575,511$ 13,200.00190912,011.606,3793,200.00191010,983.927,4853,030.80191118,181.739,11614,149.13191225,460.6311,70814,328.65Total78,276.4540,19947,908.58Average15,655.298,0399,581.17The San Diegan Sun Co.'s balance sheets as of December 31 for the years 1908 to 1912, inclusive, and as of March 1, 1913, were as follows:190819091910ASSETSCash$ 4,444.71$ 5,518.91$ 9,746.15Accounts receivable7,716.049,882.2113,701.13Paper assets454.161,745.851,851.04Land14,600.0014,600.0014,600.00Building less depreciation20,000.0019,000.0018,000.00Equipment22,057.4522,057.4533,868.45Total69,272.3672,804.4291,766.77LIABILITIES AND CAPITALAccounts payable758.053,020.442,368.50Notes payablePaper liability1,096.99884.441,042.00Bonds25,000.0023,000.0023,000.00Capital stock10,000.0010,000.0010,000.00Surplus32,417.3235,899.5455,356.27Total69,272.3672,804.4291,766.7763 191119121913ASSETSCash$ 9,613.80$ 11,679.72$ 12,306.67Accounts receivable15,419.7827,002.1428,535.84Paper assets4,085.994,293.673,555.65Land14,600.0014,600.0014,600.00Building less depreciation17,000.0016,130.0016,130.00Equipment35,724.4539,311.4539,311.45Total96,444.02113,016.98114,439.61LIABILITIES AND CAPITALAccounts payable3,492.805,184.623,723.11Notes payable900.00900.00Paper liability2,588.56Bonds19,000.0015,550.0015,050.00Capital stock10,000.0010,000.0010,000.00Surplus63,951.2278,793.8084,766.50Total96,444.02113,016.98114,439.61The San Diegan Sun Co.'s average tangible assets for the five-year period prior to December 31, 1912, were $ 88,660.91.For the seventeen-year period from 1915 to 1931, inclusive, the average annual net income and circulation of San Diego were $ 20,015.42 and 17,555, respectively. San Diego has had no net income since 1931. During the period from 1908 to 1930, inclusive, San Diego and its predecessor the San Diegan Sun Co., paid total dividends of $ 612,788.58.802 For the five-year and almost eleven-month period64 preceding November 25, 1939, San Diego paid no dividends, and during this period its net losses and average daily net paid circulation were as follows:Net lossesAverage dailyYearafter taxnet paidcirculation1934$ 54,653.4318,077193536,411.0520,855193642,781.5522,0371937$ 38,003.0422,177193877,917.8920,781To Nov. 25, 1939101,965.5718,369No tangible assets were sold to the Union-Tribune under the contract of sale dated November 17, 1939. San Diego suspended publication of "The San Diego Sun" with the publication of the regular editions on November 25, 1939, and transferred to the Union-Tribune all of its intangible assets in accordance with the contract dated November 17, 1939. Neither San Diego nor the E. W. Scripps Co. has published a newspaper in San Diego, California, since November 25, 1939. All of the notes of the Union-Tribune delivered to San Diego which have matured since November 17, 1939, have been paid when due.The fair market value on March 1, 1913, of the intangible assets, including good will, then owned by the San Diegan Sun Co. and which were acquired by San Diego in a tax-free exchange on November 2, 1914, 65 and transferred to the Union-Tribune in accordance with the contract dated November 17, 1939, was $ 57,082.80.Facts Concerning Both Toledo and San Diego.In the purchase of a newspaper business, as a going concern, it is customary that the purchaser require of the seller, in addition to the conveyance of the assets making up the newspaper business, tangible or intangible, or both, a covenant to refrain for a reasonable period from reentering into the business of publishing a newspaper within the territory in which the newspaper of the seller circulated at that time. This is necessary in order to prevent the seller from destroying the value of the good will of the business transferred.Any part of the stipulations of facts, including the exhibits thereto, not specifically set forth herein is incorporated herein by reference and made a part of these findings of fact.Facts Concerning the E. W. Scripps Co.At all times material to these proceedings, the E. W. Scripps Co., an Ohio corporation, was the owner of all the outstanding capital stock of San Diego. Pursuant to a plan of complete liquidation adopted by San Diego on October 7, 1940, all of the assets of San Diego were66 transferred to the E. W. Scripps Co., the petitioner in 803 Docket No. 110078, prior to December 31, 1940. The E. W. Scripps Co. is liable as transferee of the property of San Diego for any deficiencies in income tax and excess profits tax, plus interest, that may be determined to be due from San Diego in Docket No. 110077.OPINION.As shown in our opening statement, the contested deficiencies result from the respondent's addition in Docket No. 110076 to the net loss disclosed by Toledo's return for 1938 of "Income received under sales agreement with The Toledo Blade Company dated August 1, 1938, $ 713,554.16"; and addition in Docket No. 110077 to the net loss disclosed by San Diego's return for 1939 of "Income received under a sales agreement with The Union-Tribune Publishing Company dated November 17, 1939, $ 483,180.46." Petitioners contest the entire dificiencies on the ground that both these adjustments are erroneous in their entirety.Toledo contends that on August 1, 1938, it sold its newspaper business for a total consideration of $ 880,000; that the March 1, 1913, value of the intangible assets sold was not less than $ 880,000; and that it, therefore, realized no gain67 from the sale. The respondent contends that $ 780,000 of the consideration was for Toledo's covenant not to publish a newspaper in the city of Toledo for a period of ten years; that consideration for such a covenant represents ordinary income under section 22 (a) of the Revenue Act of 1938 rather than a gain or loss from the "sale or other disposition of property" under section 111; that Toledo is not, therefore, entitled to apply against such consideration any tax "basis" under section 111; and that, since the consideration of $ 780,000 was represented by forty noninterest-bearing notes payable over a period of ten years, the discounted value of such notes on August 1, 1938, was $ 613,554.16. The respondent also contends that $ 100,000 of the consideration was paid to Toledo for its intangible assets; that while this much of the consideration was from the "sale or other disposition of property" under section 111, Toledo has not proven any tax "basis" for the intangible assets sold; and that, therefore, the entire $ 100,000 is gain from the sale. It may be noted that this part of the total consideration mentioned in the August 1, 1938, contract was also represented by forty noninterest-bearing68 notes payable over a period of ten years and that the respondent did not discount these notes as he did the notes totaling $ 780,000, but no point is made by Toledo on this apparent inconsistency in the respondent's determination, and, there being no issue raised about it, we shall not discuss it further. The respondent does not contend that Toledo realized any taxable income in 1938 by reason of paragraph III (c) of the contract with the Blade, which provision has to do with the possible saving of taxes by the purchaser.804 San Diego and the E. W. Scripps Co. contend that on November 17, 1939, San Diego sold its newspaper business for a total consideration of $ 570,000; that the March 1, 1913, value of the intangible assets sold was not less than $ 570,000; and that San Diego, therefore, realized no gain from the sale. The respondent contends that $ 450,000 of the consideration was for San Diego's covenant not to publish a newspaper in the city of San Diego for a period of seven years and six months; that consideration for such a covenant represents ordinary income under section 22 (a) of the Internal Revenue Code rather than a gain or loss from the "sale or other disposition69 of property" under section 111; that San Diego is not, therefore, entitled to apply against such consideration any tax "basis" under section 111; and that, since $ 420,000 of the $ 450,000 was represented by fourteen noninterest-bearing notes of $ 30,000, each payable on the first day of June and December of the years 1940 to 1946, inclusive, the discounted value of such notes on November 17, 1939, plus the cash payment of $ 30,000, was $ 363,180.46. The respondent also contends that $ 120,000 of the consideration was paid to San Diego for its intangible assets; that while this much of the consideration was from the "sale or other disposition of property" under section 111, San Diego and the E. W. Scripps Co. have not proven any tax "basis" for the intangible assets sold; and that, therefore, the entire $ 120,000 cash payment is gain from the sale.We shall consider first the case of Toledo. The contract of August 1, 1938, specifically provides for two separate and distinct considerations. These considerations are fully stated in paragraphs I and III of the contract and are copied in our findings of fact and need not be repeated here.Toledo's contention with respect to these two70 separate considerations included in the contract is in substance that where, as here, there is a sale of a business as a single transaction, gain or loss is to be computed by comparing the total selling price of such business with the seller's statutory basis, and that this rule is not changed by the fact that in the contract of sale the consideration for the sale of intangible assets was separately stated from the consideration for ceasing to publish petitioner's newspaper and its agreement not to compete for a period of ten years and other things agreed to be done in this paragraph of the contract, inseparable from the conveyance of the business and its good will as a going concern to the purchaser. One of the cases relied upon by petitioner to support its contention on this point is Henry F. McCreery, 4 B. T . A. 967. We think this case does support petitioner's contention as we have stated it above. In the McCreery case, among other things, we said: * * We consider it of no importance, in this connection, that the contract provides for the payment of a specific amount for the good will and the payment 805 of a further sum to be determined71 in the manner therein set forth, specifically for the tangible assets, but regard this as a mere agreement of the parties as to the manner in which the purchase price to be paid for the entire businesses, including good will and firm name, is to be determined. The gain or loss realized by the partnership upon the sale of its assets and businesses should be determined by comparing the selling price with the cost and the March 1, 1913, value of the entire assets, tangible and intangible, taken as a whole.The substance of the general rule announced by the Board in the McCreery case we think should be applied to the particular facts of the instant case in computing gain on the transactions here involved.Among the authorities strongly urged by the respondent to sustain his contention that the consideration named in the contract of sale for Toledo's agreement to cease publication of its newspaper and not to compete for a period of ten years was not to be considered as a part of the selling price of the newspaper, but must be considered as gross income under section 22 (a), Revenue Act of 1938, are Cox v. Helvering, 71 Fed. (2d) 987; Salvage v. Commissioner, 76 Fed. (2d) 112;72 affd., 297 U.S. 106">297 U.S. 106; and Beals' Estate v. Commissioner, 82 Fed. (2d) 268, affirming 31 B. T. A. 966.It is undoubtedly true that the above cases do hold that where a corporation sells out its going business to a purchaser and incidental to such transaction some officer or employee or stockholder of the selling corporation agrees with the purchaser that he will not compete for a given number of years with the purchaser of the business and the purchaser pays him a consideration for such agreement, the consideration thus received by the officer, employee, or stockholder of the selling corporation is taxable income to him under section 22 (a). The reason for this is that he himself has sold no capital asset but has simply received a sum of money for agreeing not to compete. The court in Cox v. Helvering well stated the reason for holding such a sum taxable income to the officer, employee, or stockholder receiving it, in the following language:There is positively not one word in the record which would justify us in saying that the payment to petitioner was a capital transaction. If the 73 $ 15,000 was paid to the selling corporation and distributed by it to its principal stockholder by some intracompany agreement, it might very well be designated, as the Commissioner designated it, a liquidating dividend, for in that case it would be a profit earned in the sale of capital assets. On the other hand, if it was paid directly to petitioner, as an ancillary agreement with the contract, it was to its extent a gain received by him in consideration of forbearing, rather than doing, personal services.The conclusion we reach is consistent with the practice of the bureau over a long period of years, for as far back as 1920 it announced, through office decisions, the rule in such cases as follows: "Where a corporation sells its assets, including good will, to a competing corporation, one condition to the sale being an agreement by the president of the vendor corporation not to engage in similar business, for which he is paid a money consideration, the amount so received 806 by the president does not represent a conversion of capital, but is income for the year of its receipt." Commissioner's Bulletin 3, p. 93, O. D. 668.Toledo contends that the above mentioned cases are74 distinguishable because the payments in those cases for promises not to compete were made to the stockholders of the selling corporation rather than to the selling corporation itself or to persons who were not the owner or seller of any business.We think that petitioners are correct in contending that the above cases are distinguishable on their facts from the instant case. A reading of them will show (a) that the promise not to compete was unrelated to any sale made by the promisor and (b) that the promise not to compete did not operate as a restraint upon any property of the promisor and was not, therefore, an inherent part of anything sold by the promisor.As a part of our findings of fact both as to Toledo and San Diego we have found upon evidence introduced by petitioners at the hearing that:In the purchase of a newspaper business, as a going concern, it is customary that the purchaser require of the seller, in addition to the conveyance of the assets making up the newspaper business, tangible or intangible, or both, a covenant to refrain for a reasonable period from reentering into the business of publishing a newspaper within the territory in which the newspaper of the seller75 circulated at that time. This is necessary in order to prevent the seller from destroying the value of the good will of the business transferred.Therefore, because of these and other facts included in our findings, we hold that the entire consideration received by petitioners under the contracts must be treated as one in computing petitioners' gain from the sale, and the Commissioner was not warranted in treating the consideration specified in paragraph I of the contract as income in its entirety under section 22 (a).In addition to contending that the entire consideration must be treated as one in computing gain or loss, a contention which as above stated we sustain, Toledo also strongly argues that its going business was sold in 1938 at no greater price than its March 1, 1913, value, and therefore there was no taxable gain on the transaction. Petitioner urges in support of this contention the case of Pfleghar Hardware Specialty Co. v. Blair, 30 Fed. (2d) 614. In that case the court did hold that the Board erred in finding that there was no evidence to show what the March 1, 1913, value of the good will of the Pfleghar Hardware76 Specialty Co. was; the court further held that this March 1, 1913, value must be included as a part of the taxpayer's basis in determining gain, if any, from the sale; that the value of this good will as of March 1, 1913, was at least $ 113,888.25; and that the Board should have so found, and when this March 1, 1913, value of $ 113,888.25 for good will was used as a part of the taxpayer's basis there was no gain to it on the sale. While the Pfleghar Hardware Specialty Co. case, 807 supra, does support petitioner's contention that the March 1, 1913, value of its intangibles, including good will, must be considered in determining the gain, if any, which petitioner realized from the sale of its going business in 1938, it is needless to say that the March 1, 1913, value of intangibles, including good will, of a going business depends upon the evidence in each case. Merely because the court held in the Pfleghar Hardware Specialty Co. case that the sale price received for the going business in 1919 was less than its statutory basis, including March 1, 1913, value of good will, and therefore there was no gain on the sale, is no reason that we should so hold in the instant77 case. What we should hold in that respect depends upon the evidence in the instant case, and, for reasons which we shall presently state, we do not hold that the March 1, 1913, value of Toledo's intangibles, including its good will, was greater than the total price received in 1938 under the contract of sale.We should perhaps point out that Toledo's basis for determining gain from the sale which it made is defined differently from its basis for determining loss. Its basis (unadjusted) for determining gain is cost or March 1, 1913, value, whichever is greater. Sec. 113 (a) (14), Revenue Act of 1938. 178 Its basis as of March 1, 1913, for determining loss "is the cost or other basis provided for such property under section 113 (a) adjusted as required by section 113 (b), but without reference to the fair market value of the property as of March 1, 1913." Art. 113 (a) (14)-1, Regulations 101. Did Toledo realize any gain upon the sale involved in this proceeding, treating the entire consideration together as one, as we think it should be treated? Toledo does not claim that it sustained any loss upon the sale. Furthermore it has offered no evidence of its statutory basis for the computation of a loss, which is a prerequisite to the determination of any loss. As previously stated, its statutory basis for determining gain is cost or March 1, 1913, value, whichever is greater.In its petition Toledo alleges that "The March 1, 1913 value of the intangible assets sold to The Toledo Blade Company under the contract of sale dated August 1, 1938 was not less than $ 880,000." The respondent contends that Toledo has proven no basis for either gain or loss and that his determination that the entire $ 100,000, specified as being paid to petitioner for intangibles, represents gain should 79 be 808 approved, as well as the amount received for the agreement to cease publication and not to compete for a period of ten years. In its brief Toledo argues in part as follows:Since no physical property is involved in the instant case, and since no loss is claimed by the petitioner, the sole question is whether the value of the petitioner's business on March 1, 1913 was greater or less than its value on August 1, 1938. This is purely a matter of comparative value and actual values need not be determined. Pfleghar Hardware Specialty Co. v. Blair, 30 F. (2d) 614, 617-18, 7 A. F. T. R. 8462; Fidelity Trust Co., 3 B. T. A. 292.The parties have stipulated that Toledo "transferred to The Toledo Blade Company all of its intangible assets in accordance with said contract dated August 1, 1938." This would include any good will owned by Toledo on March 1, 1913. The applicable regulations on the sale of good will are Regulations 101, art. 22 (a)-10, and are printed in the margin. 280 As a part of the record in this case the parties have placed in evidence Toledo's balance sheets for the five years prior to December 31, 1912, from which we find that Toledo's average tangible assets for that period were $ 387,595.82. The parties have also stipulated that Toledo's average income over the same period was $ 96,646.26.In Herald-Despatch Co., 4 B. T. A. 1096, 1107, one of the questions involved the determination of gain or loss from the sale of a newspaper business in 1920 which had been organized in 1890. There "The March 1, 1913, value of intangibles was determined by the Commissioner by deducting from the average earnings of the five years next preceding 1913 an amount equivalent to 8 percent of the average tangibles for the same period, and capitalizing the remainder at the rate of 15 percent." We approved that determination, which was based upon the formula (A. R. M. 34) referred to in the Pfleghar case. We have used this same formula in arriving at the March 1, 1913, value of Toledo's intangibles, including good will, set out in our findings of fact. See Mertens Law of Federal Income Taxation, vol. 10, sec. 59.42. In the81 section above mentioned the author, among other things, in discussing the use of formulae in determining the value of good will on a given date, says:It is important to appreciate fully that the use of these formulae and the determination of the proper rates depend upon all the other existing factors of value. It is simply a method of determining a value by reference to the return which the investor would demand under all the circumstances involved. * *809 We wish to make it clear that in using the formulae which we have used in the instant case in arriving at the March 1, 1913, value of Toledo's intangibles, including good will, we do not mean to indicate that is the only method to be used in arriving at the value of good will of a going business. There may be many other factors which should be considered in a given case. But in the instant case, under the evidence which we have before us, we feel that the only practicable way to arrive at the March 1, 1913, value of Toledo's intangibles, including good will, is by use of the formulae which we have used. The March 1, 1913, fair market value of Toledo's intangibles, including good will, set out in our findings of fact, 82 is $ 437,590.60. This represents the basis (unadjusted) for determination of gain under section 113 (a) (14), supra. Section 113 (b) of the Revenue Act of 1938 provides:(b) Adjusted Basis. -- The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis determined under subsection (a), adjusted as hereinafter provided.The respondent does not contend that any of the "hereinafter" provisions referred to in section 113 (b), supra, are applicable in these proceedings.No deduction for depreciation, including obsolescence, is allowable to a taxpayer in respect of good will. See art. 23 (1) (3), Regulations 101. Likewise, it has been held that a newspaper subscription list, because it has no definite life, is not subject to depreciation or obsolescence allowances. Danville Press, Inc., 1 B. T. A. 1171. See also Meredith Publishing Co. v. Commissioner, 64 Fed. (2d) 890. Therefore, the March 1, 1913, value of petitioner's intangibles, including good will, which were sold in the contract of August 1, 1938, does not have to be adjusted83 for depreciation or obsolescence, if any, occurring between March 1, 1913, and the date of sale, for no deductions with respect thereto were allowable to Toledo in the computation of its net income during such period.It follows that Toledo's gain from the sale of its newspaper business, coupled with an agreement to cease publication and not to compete for a period of ten years, will be computed by taking the total consideration received therefrom as determined by the Commissioner, $ 713,554.16, and subtracting therefrom $ 437,590.60, the March 1, 1913, value of Toledo's intangibles, including good will.We shall now consider the case of San Diego. As far as principles of law are concerned, the contentions of the parties here are the same as in the case of Toledo, and we think it is unnecessary to restate them. The respondent does not question the proposition that, as in the case of Toledo, San Diego's basis for determining gain on the sale in 1939 of the intangible assets is the March 1, 1913, value of such assets. 810 Since the parties have tried and briefed the case on that proposition, we are not inclined to question its correctness. In its petition San Diego alleges84 that "The March 1, 1913 value of the intangible assets sold to The Union-Tribune Publishing Company by the petitioner was not less than $ 570,000," and, therefore, there was no gain to San Diego in the transaction. The respondent contends that no March 1, 1913, value has been proven. Applying the same formula as we used in the case of Toledo, we have found that the March 1, 1913, value of San Diego's intangible assets, including good will, was the amount of $ 57,082.80. See Pfleghar Hardware Specialty Co. v. Blair, supra.It follows that San Diego's gain from the sale of its newspaper business, coupled with an agreement to cease publication and not to compete for a period of seven years and six months, will be computed by taking the total consideration received from the transaction as determined by the Commissioner, $ 483,180.46, and subtracting therefrom $ 57,082.80, the March 1, 1913, value of San Diego's intangible assets, including good will. Since it has been agreed by the parties that the E. W. Scripps Co. is liable as transferee of the property of San Diego for any deficiencies in income tax and excess profits tax, plus 85 interest, that may be determined to be due from San Diego in Docket No. 110077, that fact will be given effect in a decision under Rule 50.Decisions will be entered under Rule 50. Footnotes1. SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.(a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --* * * (14) Property acquired before March 1, 1913. -- In the case of property acquired before March 1, 1913, if the basis otherwise determined under this subsection, adjusted (for the period prior to March 1, 1913) as provided in subsection (b), is less than the fair market value of the property as of March 1, 1913, then the basis for determining gain shall be such fair market value. * *↩2. Art. 22 (a)-10. Sale of good will↩. -- Gain or loss from a sale of good will results only when the business, or a part of it, to which the good will attaches is sold, in which case the gain or loss will be determined by comparing the sale price with the cost or other basis of the assets, including good will. (See articles 111-1, 113 (a) (14)-1, 113 (b)-1, 113 (b)-2, and 113 (b)-3.) If specific payment was not made for good will there can be no deductible loss with respect thereto, but gain may be realized from the sale of good will built up through expenditures which have been currently deducted. It is immaterial that good will may never have been carried on the books as an asset, but the burden of proof is on the taxpayer to establish the cost or other basis of the good will sold.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621247/	S. Franklyn Woodcock v. Commissioner.S. Woodcock v. CommissionerDocket No. 20606.United States Tax Court1950 Tax Ct. Memo LEXIS 60; 9 T.C.M. (CCH) 981; T.C.M. (RIA) 50260; October 31, 1950Joshua W. Miles, Esq., 1607 First Nat. Bank Bldg., Baltimore 2, Md., and D. Sylvan Friedman, Esq., for the petitioner. Paul E. Waring, Esq., for the respondent. KERN Memorandum Findings of Fact and Opinion Respondent determined income tax deficiencies against petitioner for the calendar years 1944, 1945 and 1946, in the respective amounts of $833.54, $190.39 and $5,384.07. The questions presented by the pleadings are: (1) whether the profits from the sale of certain real estate sold by petitioner are taxable as ordinary income or as capital gain, and (2) whether the amount of $3,018.75 received by petitioner from the sale of three tracts of land in 1946 constitutes "commissions" and taxable as ordinary income or "profit" taxable as capital gain? Findings of Fact Petitioner is an individual residing and having61 his place of business in Salisbury, Maryland. He filed his return for the periods involved with the collector of internal revenue at Baltimore, Maryland. Petitioner has been engaged in the real estate business in Salisbury during the past thirty-five years. As a real estate broker, he sold real property for others. Such properties are sold either on private listing contracts or at public auctions conducted by petitioner. On the private sales petitioner received 10% of the sales price as his commission, and on the sales at public auction he received 10% of the sales price, plus one-half of the amount obtained over the agreed selling price. Usually auction sales were extensively advertised by circulars and numerous "for sale" signs placed on the property. Private sales were, usually, advertised in newspapers. For over twenty years petitioner has acquired with other parties properties for the purpose of making profit from their resale. One of the parties was the Larmar Corporation, which dealt in real estate, promoted developments, and received substantial income from rentals. James Larmar and George F. Chandler, two officers of the corporation, are real estate men whose offices are62 located in Salisbury about a block from petitioner's office. Petitioner acquired, held and sold more property with Larmar Corporation than with other individuals. Though they were competitors, Larmar and Chandler were good friends of petitioner. When Larmar Corporation became interested in purchasing real property, Larmar or Chandler would approach petitioner in order to get his judgment on its value. After inspecting and appraising the property, petitioner would be asked if he would agree to take an interest in the property, and he frequently took a half interest. The title to most of the properties purchased was taken in the name of Larmar Corporation, and most of the sales were made by the corporation, usually after one of the officers had conferred with petitioner about the price. There was no written agreement between petitioner and Larmar Corporation, but there was an understanding that their joint holdings would not be sold for a "shoestring profit." Petitioner's holdings with other associates were on a similar basis. Petitioner's sales of properties, including his joint holdings with associates, during the respective tax years, were as follows: 1944DatePet'rs.PropertyPurchasersAcquiredInterestGordyPet'r. & Larmer Corp.Feb. 19411/2FairgroundsPet'r. & Larmar Corp.Jan. 19431/2Bay HeightsPet'r. & J. E. EvansJuly 19311/2Standard Oil Co.Pet'r. & Larmar Corp.June 19431/3Leonard MillPet'r. & Larmar Corp.Aug. 19431/2TotalMorrisPet'r. & Lloyd Chandler19441/2(1) Cost recovered in prior years.(2) Reported as short-term net gain.1945MorrisPet'r. & ChandlerMay 19441/2CollinsPet'r. & ChandlerSept. 19441/2LongPet'r. & Curtis W. Long19321/2Synepuxent FarmPet'r. & Louise Parsons19412/3States Roads CommissionPet'r. & Larmar Corp.19421/2Total(1) Cost recovered in prior years.(2) No cost allocated.1946ShowellPet'r. & Larmar Corp.July 19451/3HodgsonPet'r. & Herman Hodgson19311/2HorseyPet'r. & Larmar Corp.May 19431/2Bay HeightsPet'r. & J. E. EvansJuly 19311/2Dickerson TimberPet'r. & Larmar Corp.Oct. 19431/2Synepuxent FarmPet'r.Nov. 1941AllSalisbury Realty Co.Pet'r. & Larmar Corp.Jan. 19401/2Sunny Side lotsPet'r. & H. C. Mezick19351/2Long TimberPet'r. & Guy E. Long19351/2Wooten Corp.Pet'r. & Larmar Corp.May 19451/2Collins LandPet'r.Sept. 1945AllMaple Plains lotsPet'r. & Larmar Corp.Jan. 19401/2Leonard FarmPet'r. & Larmar Corp.Oct. 19411/2Richwill ParkPet'r. & Larmar Corp.July 19451/2Total(1), (2), (3), (4), (5), (6), (7) and (8). Cost recovered in prior years.(9) and (10). Sales price not shown. Petitioner received check from Larmar Corporation for his interest.63 1944DateSalesPet'rs.PropertyCostSoldPriceProfitGordy$9,140.42Oct. 1944$13,790.00$2,324.79Fairgrounds3,000.00Apr. 19443,700.00350.00Bay Heights(1)July 19441,000.00500.00Pet. Int.Pet. Int.Standard Oil Co.865.00Dec. 19442,840.681,974.88Leonard Mill1,200.00Dec. 19442,500.00650.00Total$5,799.67Pet. Int.Morris562.501944800.00$ 237.50(2)(1) Cost recovered in prior years.(2) Reported as short-term net gain.1945Pet. Int.Pet. Int.Morris$ 455.00Oct. 1945$ 811.67$ 356.37Collins1,135.28Nov. 19451,405.00269.72Long(1)Mar. 1945510.00255.00Pt. of FarmSynepuxent Farm3,302.84June 19456,000.001,798.11Pet. Int.States Roads Commission(2)1945135.50135.50Total$2,814.70(1) Cost recovered in prior years.(2) No cost allocated.1946Showell$3,600.00June 1946$ 5,000.00$ 466.67Pet. Int.Hodgson(1)April 1946422.50422.50HorseyPet. Int.(2)June 1946210.00210.00Bay Heights(3)Jan. 194610,000.005,000.00Dickerson Timber(4)Sept. 194611,000.008,318.47Synepuxent Farm1,676.56Sept. 19462,000.00323.44Pet. Int.Salisbury RealtyCo.100.00Sept. 19461,696.25Dec. 19461,000.002,596.25Pet. Int.Sunny Side lots(5)Jan. 194633.0033.00Pet. Int.Long Timber(6)Jan. 1946125.00125.00Pet. Int.Wooten Corp.20,000.00194612,500.002,500.00Pet. Int.Collins Land3,500.00Mar. 19464,000.00383.75Maple Plains lots(7)Jan. 1946(9)734.36Leonard Farm(8)Jan. 1946(10)290.00Pet. Int.Pet. Int.Richwill Park826.00Feb. 19463,656.002,830.00Total$24,233.44(1), (2), (3), (4), (5), (6), (7) and (8). cost recovered in prior years.(9) and (10). Sales price not shown. Petitioner received check from Larmar Corporation for his interest.64 Petitioner and respondent are in agreement that petitioner's profits during the tax years 1944, 1945 and 1946 were, respectively, $5,799.67, $2,814.70, and $24,233.14, and that such amounts were, respectively, reported by petitioner as long-term capital gains. The properties were, respectively, acquired and disposed of under the following circumstances: 1944 Ida Ward Gordy Property. This property was purchased at the cost of $9,140.42 from Ida Ward Gordy in 1941. It was a small farm and was located on Fitzwater Street extended, which is a wide street west of Salisbury. It was purchased for the purpose of reselling for profit after it had appreciated in value, and at the time of purchase there was the prospect of the railroad company running a siding to this property. Later the construction of the siding was started and was in progress at the date of hearing. This property was held until 1944. In the meantime H. B. Roberts acquired adjoining property on which he operated the Salisbury Shipyard, and he desired additional space. Arthur Eypel owned property adjoining the shipyard, and he wanted a portion of the Gordy property so as to protect himself from the shipyard and to65 straighten out his property line. A part of the property was sold to Eypel, and the remainder to the Roberts' interests. This property was not advertised for sale as the interested individuals approached Larmar Corporation, and petitioner agreed to sell for $13,790 and the profit he received was $2,324.79. Fairground Property. This piece of property was a residue of the old County Fairgrounds, and was located on Fitzwater Street extended. It is not shown how much ground was acquired. Other Fairground property was used for manufacturing purposes. This parcel of real estate was purchased at an auction sale in January, 1943, at the cost of $3,000 for the purpose of selling for profit after it had appreciated in value. It was sold by Larmar Corporation the next year after its purchase for $3,700 and netted petitioner a profit of $350. Bay Heights Development Company Property. This property was acquired in 1931 by petitioner and J. Edward Evans of Pittsville, Maryland, who had suggested that petitioner and he buy the property. It was located on Ocean City, Maryland, and belonged to the Pennsylvania Railroad Company. The property was marsh land and was acquired for the purpose66 of developing it. Petitioner and Evans built three houses and attempted to make a fill, but that being expensive and the depression having set it, they could not complete the development. They sold each of the houses at a loss. In 1933 a storm cut an inlet just south of Ocean City and the Government dredged the channel. As the property was located on this body of water, petitioner and Evans gave the Government a 150-foot right-of-way in return for the filling of their property. They had advertised the property for sale, but were able to sell only a few lots for $300 apiece. Since then, they have sold lots for as high as $2,500. The property had been subdivided by a subsidiary of the railroad company many years before petitioner and Evans acquired it. They still have some unsold lots. Between the years 1931 and 1944 petitioner and Evans had recovered their cost of the property, which is not shown. Standard Oil Property. This property was located on Camden Street in Salisbury on what was then Route No. 13. Standard Oil Company had paid approximately $15,000 for the property, and had operated a filling station thereon. Route No. 13 was rerouted and, with the traffic being diverted, 67 the value of the property decreased. The company sold it to petitioner, Larmar Corporation, and Demmead Kolb. Petitioner's cost for one-third interest amounted to $865.80. The parties had planned to make a parking lot and had improved the back of the property for that purpose. During 1944 Kolb advised the other parties that the property was wanted for a Jewish synagogue. However, Victor Lynn, who owned adjoining property, had wanted at least a part of it and was promised a refusal to buy before the property would be sold. A small lot in the back was sold to Lynn as he wished to straighten the line of his adjacent property, and the balance was sold to the Jewish synagogue. When this property was purchased, the parties thought it was a good buy at the price but intended to use it as a parking lot. Leonard Mills Property. This property was located on the Del Mar Highway. It appeared to be good property for development. Parcels of the property were sold to various people from time to time, although no "For Sale" sign was placed on the property. The property had been subdivided into lots and sold at auction. Petitioner and Larmar Corporation bought the residue of the unsold lots looking68 forward to development and the enhancement in value of the property. This sale was made in December 1944, a little over a year after the lots were bought. It is not shown how many lots were purchased or the number still owned by petitioner and Larmar Corporation. Morris Property. This property was purchased by petitioner and Lloyd Chandler at an auction of an estate. It was located between Parsonsburg and Pittsville, Maryland, one of the largest strawberry markets in the country. Chandler sold the property and petitioner was willing. As this property was purchased and sold in 1944, petitioner reported his profit of $237.50 as short-term gain. 1945 Morris Property. Petitioner and Lloyd Chandler acquired this property in May 1944. It was a farm situated near Mardela, Maryland. As it had a stone road frontage, petitioner considered it to be good property and his money safe in it. Chandler sold the property and petitioner was willing to sell for his profit of $356.37. The sale took place in October 1945. Petitioner's interest cost $455 and was sold for $811.67. Collins Property. This property was acquired at an auction sale by petitioner and Lloyd Chandler in September69 1944, and sold in November 1945. It was a farm with growing timber, and was located near Hallwood, Virginia, just across the Maryland line. Chandler sold the property and petitioner was willing to sell for his profit of $269.72. Petitioner's interest cost $1,135 and was sold for $1,405. Curtis W. Long Property. Petitioner and Curtis W. Long had acquired and sold property together for over 20 years. This sale was of a lot located on East Church Street in Salisbury, which had been held by petitioner and Long since 1932. Long sold the property in 1945, and brought petitioner his profit of $255. Long kept the books on the joint holdings, and he and petitioner had recovered the cost of the lot from previous sales of other properties, the cost of which is not shown. Petitioner did not know what cost Long carried on the property and was willing that it be sold at a profit. Synepuxent Property. This property was a farm of approximately 579 acres, with 150 acres in woodland, located on the Synepuxent Bay, about six miles south of Ocean City, Maryland. Petitioner and his secretary, Louise Parsons, purchased the farm in 1941, with petitioner obtaining two-thirds interest and his secretary70 one-third interest. They first rented it to Dulaney Frozen Foods, but now they operate it themselves with the assistance of two tenants. In 1945 petitioner was approached by two prospective purchasers who wanted plots for home sites. Ten-acre plots were sold to each. In 1946 another plot of ten acres was sold as a home site to a third purchaser. Two fine homes have been erected and the other purchaser is going to build another. Petitioner felt it would not hurt the rest of the farm to sell thirty acres, and the sale would help his secretary to pay on what she owed for her portion. The cost of the farm to petitioner and Parsons is not shown, but the cost of the property sold in 1945 at $6,000 is stipulated to be $3,302.84, giving petitioner a profit of $1,798.11, two-thirds of $2,697.16. The cost of the plot sold in 1946 for $2,000 is stipulated to be $1,676.56. States Roads Commission Property. Petitioner and Larmar Corporation, in 1942, acquired two adjoining pieces of property just north of Salisbury on Route No. 13. One of the pieces of property has a filling station on it. The state wanted to straighten a curve of the highway. Petitioner and Larmar Corporation sold the state71 a small strip of land from both pieces of property at the price the state was willing to pay. The sale prevented possible condemnation proceedings. The cost of the two pieces is not shown, and no allocation of cost was placed on the property sold, as the joint holders considered the improvement of the road enhanced the value of the remainder of the property. They treated the amount received as profit. Showell Property. This property was located between Salisbury and Berlin. It had been in the Showell family for many years. In 1945 they had to dispose of it. At the request of James Larmar and George P. Chandler of the Larmar Corporation, petitioner went with them to look over the property. The buildings were in a dilapidated condition but the property was thickly set in growing timber. Petitioner and Larmar Corporation bought it in July 1945, petitioner acquiring one-third interest. Larmar was a breeder of registered beagle hounds and president of a beagle club. He was not satisfied with the running grounds the club had and suggested that the Showell property be sold to the club. Although the property was bought because of the value of timber and petitioner preferred to hold it, 72 he agreed to the sale to the club for $5,000, petitioner's profit being $466.67. Hodgson Property. The sales from this property were determined by respondent to be "Commissions." Petitioner and Herman Hodgson owned a number of lots together. They acquired this particular lot in 1931 and sold it in 1946. Hodgson made the sale and brought petitioner his profit of $422.50. Hodgson kept books on their joint holdings. This particular property was a leftover lot in the Pinehurst Development for which petitioner and Hodgson traded. As their cost of the property traded had been recovered from previous sales, no cost was allocated to this lot. Horsey Land. One Horsey of Laurel, Delaware, formerly owned the property from which this sale was made. The property was located about two miles from Del Mar and had frontage on Route 13. As long as Horsey lived, the property was not for sale. After his death, petitioner and Larmar Corporation bought it from the heirs in 1943. They subdivided the property into lots and sold all that could be sold. The lot sold in 1946 was a leftover from the subdivision, and no cost was allocated to it, as the co-owners had recovered their cost in the earlier73 sales. Petitioner's profit was $210. Bay Heights Development Co. Property This particular sale was made from the same property acquired in 1931 by petitioner and J. E. Evans, described in the list of sales for the year 1944. As the joint holders had recovered their cost from sales made between 1931 and 1944, no cost was allocated to these lots. The sales price of $10,000 represents the sale of four separate lots, and petitioner's profit therefrom amounted to $5,000. Dickerson Timber Land. This property of between 400 and 500 acres was part of the U. R. Dickerson Estate, and was acquired by petitioner and Larmar Corporation in October, 1943. It was located in the southeast section of the county from Salisbury and consisted of farm land, scrub woodland, and merchantable timber. A lot of the property fronted on a hard-surfaced road, but the timber was further out on a county road. In 1944 Larmar thought it was a good time to sell some of the property, and while petitioner preferred to hold because the timber property was growing, he agreed to sell. They advertised a public auction and put up the farm part for sale in acreage units along with some lots on another small piece74 of the property. One purchaser bought all the farm units at the sale. The scrub woodland was subdivided into lots but they were not offered for sale at this auction. They were later offered for sale, but not all have been sold. In 1946 the timberland was sold and also a lot. No cost was allocated to these particular sales made in 1946 as the cost of the property had been recovered from the earlier sales. Larmar Corporation, which kept the records, gave to petitioner his profit of $8,318.47. Synepuxent Property. This is another sale from the farm acquired by petitioner and his secretary and described in the list of sales for 1945. It does not appear she had any interest in this sale, for the profit of $323.44 was petitioner's. Salisbury Realty Co. and Laurel Land Property. Respondent determined that the amounts received by petitioner from these two sales were "commissions." The Salisbury Realty Company had originally promoted a development in which these particular lots were situated. Prior to 1940 Larmar Corporation purchased the unsold residue of the development and engaged petitioner to sell the property at public auction. The sale was thoroughly advertised but some lots75 located on Meadow Street in Salisbury would not sell. Larmar Corporation offered to take $200 apiece for these remaining lots. Petitioner purchased a half interest in the lots in 1940. They were in a commercial zone and appreciated in value. While these lots were not advertised for sale after petitioner had acquired his interest in them, some sales were made from time to time and on each sale his cost was shown at $100. Petitioner's profits from the sale in 1946 amounted to $2,596.25. The joint holders still own 10 or 15 of the lots. Sunny Side lots. Petitioner and H. C. Mezick, of Fruitland, Maryland, acquired these lots about 1935 in Mezick's name. They were located in a colored section and as Mezick sold the lots he would deliver petitioner's profits to him. Petitioner was willing for Mezick to sell the property as he was perfectly reliable. This sale in 1946 was a small transaction, and there was no cost charged against petitioner's profit of $33. Long Timber property. Petitioner and Guy E. Long bought a farm in 1935. It was situated on two sides of the road. They early sold the larger part on which the house was located, but could not sell the smaller part, which at76 that time was cut-over land and was not of much value. In 1946 Long went to petitioner and stated that he could sell the property for $250, which petitioner was glad to get. As cost had been recovered from the previous sale, no cost was charged against petitioner's profit of $125. Wootten Corporation property. Petitioner and Larmar Corporation acquired this property in May 1945, at the cost of $20,000. It was a brick building on East Main Street in the business section of Salisbury. It was purchased for rental. At the end of the year Larmar and Chandler (Larmar Corporation) expressed the desire to own it all, as they owned the adjoining property on which they intended to build. They wanted to control and use the wall of the brick building. Petitioner sold his half interest in the property to Larmar Corporation for a profit of $2,500. Collins Land. Petitioner did not recall how he acquired this property in September, 1945, at the price of $3,600. Nettie Chandler purchased it in March 1946, at the price of $4,000, but petitioner thought he was solicited by her husband to sell. After deducting expense for attorney's fees for preparing papers, petitioner realized the profit of77 $383.75. Maple Plains lots. In 1940 petitioner and Larmar Corporation bought the residue of a subdivision in which there remained a number of lots. The lots were sold from time to time when profit was available. They were located north of Salisbury, about one-half mile from the city limits. In 1946 Larmar Corporation made this particular sale, and sent petitioner its check in the amount of $734.36 as his profit. They still have some unsold lots in this subdivision. Leonard Farm property. In 1941 petitioner and Larmar Corporation acquired the remainder of this subdivided property. The lot sold in 1946 by Larmar Corporation was one of the leftover lots. Larmar Corporation sent petitioner its check $290for as his profit from the sale. Petitioner and Larmar Corporation still own a considerable part of this property. Richwill Park property. Petitioner and Larmar Corporation acquired the residue of this subdivided property in July 1945. The property was located on Snow Hill Road, and adjoins a golf course. It cost about $6 per front foot, and the lots were 50 and 60-foot fronts. This particular sale in 1946 shows petitioner's interest sold at $3,656, against which $826 was78 charged as his cost, netting him a profit of $2,830. This represents a sale of 2 or 3 lots. The parties still have some of the lots for sale. At the date of hearing petitioner still had substantial joint holdings with Larmar Corporation, some of which are as follows: DatePet'rs.PropertyAcquiredCostInterestSalisbury Realty Co. lotsJan. 1940$ 1/2Maple Plains lotsJan. 19401/2Leonard Farm subdivisionSept. 19415,500.001/3Synepuxent Worcester CountyNov. 194134,340.001/2Property from which piece wassold to States Roads Com.19421/2Nutters DistrictJan. 19431,100.001/2Horsey landMay 19431/2Dickerson PropertyOct. 194326,500.001/2Tony Tank Dev. Co. 26 acresOct. 19437,969.001/2Townsend FarmMay 194423,000.001/2F. Frank GosleeJuly 19442,250.001/2Mollie D. MerrittJuly 19442,750.001/2Camden Ave. lots 2 and 3Oct. 19442,017.951/2Elzey-Parsons Murrell lotsMar. 19451,250.001/2Harry CallowayApr. 19455,785.001/2J. H. Perdue lotMay 1945600.001/2J. H. Perdue land 20 lotsMay 19455,000.001/2J.S.T. WilcoxMay 19454,000.001/3Richwill ParkJuly 19451/2Oaks Dev. Co.Aug. 19453,500.001/2Sherman Townsend lotAug. 19456,025.001/2Sadie ToadvineSept. 194510,000.001/2Geo. E. RichardsonFeb. 19463,950.001/2Harlan WestApr. 19464,000.001/2Gordy CulberSept. 1946500.001/2Allen land, 3 lotsAug. 194615,235.001/2 sold 65 feet4 lots21,7501/2 $3,25079 There is no complete list of properties still held jointly by petitioner with other individuals, but from the sales shown during the tax years herein the holdings listed below are known: YearPet'rs.PropertyAssociatedAcquiredInterestHodgsonHerman Hodgson19311/2Bay Heights Dev. Co.J. E. Evans19311/2LongCurtis W. Long19321/2Sunny Side lotsH. C. Mezick19351/2Long TimberGuy E. Long19351/2Synepuxent FarmLouise Parsons19412/3There is no complete list of petitioner's joint holdings acquired and disposed of prior to 1944, but it is known that the following properties were some of such holdings: YearPet'rs.PropertyAssociateAcquiredCostYear SoldPriceInterestCalebCurtis W. Long1937 & 1938$1,776.2619391/2SalisburyRealty Co.Larmar Corp.Jan. 1940May 1941$3,600.001/2Aug. 19421,000.001/2Aug. 1942350.001/2Aug. 1942525.001/2Aug. 19421,362.001/2Penn. R.R.Co.Larmar Corp.Oct. 194015,750.00June 194127,200.001/3PartLeonardFarmLarmar Corp.Sept. 19415,500.00Sept. 19436,673.001/3HorseyLarmar Corp.May 19436,200.00Nov. 194314,596.631/21943lot6001/21943lot8001/2NunvarFarmLarmar Corp.Oct. 19433,500.00Nov. 19435,700.001/280 Petitioner reported in his income tax returns for the years 1942-1946, inclusive, the following incomes from his real estate business, farm and sales of capital assets: 19421943194419451946Real Estate and RentalBusinessGross income$17,080.50$27,009.82$39,884.38$31,645.51$38,675.12Expense9,349.4011,692.9519,408.7522,203.3032,728.24Net income$ 7,731.10$15,316.87$20,475.63$ 9,442.21$ 5,946.88FarmGross income1,173.002,001.172,211.528,270.66noneExpenses10,097.6415,674.1821,309.0811,985.06noneLoss$ 8,924.64$13,673.01$19,097.56$ 3,714.40Capital GainsLong Termnonenone5,799.672,815.0024,233.44Short Termnonenone237.50nonenoneThe reports do not show petitioner's "commission" from real estate sales, as they were included with "rentals," and petitioner was unable to give such amounts at the hearing. Petitioner was in the business of buying and selling real estate and the properties, including his joint holdings, sold during the tax years 1944, 1945 and 1946, had been respectively held by him primarily for sale to customers81 in the ordinary course of his business, with the exception of the properties identified in our findings as the Standard Oil property, the Synepuxent property, and the Wootten Corporation property. Opinion KERN, Judge: The proof shows that petitioner owned a half interest in the Hodgson property with Herman Hodgson, and the Salisbury Realty Company lots with Larmar Corporation, which removes the question of whether the profits from the sales of such properties were "commissions" as determined by respondent. The only question that remains is whether the profits realized from the sales of real estate, including the Hodgson and the Salisbury Realty Company properties, during the tax years involved, are taxable as ordinary income or as capital gain under section 117 of the Code. 182 We have carefully considered the arguments of both parties in the light of the record before us, together with the authorities cited in their briefs, and have concluded that petitioner, during the taxable years, was engaged in the business of buying and selling real estate, and that the real estate sold by or for him during the taxable years, with the three exceptions noted in our findings of fact, constituted property held by him primarily for sale to customers in the ordinary course of such business. See et seq. Decision will be entered under Rule 50. Footnotes. Not shown in the record.↩. Not shown in the record.↩1. Section 117 (a) (1) defines capital assets as follows: The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business) but does not include * * property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business * * *. Subsection (a) (4) states that: The term "long-term capital gain" means gain from the sale or exchange of a capital asset held for more than six months, if and to the extent such gain is taken into account in computing net income. Subsection (b) provides that: The percentage of the capital gain to be taken into account in computing net income shall be "50 per centum if the capital asset has been held for more than six months."↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621248/	Modern American Life Insurance Company, Petitioner v. Commissioner of Internal Revenue, Respondent; Modern American Life Insurance Company, a Missouri Corporation, Petitioner v. Commissioner of Internal Revenue, RespondentModern American Life Ins. Co. v. CommissionerDocket Nos. 17025-85, 31081-85United States Tax Court92 T.C. 1230; 1989 U.S. Tax Ct. LEXIS 84; 92 T.C. No. 80; June 8, 1989. June 8, 1989, Filed 84 Decisions will be entered under Rule 155. M & P guaranteed payments to certain of their policyholders in 1978 and 1979. Held, the payments are properly characterized as policyholder dividends under sec. 809(d)(3) of the Internal Revenue Code. Held, further, the reserves established for the payment of these guaranteed payments are policyholder dividend reserves. Held, further, M is entitled to an operations loss carryback under sec. 812 of the Internal Revenue Code, to 1978 and 1979 based upon a total operations loss of $ 1,418,441 in 1981. Raymond Turner, for the petitioners.John Kent, for the respondent. Parr, Judge. PARR1230 Respondent determined the following deficiencies against Modern American Life Insurance Co. (petitioner) in the following years:YearDeficiency1978$ 463,6041979676,450Respondent also determined the following deficiencies against Progressive National Life Insurance Co. (Progressive) in the following years:YearDeficiency1978$ 387,3431979350,3761231 Modern American Life Insurance Co., formerly known as Modern Security Life Insurance Co., merged with Progressive National Life Insurance85 Co. on September 30, 1983. On April 13, 1987, Modern American Life Insurance Co. moved under Rule 63(d) 1 to be substituted for Progressive National Life Insurance Co. as a party in this case under the name "Modern American Life Insurance Co., a Missouri Corporation." The motion was granted on April 22, 1987. Progressive National Life Insurance Co. and Modern American Life Insurance Co. were separate entities during the years in issue. For clarity, we continue to refer to the two companies as separate entities.After concessions, we must decide: (1) Whether yearly distributions to policyholders designated as "guaranteed benefits" 2 were policyholder dividends or accrued policy benefits under section 809; (2) whether the reserves set aside to fund the payments were policyholder dividend reserves86 or life insurance reserves; and (3) whether petitioner is entitled to an operations loss carryback from 1981 to the years in issue.FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulated facts and exhibits are incorporated by this reference.The findings of fact for petitioner and Progressive, are separated for clarity. However, the opinion section addresses both petitioner and Progressive together and the companies are sometimes referred to as petitioners.Modern American Life Insurance CompanyPetitioner is a life insurance company organized under the laws of the State of Missouri. Petitioner's principal office was located in Englewood, Colorado, when it filed the petition in this case. Petitioner was known as Modern Security Life Insurance Co. prior to September 30, 1983; 1232 and petitioner filed its Federal tax returns, Forms 1120L, with the Internal Revenue Service87 Center in Cincinnati, Ohio, for its taxable years ending December 31, 1978, and December 31, 1979.Petitioner issued participating life insurance policies as part of its insurance business. A participating life insurance policy pays the policyholder annual dividends out of a portion of the surplus, if any, earned by the issuing company. Missouri law governs petitioner's distribution of policyholder dividends. Mo. Ann. Stat. sec. 376.360 (Vernon 1968). The determination of the amount of earned surplus is made after the close of an insurance company's fiscal year. Petitioner used a calendar year as its fiscal year.Petitioner's board of directors held a special meeting on December 21, 1977, in lieu of its annual board of directors meeting. At that meeting petitioner's board adopted a resolution establishing "guaranteed benefit" payments for three types of participating life insurance policies previously issued by petitioner, numbered 352260, 532260, and 572262.The resolution provided:RESOLVED, that the Schedule of Guaranteed Benefits on Plan Code 352260 and 532260 attached hereto as Exhibit "B" and the Schedule of Guaranteed Benefits on Plan Code 572262 attached hereto as 88 Exhibit "C" be, and they hereby are, approved; * * The schedule provided for the payment of a fixed dollar amount per $ 1,000 of face amount of insurance of a policy. The amount of the payment was dependent upon the policyholder's age at the time the policy was issued and either the duration or the age of the particular policy. The payments were to be made on the policy's anniversary date, i.e., the anniversary date of the inception of insurance coverage on the policy. The guaranteed payment also depended upon the policyholder's survival until his policy's anniversary date and upon premium payments through the policy's anniversary date.The benefited policies were all participating life insurance policies. Thus, dividends were also paid on the policy anniversary date. In 1978 and 1979, when petitioner made the guaranteed payment, the level of dividends generally decreased. In fact, in 1979, the dividends decreased dollar for dollar by the amount made in guaranteed payments.1233 Petitioner's board of directors held another special meeting on December 28, 1978. The board adopted another resolution regarding the guaranteed payments to policyholders during 1979. The resolution89 applicable to 1979 was identical to the resolution adopted for 1978 except that in 1979 payments were expanded to cover policies with earlier issue dates than the originally benefited policies.Petitioner distributed $ 371,326 in 1978 and $ 398,895 in 1979 in guaranteed payments, in accordance with the terms and restrictions of the above mentioned resolutions.In a meeting on November 10, 1979, petitioner's board substantially expanded the level of previously established guaranteed payments for 1980. It increased the amount per $ 1,000 of policy coverage and extended the payment to additional policy plans. The resolution was much more detailed and specifically provided:WHEREAS, high interest rates caused by inflation coupled with increasing policy cash values has caused some insurers to develop and market specialty insurance products designed to replace existing whole life insurance policies; andWHEREAS, it is deemed to be in the best interest of the Company that it take steps to reduce the risk of replacement of its policies; andWHEREAS, in the exercise of its business judgment this Board of Directors is of the opinion that the establishment of certain irrevocable benefits which90 the Company shall forever be legally obligated to pay each year to the holders of specified policy plans would tend to reduce the risk of replacement by other insurers and improve the results of the Company's conversion efforts;NOW, THEREFORE, be itRESOLVED, that the Company does hereby irrevocably grant, bargain, assign and convey unto the holders of the insurance policies issued or assumed by the Company under the Plan Codes listed below the right to receive, in addition to any other guaranteed benefits stipulated in said policies, level annual benefits in the amounts calculated in accordance with the Guaranteed Benefit Schedules attached as exhibits hereto and incorporated herein. The guaranteed benefit amounts, determined from the Guaranteed Benefit Schedule for the policy anniversary that falls within the calendar year 1980, will remain unchanged and will be paid on the policy anniversary and on each succeeding policy anniversary during the continuation of the policy on a premium paying basis. It is the express intent of this Board of Directors that the obligation to pay said level annual benefits shall be a legally binding and enforceable liability of the Company for 197991 and all subsequent years to be paid regardless of the future experience of the Company and without further action by the Board of Directors of the Company; and, be it further1234 RESOLVED, that the amounts of such guaranteed level annual benefits calculated in accordance with the Guaranteed Benefit Schedules attached as exhibits hereto and incorporated herein includes the amounts of all annual benefits previously guaranteed by this Board of Directors for payment to holders of policies under the Plan Codes specified herein and that this Board of Directors by these resolutions hereby ratifies and confirms such previously guaranteed benefits; and, be it furtherRESOLVED, that to the extent, if any, that the Company is required to make any distribution to holders of any of the policies issued or assumed by the Company under the Plan Codes specified herein while the policies are in a premium paying status and not continued under any non-forfeiture provision, the payment of the guaranteed level annual benefits provided for herein shall, to the extent thereof, be deemed to satisfy said required distributions; and, be it furtherRESOLVED, that the amounts of said guaranteed level92 annual benefits created, ratified or confirmed hereby, shall be those amounts calculated in accordance with the Guaranteed Benefit Schedules attached hereto as Exhibits "A" through "T" and incorporated herein * . [Emphasis in original.]During 1977, 1978, and 1979 petitioner mailed anniversary notices to the policyholders of the benefited policies 21 days prior to each policy anniversary date. An "anniversary notice," in pertinent part, is as follows:Anniversary NoticePolicy Number DividendDeposit for Current$ Anniversary Previous Deposits$ Interest Earned onRatePrevious Deposits3.5 $ Total $Some of the policyholders with anniversary dates early in January received anniversary notices in December of the previous year.Also during 1977, 1978, and 1979 petitioner sent the same policyholders a dividend statement, a sample of which is reproduced, in pertinent part, below:Dividend StatementAmount ofPolicyCurrentDate of DividendCurrentNumberOptionMoDayYr Dividend$ Includes Guaranteed Benefits[Policyholder's Name and Address]93 1235 Your policy has earned the above Future dividends will be applied dividend which has been applied inin a like manner although you haveaccordance with the option lastthe right to change this option byselected by you, or as provided forgiving written notice to the homein the policy.office.The amount attributable to "Guaranteed Benefits" was not shown on either the anniversary notice or dividend statement, nor was there any indication that such benefits would continue. If a policyholder elected to receive the annual payment in cash, during 1978 and 1979 the policyholder received a check, the stub of which did indicate the portion of the distribution attributable to the policy dividend and the portion attributable to the guaranteed benefit. Again, there was no indication that the benefits would continue.Benefited policyholders did not receive any separate written notice informing them of the board's resolution, nor did the policyholders ever manifest their assent to these "additional" benefits. Not unless a policyholder attempted to cancel his policy was he informed of this "additional" benefit which was not included on the face of his policy or in 94 any written amendment thereto.Each of the affected policies provided that the policy constituted the entire contract between the parties. The policies also provided that no modification of the policy would be valid unless it was in writing.Petitioner established life insurance reserves for the guaranteed payments in 1977, 1978, and 1979. At the end of 1978, petitioner held $ 374,588 in these reserves and $ 1,230,970 at the end of 1979. Petitioner's actuaries figured the amount of the reserves based upon recognized mortality tables and assumed rates of interest.The Division of Insurance of the State of Missouri requires insurance companies operating within the State to file an annual statement. In 1977, 1978, and 1979 petitioner reported these reserves for guaranteed annual benefits on line one of the "Liability, Surplus and Other Funds" section of the annual statement. Since these reserves were reported on line one, the State of Missouri required petitioner to deposit an aggregate sum of cash or securities which included the amount of these particular reserves. Mo. Ann. 1236 Stat. sec. 376.170 (Vernon 1968). In contrast, under Missouri law the reserves for policyholder95 dividends did not increase the deposit obligation of petitioner. All required deposits were held by the Missouri insurance authorities.The parties stipulated that petitioner is entitled to an operations loss carryback to 1978 and 1979 attributable to the operations loss in 1981 of $ 1,418,441. Petitioner has been allowed tentative operations loss carrybacks from 1981 for $ 424,805 for 1978, $ 285,291 for 1979, and $ 89,175 for 1980. The remainder of the loss, $ 619,170 was carried forward and completely used up by petitioner on its 1982 tax return.Progressive National Life Insurance CompanyProgressive was a life insurance company organized under the laws of Missouri before it merged with petitioner on September 30, 1983. When it filed its petition in this case, Progressive's principal office was in Englewood, Colorado. According to the terms of the "Agreement and Plan of Merger" dated July 7, 1983, any claim existing or action or proceeding pending by or against Progressive may be prosecuted as if the merger had not taken place.Progressive filed its Federal tax returns for the 1978 and 1979 taxable years, Forms 1120L, with the Internal Revenue office in Cincinnati, Ohio. 96 Progressive's Board of Directors held a special meeting on December 27, 1976, in which it adopted a resolution establishing the payment of "guaranteed benefits" on four participating policies previously issued by Progressive, numbered 552202, 552204, 552209, and 552210, payable for 1977. Like the guaranteed payments by petitioner, these payments provided a set amount to be paid per $ 1,000 of the face amount of coverage of each affected policy, dependent on: (1) The policyholder's age at the issuance of the policy and the duration or age of the policy; (2) the policyholder's survival through the policy anniversary date; and, (3) payment of premiums through the policy anniversary date.Progressive's original resolution provided:RESOLVED, that the attached benefit schedule for benefits which comprise a portion of any existing required distribution to policy owners 1237 under the terms of life insurance contracts for Policy Plans 552202, 552204, 552209, and 552210 are hereby guaranteed for all issue years and the benefit schedule is hereby adopted for the life of the contract for as long as it may remain on current premium paying status.At that same board of director's meeting, 97 a previously adopted schedule of dividends was rescinded and a new schedule of dividends was adopted. In taking this action the minutes of the meeting state:Mr. Lay reported that management of Progressive National Life had determined that certain benefits to policyholders under the terms of the life insurance contracts on certain plans of insurance could be guaranteed thus improving the conservation efforts in connection with such plans and perhaps aiding the marketing personnel in increasing life insurance coverage with those policyholders. Mr. Lay stated that in order to do so, the action of the Board of Directors in approving dividend schedules in a directors' meeting held July 12, 1976 would have to be rescinded and a new dividend schedule would need to be approved. * * Progressive was subject to one of its triennial examinations by the National Association of Insurance Commissions (NAIC) for 1976. The examination was completed in November of 1977. The NAIC was aware of the board's resolution concerning 1977 distributions. It commented on the need to clarify the resolution to indicate the company was going to pay level premiums, otherwise the company's reserve requirement98 would increase. In addition it stated:Also, policyholders have not received a clear notice that certain amounts are now guaranteed. It is recommended this be done by endorsement or letter which a policyholder may keep with his policy. Such letter or endorsement must have the approval of the Missouri Division of Insurance and any other insurance department having jurisdiction.Progressive, apparently did not heed NAIC's recommendation on either matter.The resolution adopting guaranteed annual benefits for 1978 was, instead, less specific than the resolution for 1977. There was no mention that this was to be a continuing obligation. The resolution merely provided:RESOLVED, that the Schedules of Guaranteed Benefits on Plan Codes 552202, 552204, 552209 and 552210, which are attached to the Minutes of this meeting as Exhibit "B" are incorporated herein, be, and the same 1238 hereby are, approved as the Guaranteed Benefits on Said Plan Codes for the year ending December 31, 1978 * The resolution adopted at the special meeting of Progressive's board of directors held December 28, 1978, for benefits in the 1979 year used the same language as the resolution for the 1978 year. 99 Finally, at the regular meeting of Progressive's board of directors held November 10, 1979, the board ratified and confirmed the level of guaranteed payments previously established and adopted a unified schedule format showing both the dividends and guaranteed payments payable on a particular plan. Specifically the resolution provided:RESOLVED, that in the exercise of its business judgment this Board of Directors is of the opinion that the prior establishment of certain irrevocable benefits which the Company shall forever be legally obligated to pay each year to the holders of specified policy plans tends to reduce the risk of replacement by other insurers and to improve the results of the Company's conservation efforts; and, be it furtherRESOLVED, that the Company does hereby irrevocably grant, bargain, assign and convey unto the holders of the insurance policies issued or assumed by the Company under the Plan Codes listed below the right to receive, in addition to any other guaranteed benefits stipulated in said policies, for all policy ages and durations listed on the below mentioned Guaranteed Benefit Schedules and during all periods that the policy is in a premium paying status100 level annual benefits in the amounts calculated in accordance with the Guaranteed Benefit Schedules attached as exhibits hereto and incorporated herein with the amount payable being determined by policy duration and issue age in the year in which said amounts were first guaranteed by this Board of Directors, it being the express intent of this Board of Directors that the obligation to pay said level annual benefits shall be a legally binding and enforceable liability of the Company for 1979 and all subsequent years to be paid regardless of the future experience of the Company and without further action by the Board of Directors of the Company; and, be it furtherRESOLVED, that this Board of Directors acknowledges that the amounts of such guaranteed level annual benefits calculated in accordance with the Guaranteed Benefit Schedules attached as exhibits hereto and incorporated herein and on the basis of the policy duration and issue age in the year in which said amounts were first guaranteed is the same as the amounts of all annual benefits previously guaranteed by this Board of Directors for payment to holders of policies under the Plan Codes specified below and that this Board of101 Directors by these resolutions hereby ratifies and confirms such previously guaranteed benefits; and, be it further1239 RESOLVED, that to the extent, if any, that the Company is required to make any distribution to holders of any of the policies issued or assumed by the Company under the Plan Codes specified below while the policies are in a premium paying status and not continued under any non-forfeiture provisions, the payment of such guaranteed level annual benefits shall, to the extent thereof, be deemed to satisfy said required distributions; and, be it furtherRESOLVED, that the amounts of said guaranteed level annual benefits ratified and confirmed hereby, shall be those amounts calculated in accordance with the Guaranteed Benefit Schedules attached hereto as Exhibits "K" through "M" and incorporated herein * .After the resolution adopted on November 10, 1979, no further resolutions regarding guaranteed payments were passed by Progressive, although distributions were made in accordance with the above mentioned schedules through September 30, 1983, when Progressive merged with petitioner. Progressive made guaranteed payments of $ 270,020 during 1978, and $ 261,295102 during 1979.As was the case with petitioner, the benefited policies were all participating life insurance policies; as such, dividends were also paid during the years in issue. Progressive reduced the distributions designated as "dividends" while it paid the "guaranteed benefits." In 1979, the amount of dividends was reduced dollar for dollar by the amount of guaranteed payments.During 1976 through 1979, policyholders received an anniversary notice 21 days before the policy anniversary date. Like petitioner's anniversary notices, the notice specified that any policyholder dividend payable included the guaranteed benefits. If a policyholder's anniversary date occurred in early January, that policyholder received notice in the previous year.Progressive also mailed dividend statements 21 days before the policy anniversary date. Again, like petitioner's dividend statement, this statement indicated that the dividend payable included the guaranteed benefit. No breakdown was shown on either statement. Likewise, if a policyholder elected to have the annual policy distributions made in cash, the check stub indicated which portion was attributable to the "guaranteed benefit" and which103 portion was attributable to the "dividend." Again, there was no 1240 indication that benefits would continue beyond the current year.Policyholders did not receive any separate written notice informing them of the Board's resolution, nor did any of the policyholders assent to these "additional" benefits. However, if a policyholder attempted to cancel his policy he was informed of this "additional" benefit which was not included on the face of his policy or in any written amendment to the policy.Each of the affected policies provided that the policy constituted the entire contract between the parties. The policies also provided that no modification of the policy would be valid unless it was in writing.Progressive established life insurance reserves for the guaranteed payments. At the end of 1978, Progressive held $ 232,188 in these reserves and at the end of 1979, Progressive held $ 220,579. Progressive's actuaries figured the amount of the reserves based upon recognized mortality tables and assumed rates of interest.In 1977, 1978, and 1979, Progressive reported the reserves for these guaranteed annual benefits on line one of the "Liability, Surplus and Other Funds" section104 of the annual statement. Since these reserves were reported on line one, Missouri required Progressive to deposit an aggregate sum of cash or securities which included the amount of these particular reserves. Mo. Ann. Stat. sec. 376.170 (Vernon 1968). In contrast, the reserves for policyholder dividends did not increase the deposit obligation of Progressive. All of the required deposits were held by the Missouri insurance authorities.OPINIONThe first issue we must decide is whether amounts paid to policyholders in 1978 and 1979 pursuant to the boards of directors' resolutions are policyholder dividends deductible under section 809(d)(3) or accrued benefits deductible under section 809(d)(1) [now sections 805(a)(3) and 805(a)(1)]. If the distributions are policyholder dividends, as respondent contends, then the amount of the deduction is limited to the excess of gains from operations without regard to the dividend deduction over taxable investment income, plus 1241 $ 250,000. Sec. 809(f) [now see sec. 808(c)]. On the other hand, if the payments are part of "All claims and benefits accrued * * * on insurance and annuity contracts," then there is no limit to the amount105 of the deduction.Relying primarily upon the language of sections 809(d)(1) and 811(a) and sections 1.809-5(a) and 1.811-2(a), Income Tax Regs., respondent contends that the guaranteed payments were not "fixed in the contract," but are merely redesignated policyholder dividends or "similar payments." Respondent denies that State law controls the definition of a policyholder dividend or similar payment; and that in any event, these payments were not in actuality a fixed obligation of petitioners.Petitioners respond that under State law, which petitioner contends is controlling, the guaranteed payments were policy benefits, not dividends. Petitioners do not allege (as they cannot) that these benefits are found in the four corners of the written contract or an amendment thereto. Petitioners assert instead that the unilateral increases by board resolution were binding and enforceable under State law, became a part of the contract as a matter of law, and are therefore "fixed policy benefits" (a phrase not found in the statute or regulation).For the reasons outlined below, we hold that the annual payments made by petitioners were policyholder dividends.The Statutory106 Framework -- Internal Revenue CodeWe begin our analysis by looking to the words of the statute and the regulations. 3 We consider all facts and circumstances in making our determination.Section 809(d)(1) provides a deduction for "All claims and benefits accrued, * * * during the taxable year on insurance and annuity contracts (including contracts supplementary thereto)." This deduction is further defined in section 1.809-5(a)(1), Income Tax Regs., as:All claims and benefits accrued (less reinsurance recoverable), and all losses incurred (whether or not ascertained), during the taxable year on insurance and annuity contracts (including contracts supplementary thereto). The term "all claims and benefits accrued" includes, for 1242 example, matured endowments and amounts allowed on surrender. The term "losses incurred (whether or not ascertained)" includes a reasonable107 estimate of the amount of the losses (based upon the facts in each case and the company's experience with similar cases) incurred but not reported by the end of the taxable year as well as losses reported but where the amount thereof cannot be ascertained by the end of the taxable year.Section 1.809-5(a)(3), Income Tax Regs., does not specifically define policyholder dividends but states that these dividends are determined under section 811 and section 1.811-2, Income Tax Regs.Under section 811(a), a policyholder dividend is defined as "dividends and similar distributions to policyholders in their capacity as such. Such term does not include interest paid (as defined in section 805(e))."Policyholder dividends are further defined by section 1.811-2(a), Income Tax Regs., as:(a) Dividends to policyholders defined. * * * dividends and similar distributions to policyholders in their capacity as such. The term includes amounts returned to policyholders where the amount is not fixed in the contract but depends on the experience of the company or the discretion of the management. In general, any payment not fixed in the contract which is made with respect to a participating 108 contract (that is, a contract which during the year contains a right to participate in the divisible surplus of the company) shall be treated as a dividend to policyholders. Similarly, any amount refunded or allowed as a rate credit with respect to either a participating or nonparticipating contract shall be treated as a dividend to policyholders if such amount depends upon the experience of the company. However, the term does not include interest paid (as defined in section 805(e) and paragraph (b) of sec. 1.805-8) or return premiums (as defined in section 809(c) and paragraph (a)(1)(ii) of sec. 1.809-4). Thus, so-called excess interest dividends and amounts returned by one life insurance company to another in respect of reinsurance ceded shall not be treated as dividends to policyholders even though such amounts are not fixed in the contract but depend upon the experience of the company or the discretion of the management. [Emphasis added.]Generally speaking, a dividend on an insurance contract represents either a return of unearned premiums to the insured or a proportional distribution of profits. 6 G. Couch, Insurance 2d, sec. 34:118 (2d ed. 1985). This definition 109 is not explicitly reflected in section 811 and the regulations thereunder. One court has noted, however, that the floor debates on the Life Insurance Company Income Tax Act of 1243 1959, indicate that Congress was aware that "dividend' as used in the insurance industry is a term of art which means almost any payment not derived from premium income." Republic National Life Ins. Co. v. United States, 594 F.2d 530">594 F.2d 530, 536 (5th Cir. 1979). In addition, courts have recognized that it was Congress' intent to tax the return of investment income to participating policyholders. Prairie States Life Ins. Co. v. United States, 828 F.2d 1222">828 F.2d 1222, 1225-1226 (8th Cir. 1987); American National Life Ins. Co. v. United States, 231 Ct. Cl. 604">231 Ct. Cl. 604, 690 F.2d 878">690 F.2d 878 (1982).The area of accrued benefits has not been previously explored by any court. Section 809(d)(1) merely states that all claims and benefits accrued on insurance and annuity contracts during the taxable year fall under that section. The regulations add that the term "all claims and benefits accrued" includes, for example, amounts allowed110 on surrender and matured endowments. Neither the code nor the regulations tell us anything regarding the characteristics of the payment. Also, unlike either dividends or return premiums, there is no clear indication as to the ultimate source of these payments (i.e., it seems irrelevant whether the payment comes from premiums or investment income).From the words of the statute we are able to determine, however, that accrued benefits, unlike dividends, are not paid "to the policyholder in his capacity as such." This is obvious because death benefits, which go to beneficiaries and not to policyholders, are included.Another distinction may be drawn between policyholder dividends and "accrued benefits." Policyholder dividends are not "fixed in the contract." Sec. 1.811-2(a), Income Tax Regs. While not stated explicitly, it seems evident that "accrued benefits" are, conversely, the type of benefits that are fixed in the contract. For example, death benefits, endowment benefits, and cash surrender benefits are all specified in the terms of insurance or annuity contracts. What's more, all of these benefits are bargained-for benefits. That is, the cost to the insured is based upon111 the benefits that the insured chooses to buy. Conversely, the amounts paid as dividends are determined unilaterally by the insurance company. Clearly, in one sense dividends are "benefits" the participating policyholder buys, but unlike the 1244 other types of benefits, they are not a specified amount the insured knows he is going to receive when he signs the contract.In this case the so-called guaranteed benefits were not "fixed in the contract." That is, a policyholder's entitlement to this benefit was not contained in the four corners of the instrument and there were no riders, endorsements, or supplemental contracts signed by the insurance company and the insured relating to the benefit. Petitioners argue, in effect, that "fixed in the contract," means the same thing as required by law. Since the continuing payment of these benefits would have been required under Missouri law, so they contend, the benefits were "fixed policy benefits" and are therefore not policyholder dividends. We do not agree that State law controls the definition of "dividend" for Federal tax purposes. Nor are we persuaded that the benefits in question were actually required to be paid in subsequent112 years under State law, and were thus incorporated into the contract. 4Effect of State LawPetitioners ask us to consider State law in two contexts. First, petitioners argue that the Code and regulations leave the definition of "dividend to policyholders" to State law. We disagree.State law defines and regulates relationships between parties, i.e., when a dividend is permissible or required for State law purposes. However, the determination by the State that a payment constitutes a dividend does not necessarily mean such payment is a dividend for Federal tax purposes. Conversely, the fact that a payment is not a dividend for State law purposes is not determinative for Federal tax purposes. If the Federal tax statute does not plainly indicate a purpose or intent for State law to be taken into account, taxability of corporate distributions are determined in accordance with Federal113 law. Helvering v. Northwest Steel Rolling Mills, Inc., 311 U.S. 46 (1940); Lundeen v. Commissioner, 33 T.C. 19">33 T.C. 19 (1959). This is similar to those cases where a business association is classified one 1245 way for State law purposes and another for Federal tax purposes. See, e.g., Burk-Waggoner Oil Association v. Hopkins, 269 U.S. 110 (1925) (holding associations considered partnerships under State law were nevertheless taxable as corporations); Wholesalers Adjustment Co. v. Commissioner, 88 F.2d 156">88 F.2d 156 (8th Cir. 1937) (holding that in determining an organization is an association for Federal tax purpose, it is irrelevant whether it would be classified as such under State law or common law).Furthermore, section 811 specifies that dividends and similar distributions are deductible as policyholder dividends under section 809. Obviously State insurance laws cannot define a "similar distribution." The determination of what constitutes a dividend or similar distribution is necessarily a question of Federal tax law.Second, petitioners argue that all the rights114 policyholders would enjoy under State law are automatically incorporated as a part of the contract. Petitioners tried to establish through the testimony of Mr. Jourdon, a previous Chief Examiner of the Missouri Division of Insurance, that the State would have construed the additional benefits voted by the board for 1978 and 1979 as being payable throughout the life of the contract. Petitioners further contend that if petitioners had failed to pay the benefits -- for any reason other than insolvency -- the State would have enforced a claim by policyholders.Petitioners' argument must fail. It is based on speculation within speculation. Petitioners are saying, in effect, that:if the policyholders had come to learn they were entitled to additional benefits (of which they were never clearly told); and if a claim were made based upon the Board resolutions pertaining to 1977 and 1978;and if petitioners had refused to pay -- then the State would have found the Board resolutions to have been binding in subsequent years and the State would have enforced the claim.None of this ever occurred.We are not persuaded, moreover, that petitioner itself intended the resolutions115 regarding 1978 and 1979 to be effective beyond those years, absent further corporate action. This is strongly suggested by reenactment of 1977's 1246 resolution with a nearly identical resolution in 1978 (a superfluous act if the earlier benefit were already irrevocably "fixed in the contract").Not until November 28, 1979 -- with regard to 1980 -- was specific language used establishing "certain irrevocable benefits which the company shall forever be legally obligated to pay." Such language is conspicuous by its absence during the years in issue.Likewise, Progressive's resolutions for 1978 and 1979 made no mention of any continuing obligations to pay. This is particularly striking in light of the language used in a resolution affecting a prior year 1977 (not in issue). That resolution said, in part, "the benefit schedule is hereby adopted for the life of the contract." Again, however, the question arises: if the benefits were to continue, why was it necessary to authorize them again in later years? Moreover, Progressive ignored NAIC's recommendation to give clear notice to policyholders, and instead adopted language that could have been construed as effective only 116 for the year specified.As in the case of petitioner, the language of Progressive's resolution changed for the 1980 year. That resolution referred to "irrevocable benefits which the Company shall forever be legally obligated to pay each year."We do not decide whether such language would suffice to bring the benefits paid within the ambit of section 809(d)(3). The 1980 year is not before us. The point is that both petitioners knew how to talk about irrevocability if that was intended.On this record we simply cannot find that under Missouri law an obligation to pay the approved benefits extended beyond the next succeeding year. We therefore hold that the benefits were not "fixed in the contract" within the purview of section 1.811-2(a), Income Tax Regs.Other Indicia of Dividends and Similar DistributionsBesides being "payments not fixed in the contract" under section 1.811-2(a), Income Tax Regs., the benefits in issue were distributions similar to dividends in other respects.First, they were made to policyholders who had a right to participate in the divisible surplus of the company -- that is, 1247 to the very persons who would otherwise receive payments in the form117 of dividends. In fact, simultaneously with increasing the benefits, petitioners greatly reduced dividends. In 1979, the reduction was dollar for dollar.Second, during the years in issue, the amounts of the payments depended solely on the discretion of management. The benefits were unilaterally increased by the directors, not bargained for by the policyholders. Moreover, in every case, the decision to increase benefits and decrease dividends was made near the end of the year when the experience of the company was known and profitability foreseeable.Third, the element of secrecy concerning the increased benefits strongly implies an intent by management to maintain discretion and flexibility concerning payment in subsequent years, rather than an intent to give policyholders an irrevocable right to legally enforce future payments. A policyholder was not explicitly told of the increased benefits until and unless she tried to cancel the policy in the mistaken belief it was not competitive with another insurer. Otherwise, she merely continued to receive a single yearly check, similar to the dividend check received in prior years. The only change was that the stub now showed a portion118 of the total was a "dividend" and a portion a "benefit." Certainly a policyholder would not deduce from the check stub that the "benefit" would continue into subsequent years. Our position is further supported by the fact that petitioners never actually amended the affected policies to include the "guaranteed" benefits, a process required by the terms of the contract in order to modify the contract. No rider or endorsement was ever sent to policyholders, despite NAIC's explicit recommendation.Characterization of ReservesHaving determined that the payments are dividends or similar distributions to policyholders, we now examine whether the reserves for those payments are life insurance reserves or policyholder dividend reserves.It is undisputed that petitioners funded reserves for these payments by giving securities to the State, in trust, to cover the obligation.1248 Not coincidentally, each party bases its arguments as to the appropriate reserve treatment on its espoused treatment of the payment itself. Additionally, however, petitioners assert that under section 818, NAIC accounting practices are appropriate for tax purposes unless specifically usurped by accrual119 method accounting procedures. We assume without deciding that under NAIC rules petitioners were required to report the amount as a liability for life reserves and that the correct accounting treatment is to consider the reserves "life insurance reserves." Petitioners then argue that NAIC categorization of liabilities also controls for Federal tax purposes. The question then becomes, if the payments are dividends for Federal tax purposes, but are not dividends for State insurance law purposes, are the reserves for these payments correctly treated as policyholder dividend reserves under section 1.811-2(c), Income Tax Regs., or life insurance reserves within the meaning of section 801(b)(1) and (b)(2)?A reserve must meet the following requirements in order to be considered a life insurance reserve under the Code and Regulations --1. They must be "computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest." Section 801(b)(1)(A).2. They must be "set aside to mature or liquidate, either by payment or reinsurance, future unaccrued claims arising from life insurance * * * contracts * * * involving, at the time with respect to 120 which the reserve is computed, life, health, or accident contingencies." Section 801(b)(1)(B).3. They must be required by law. Section 801(b)(2), and4. They must be actually held by the company during the taxable year for which the reserve is claimed. Section 1.801-4(a), Income Tax Regs.Conversely, policyholder dividend reserves are defined in section 1.811-2(c), Income Tax Regs., as:(1) In general. * * means only those amounts --(i) Actually held or set aside as provided in subparagraph (2) of this paragraph and thus treated as actually held, by the company at the end of the taxable year, and(ii) With respect to which, at the end of the taxable year or, if set aside, within the period prescribed in paragraph (2) of this paragraph, the company is under an obligation, which is either fixed or determined according to a formula which is fixed and not subject to change by the company, to pay such amounts as dividends to policyholders (as defined in section 811(a) and paragraph (a) of this section) during the year following the taxable year.1249 (2) Amounts set aside. (i) In the case of a life insurance company * * all amounts set aside before the 16th day of the121 3rd month of the year following the taxable year for payment of dividends to policyholders * * during the year following such taxable year shall be treated as amounts actually held at the end of the taxable year.Sections 1.801-4(e)(8) and (9), Income Tax Regs., state that life insurance reserves do not include(8) Liability for annual and deferred dividends declared or apportioned.(9) Liability for dividends left on deposit at interest.Since we have determined that the payments were dividends or similar distributions, the amounts were set aside for the payment of dividends or similar distributions. Therefore the reserve is correctly treated as a reserve for dividends to policyholders.Loss Carrybacks from 1981Petitioner was allowed tentative carrybacks for an operations loss incurred in 1981 to the 1978 and 1979 taxable years. Respondent now contests the amount of the carrybacks. However, the parties stipulated that petitioner is entitled to operations loss carrybacks to 1978 and 1979 attributable to the operations loss of $ 1,418,441 generated in 1981. Rule 91(e) states that a stipulation shall be treated, to the extent of its terms, as a conclusive admission by the122 parties to the stipulation unless otherwise permitted by the Court or agreed upon by the parties. Based upon the stipulation we hold for petitioners on this point.In light of concessions and to reflect the foregoing,Decisions will be entered under Rule 155. Footnotes1. All Rule references are to the Tax Court Rules of Practice and Procedure. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as amended and in effect during the years in issue.↩2. The term guaranteed payments will be used herein to refer to the disputed "guaranteed benefits."↩. Includes Guaranteed Benefit[Policyholder's Name and Address]↩3. For a discussion of the operation of subch. L, see North Central Life Insurance Co. v. Commissioner, 92 T.C. 254↩ (1989).4. We thus do not↩ decide whether enforceability of payment, by the State, standing alone, would change the result herein.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621249/	KAHUKU PLANTATION COMPANT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. MCBRYDE SUGAR COMPANY, LTD., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Kahuku Plantation Co. v. CommissionerDocket Nos. 99916, 101307.United States Board of Tax Appeals43 B.T.A. 784; 1941 BTA LEXIS 1452; February 28, 1941, Promulgated 1452 Prior to 1936 the petitioners kept their books of account and made their income tax returns upon the crop basis of reporting income. From the gross sales of sugar during the year was deducted the cost of producing the sugar, including indirect expenses, such as property taxes and overhead, charged to the crop. In 1936 the petitioners requested the permission of the respondent to change their methods of accounting and reporting and to be permitted to deduct from the gross income of each year the full amount of indirect expenses incurred in that year whether relating to the crop harvested during the year, or to crops to be harvested during the succeeding two years, instead of the amount of such indirect expenses charged to the crop harvested during the year. The respondent granted the request upon the condition that the petitioners "exclude from deductions for the year of change and subsequent years the indirect charges which have been deferred under the method of allocating such costs to crops in process." This condition was accepted by the petitioners. Under such condition the petitioners excluded from the deductions of 1936 the indirect expenses allocated to the crop harvested1453 and sold in 1936, but did not exclude such expenses allocable to certain sugar carried over from 1935 under a marketing quota agreement with the Secretary of Agriculture. Held, that the petitioners are not entitled to deduct from the gross income of 1936 the indirect expenses allocable to the sugar on hand at December 31, 1935, which was sold in 1936. Montgomery E. Winn, Esq., R. A. Vitousek, Esq., and Thomas P. Goodbody, Esq., for the petitioners. T. M. Mather, Esq., for the respondent. SMITH 784 These proceedings, consolidated for hearing, involve income tax deficiencies for 1936 of $7,577.45 against the Kahuku Plantation Co. and $1,356.28 against the McBryde Sugar Co., Ltd. The only issue 785 for our determination, which is common to both proceedings, is the cost basis to be used in determining the gain or loss on the sale in 1936 of sugar which the petitioners carried over from their 1935 crops in an "emergency reserve" set up under agreement with the Secretary of Agriculture. Other issues raised in the pleadings were conceded by the respondent at the hearing. FINDINGS OF FACT. The petitioners are corporations organized1454 under the laws of the Territory of Hawaii, engaged in the operation of large sugar cane plantations in the Hawaiian Islands and the manufacture of raw sugar. Their principal office is in Honolulu and they filed their income tax returns with the collector at Honolulu. The production of a mature crop of sugar cane in the Hawaiian Islands requires three years. The cane is planted in the first year, fertilized and cultivated in the second year, and harvested in the third year. Thus, there are three distinct crops in process in each year. For many years prior to 1936 the petitioners, in common with other sugar producers in Hawaii, kept their books of account and made their income tax returns on the so-called "crop basis", charging to each crop all of the expenses incurred in its production, both "direct" and "indirect" expenses, and applying the sum total of such expenses against the selling price in the year when the crop was sold. The difference between those amounts was the gain or loss on the crop which the petitioners reported in their income tax returns. This method of accounting and of reporting income was approved by the Commissioner. The direct expenses of each crop1455 consisted of the cost of plowing, preparing, planting, cultivating, irrigating, fertilizing, etc., while the indirect expenses were such as camp sanitation, hospital maintenance, repairs, camp fuel, legal expenses, forestry maintenance, property taxes, workmen's compensation, insurance, industrial welfare, agricultural research, camp police, day nurseries, interpreters, and office salaries. The indirect expenses were distributed or allocated to the three crops in process on thesame basis as the direct expenses attributable to each crop; that is, on the basis of the actual labor hours required on each separate crop. During 1935 the petitioners, as well as other sugar cane growers in Hawaii, entered into "Sugarcane Production Adjustment Contracts" with the Secretary of Agriculture under authority of the Jones-Costgan Sugar Act. Under the terms of those contracts the petitioners agreed to limit their sales of raw sugar for consumption during 1935 to certain fixed market quotas and to manufacture an additional amount 786 of not less than 9 percent of their base production to be held in an "emergency reserve." For 1935 Kahuku's total crop of sugar amounted to approximately1456 20,148 tons. Of that amount 18,414.76 tons were sold in 1935 and 1,733.435 tons were allocated to and held in the emergency reserve. McBryde's total crop for 1935 was approximately 23,016 tons, of which 21,622 tons were sold and 1,394.82 tons were retained in the emergency reserve. In closing their books for 1935 the petitioners inventoried the sugar retained in the emergency reserve at the close of the year at cost of production, which was less than the market value at that time. The cost of production was arrived at by allocating to the reserve sugar a portion of the total cost of the entire 1935 crop, including both the direct and indirect expenses allocable thereto which had accumulated over the three-year production period. Kahuku's 1,733.435 tons of emergency reserve sugar were inventoried at $88,977.22 and McBryde's 1,394.82 tons at $65,378.93. Those amounts were taken up in petitioners' 1935 income while all of the expenses, both direct and indirect, which had been charged against the entire 1935 crop, including the sugar sold as well as that held in the emergency reserve, were taken up as deductions. Prior to December 31, 1935, all of the petitioners' emergency1457 reserve sugar had either been delivered to or was in transit to the California & Hawaiian Sugar Refining Corporation, Ltd., at Crockett, Port of San Francisco, California, where it was to be held in bond to prevent Its being processed or sold for consumption in the continental United States, under an arrangement made with the Agricultural Adjustment Administration. The petitioners had received partial payments on some of those shipments. In their income tax returns for 1935 the petitioners reported all of the proceeds from the sale of sugar in that year and also reported as "Other Income" the above amounts of inventories of sugar retained in the emergency reserve. Also, in their 1935 returns they claimed the deduction of all of the expenses, both direct and indirect, attributable to the entire 1935 crop. A controversy arose between the petitioners and the Commissioner as to the method of inventorying the emergency reserve sugar, the Commissioner contending that it should be inventoried at market value on December 31, 1935, instead of on the cost of production basis used by the petitioners. The petitioners' 1935 returns were finally audited without any change in respect of1458 the inventories in question, that is, the inventories of sugar held in the emergency reserve were taken up in income at cost (including indirect expenses) as reported in the returns. 787 On February 1, 1936, the petitioners applied to the Commissioner for permission to change their method of accounting to the extent of charging all of the indirect expenses such as property taxes, camp sanitation, hospital maintenance, etc., on the annual accrual basis in the year when such expenses were paid or incurred, rather than on the crop basis. On July 17, 1936, the Commissioner replied to this request in part as follows: Permission will be granted each of the taxpayers above named to change the method of allocating expenses to the respective crops under the crop basis of reporting income so as to take indirect charges on an annual basis as accrued instead of being allocated to the crops in process, provided the taxpayers express their willingness to exclude from deductions for the year of change and subsequent years the indirect charges which have been deferred under the method of allocating such costs to crops in process, and to confine the deductions for indirect charges for1459 the year of change and subsequent years to those actually accruing within the given taxable year, excluding any deductions previously claimed in prior years. The taxpayers must, after making the change, report such deductions consistently with the method of accounting employed. The petitioners agreed to the conditions set forth in the Commissioner's letter of July 17, 1936, and on August 28, 1936, permission for the petitioners to make the proposed change was granted by the Commissioner. Under their modified accounting system the petitioners in December 1936 wrote off, by a charge to surplus, all of the indirect expenses which had been allocated to the 1936 and 1937 crops in process prior to January 1, 1936. For Kahuku the total amount so written off was $175,616.49, of which amount $139,295.91 had been charged to the 1936 crop and $36,320.58 to the 1937 crop. The total amount written off by McBryde was $269,792.28 of which $188,276.70 had been charged to the 1936 crop and $81,515.58 to the 1937 crop. In further compliance with the conditions upon which permission for the accounting change was granted, the petitioners in computing their profits on the 1936 crop deducted1460 all of the direct expenses which had been charged to that crop in 1934, 1935, and 1936, and in addition thereto all of the indirect expenses paid or incurred during that year, a portion of which under the old method of accounting would have been allocated to the 1937 and 1938 crops. In 1936 the petitioners sold all of the sugar produced in that year as well as the emergency reserve sugar brought over from 1935, the quota restriction having been removed by the ruling of the Supreme Court in 1936 that the Agricultural Adjustment Act was unconstitutional. See . In their income tax returns for 1936 the petitioners reported the profits on the 1936 crop, computed by deducting from the proceeds of the sales of sugar in that year the direct expenses incident thereto 788 over the years 1934, 1935, and 1936, and all of the indirect expenses paid or incurred in that year in respect of the 1936, 1937, and 1938 crops. These computations, as applied to the 1936 crop, were in accordance with the accounting plan agreed to by the Commissioner and are not questioned in these proceedings. In computing their profit1461 on the sales of the emergency reserve sugar broght over from 1935 the petitioners used as a cost basis the values at which this sugar had been inventoried at the close of 1935. The respondent has determined, however, that the inventory values which were based on cost of production and included both the direct and indirect expenses allotted to the 1935 crop were not the correct bases; that under the agreement by which the petitioners were given permission to change their method of accounting the profits on the sale of the emergency reserve sugar carried over from 1935 must be computed in the same manner as the 1936 crop; that is, by eliminating from the cost all of the deferred indirect expenses which had been allocated to it. This results in a reduction of $23,904.07 in the cost basis of Kahuku's emergency reserve sugar and of $17,909.49 in McBryde's, those being the respective amounts of such indirect expenses. OPINION. SMITH: The question presented is the correct interpretation of the respondent's letter of July 17, 1936, permitting a modification of the crop basis of reporting taxable income. The respondent contends that his letter meant that for 1936 and subsequent years1462 the petitioners were not to deduct from gross income under the new accounting system any indirect expenses except those which were incurred during the taxable year. The petitioners, on the other hand, contend that the conditions of the letter did not require them to exclude from the deductions of 1936 the indirect expenses incurred and paid in years prior to 1936 in connection with the production of sugar which they had on hand at December 31, 1935. They were not able to sell that sugar in 1935 by reason of the quota provisions of the Agricultural Adjustment Act. The argument of the petitioners is that this sugar was not a part of the "crops in process" referred to in the respondent's letter of July 17, 1936. They point out that this sugar on hand was inventoried in their accounts and in their returns for 1935 not at market, but at cost of production, including indirect expenses properly allocable to the sugar; and contend that in computing profits from the sale of that sugar in 1936 they should use as a basis the same inventory value as was shown by their books of account at December 31, 1936. 789 In this connection it should be noted that the treatment of the carry-over1463 sugar by the petitioners in 1935 had the effect of leaving the account for such sugar in suspense; in other words, the sugar was inventoried exactly at the cost of production, including the indirect expenses. No gain or loss on the sugar was reflected in the accounting for 1935. The accounting for profit or loss in respect of that sugar was deferred to 1936, the year in which it was sold. It seems to us clear that the condition upon which the petitioners were permitted to modify their system of accounting and reporting was that for the year 1936 the petitioners should not receive the benefit of the deduction of any of the indirect expenses allocable to the sugar sold in 1936, except, of course, the total indirect expenses incurred in 1936. The pertinent language of the letter of July 17, 1936, bearing upon this point is the proviso that "the taxpayers express their willingness to exclude from deductions for the year of change and subsequent years the indirect charges which have been deferred under the method of allocating such costs to crops in process." The indirect expenses pertaining to the sugar on hand at December 31, 1935, was in the case of the Kahuku Plantation Co. $23,904.071464 and in the case of the McBryde Sugar Co., Ltd., $17,909.49. We think that these indirect expenses must be excluded from the deductions of 1936 as well as the other indirect expenses which had been charged on the books of account to the 1936 and 1937 crops which were charged off to profit and loss in 1936 in compliance with the condition of the permission to change. The petitioners complain that under this construction of the respondent's letter they will never be allowed to deduct the indirect expenses pertaining to the carry-over sugar. The respondent admits that this is so but insists that it was a condition of the grant of the permission for the petitioners to change their accounting method. The petitioners admit that under the condition of the grant they forever lose the right to deduct the indirect expenses which had been incurred and paid in years prior to 1936 which they had charged to the 1936 and 1937 crops, the amounts being $175,616.49 in the case of the Kahuku Plantation Co. and $269,792.28 in the case of the McBryde Sugar Co., Ltd. We can see no good reason why the indirect expenses allocable to the carry-over sugar should not be given the same treatment. It1465 seems to us that a fair interpretation of the respondent's letter requires such a conclusion. The respondent's action upon the point involved is approved. Decisions will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621250/	James J. Weaver and Ora J. Weaver v. Commissioner.Weaver v. CommissionerDocket No. 65061.United States Tax CourtT.C. Memo 1959-199; 1959 Tax Ct. Memo LEXIS 49; 18 T.C.M. (CCH) 888; T.C.M. (RIA) 59199; October 23, 1959John McCrea, Esq., 24 West King Street, Shippensburg, Pa., for the petitioners. George H. Bowers, Jr., Esq., for the respondent. TIETJENSMemorandum Findings of Fact and Opinion TIETJENS, Judge: The Commissioner determined deficiencies in petitioners' income tax and additions thereto, for the years, and in the amounts as set forth below: Sec. 294Sec. 294YearDeficiencySec. 291(a)Sec. 293(b)(d)(1)(A)(d)(2)1942$ 1,074.48$ 268.62$ 537.24194329.017.2514.511944228.2957.07114.15$ 20.55$ 13.7019451,043.68260.92521.8493.9362.621946194739.009.7519.503.532.3419481,697.48424.37848.74152.78101.85194910,392.082,598.025,196.04935.28632.5250 At trial, the Commissioner abandoned his determination of additions to tax for fraud under section 293(b), I.R.C. of 1939. The only issue for decision is whether, in computing petitioners' income on the basis of their net worth plus personal expenditures, the Commissioner properly determined the cost of cattle on hand as of December 31 for each of the years 1941 through 1949. Findings of Fact Petitioners, James J. and Ora J. Weaver, husband and wife, are residents of Orrstown, Pennsylvania. They filed no Federal income tax returns for the years 1942 through 1949. In 1941, petitioners owned some 200 acres of farm land which they operated as dairy farmers. They were also engaged in the livestock and farm equipment business. They continued these lines of endeavor through the years in issue. During each of the years 1941 through 1949, petitioners maintained a dairy herd which consisted of two groups of cattle: (1) those animals which they kept on their own farm, and (2) those animals placed on other farms under oral agreements with other farmers. The second category of animals was referred to as cows "on feed." Petitioners' herd increased through each of the years in issue51 as a result of births to the herd as well as purchases made by petitioners. Petitioners kept no books or records of their business activities or other income producing transactions during the years in issue. In the absence of books and records the Commissioner determined their income for each of the years 1942 through 1949 on the basis of annual increases in their net worth plus personal living expenses. As part of that net worth computation, the Commissioner determined that for the calendar years ended December 31, 1941 through 1949, petitioners owned cattle having the values set forth below: 194119421943194419451946194719481949Cows,$1,500$2,000$3,000$4,000$5,945$8,145$10,245$12,345$56,000dairy onown farmCows,3,7403,7403,7403,7406,6509,20011,275dairy onfeedOn the assumption that the annual increases in the value of their cattle represented purchases made during each year, the Commissioner proceeded to determine the total increases in petitioners' net worth for the years 1942 through 1949, to which he added their personal expenditures, then reduced the total by an item referred52 to as "Adjustment of inventories of Cows to 'Farm Price Method'" thereby determining their net income in the manner set forth below: 1942194319441945Increases in net worth:$ 7,599.82$ 857.20$ 4,512.63$ 7,878.49Add: Living and personal expenses1,500.001,500.001,500.001,651.40Total:$ 9,099.82$ 2,357.20$ 6,012.63$ 9,529.89Less: Adjustment of inventoriesto "FarmPrice Method"401.80471.80541.80675.15Net Income$ 8,698.02$ 1,885.40$ 5,470.83$ 8,854.741946194719481949Increases in net worth:$ 3,512.96$ 3,740.80$14,299.08$41,142.56Add: Living and personal expenses1,786.722,286.722,286.722,286.72Total:$ 5,299.68$ 6,027.52$16,585.80$43,429.28Less: Adjustment of inventoriesto "FarmPrice Method"1,035.651,361.151,653.403,920.00Net Income$ 4,264.02$ 4,666.37$14,932.40$39,509.28In 1941, petitioners' entire herd consisted of 15 animals, 10 cows and 5 heifers. The cows had been purchased by them at a total cost of $1,500, and the heifers they had raised. These 15 head of cattle were maintained by petitioners on their own farm. 53 Petitioners increased their farm herd during each of the years 1942 through 1945 by the addition of animals purchased for the following amounts: 1942194319441945$500$1,000$1,000$1,945At a conference between petitioners, their counsel, and the internal revenue agents examining petitioners' case, petitioners' counsel, in response to questioning as to the cost of cattle added to the farm herd in 1946 and later years, stated that: "a depreciation basis would be impossible but an inventory amount reflecting a 20% increase in number of cattle and $2,100.00 monetary increase in value of inventory per year would satisfactorily reflect the replacements by heifers and bulls born each year and monetary acquisitions to replace diseased cattle or ones disposed of." With respect to animals "on feed", petitioners submitted information to the examining agents which reflected purchases of cattle added to that herd in each of the years 1942, 1946, 1947, and 1948 as set forth below: 1942194619471948$3,740$2,910$2,550$2,075In September of 1949, James Weaver submitted a financial statement to a bank in Shippensburg, Pennsylvania, 54 wherein he acknowledged ownership as of that time of 224 head of cattle having a cost basis of $250 per head, or a total value of $56,000. During 1948, petitioners deposited a total of $206,816.55 in various bank accounts which they maintained, which represented the proceeds of discounted notes, sale of cattle, milk checks, and various other transactions. Ultimate Finding of Fact Petitioners expended the following amounts on purchases of cattle during each of the years in issue: 19421943194419451946194719481949On own farm$ 500$1,000$1,000$1,945$2,100$2,100$2,100$2,100On feed$3,740$2,910$2,550$2,075Opinion The Commissioner determined petitioners' income for the years in issue on the basis of annual increases in their net worth plus their personal expenditures. No issue has been raised with respect to the use of that method, nor with respect to any item appearing on the net worth statement, save the annual increases in cattle inventory determined to have been the result of purchases made during the net worth period. While petitioners do not contend that there was no increase in their55 cattle inventory, they do contend that a portion of that increase was due to animals born to their respective herds. They further contend that inventory increases resulting from births should not be included in a net worth statement which, with certain adjustments, attributes such annual increases to taxable income. Inasmuch as the record reveals that the net worth statement fails, at least in part, to take into account those animals which might have been born to their herds, petitioners submit that it has lost its presumptive correctness, as to this item, and that the burden of proof has thus shifted to the Commissioner. The record indicates that the annual increases in cattle attributed to petitioners' farm herd on the net worth statement, for the years 1942 through 1945, were based upon figures supplied either by petitioners or their counsel. It further indicates that those increases were due to purchases made by petitioners during each of these years. The same is true with respect to the figures which the net worth statement attributes to cattle "on feed" for each of the years 1942, 1946, 1947, and 1948. No evidence has been introduced which establishes error in these figures, 56 and they have been incorporated in our ultimate finding of fact. As to the figures for the years 1946 through 1948, attributed by the net worth statement to increases in petitioner's farm herd, the record indicates that they were based upon information supplied the Commissioner by petitioners' counsel to the effect that: "a depreciation basis would be impossible but an inventory amount reflecting a 20% increase in number of cattle and $2,100.00 monetary increase in value of inventory per year would satisfactorily reflect the replacements by heifers and bulls born each year and monetary acquisitions to replace diseased cattle or ones disposed of." Petitioners now maintain that the $2,100 figure referred, not to annual net purchases, but rather to total increases attributable to both births and purchases. We have carefully read counsel's statement, and in light of the circumstances under which it was made, and in the absence of any evidence to the contrary, have concluded the Commissioner properly treated it as representing the cost of the net acquisitions made to the farm herd during the years 1946 through 1948. We note that the increase attributed to the farm herd for the year57 1946 is $2,200. However, the record establishes that the $2,100 figure should have been used. Thus, we have used the latter in our ultimate finding of fact for the year 1946. As to the year 1949, the Commissioner lumped both the home and away herds together, and determined a $32,380 inventory increase, all of which he attributed to purchases made during that year. The record indicates that the basis of this determination was a financial statement submitted by James Weaver to a Shippensburg bank, wherein he acknowledged ownership in 1949 of 224 head of cattle having a cost basis of $250 per head. However, the revenue agents assigned to petitioner's case admitted no attempt was made to determine how many of those 224 head were born to petitioner's herd during 1949. Moreover, on brief, the Commissioner has conceded that at least 20 of those 224 head were born to petitioners' herd during 1949, and accordingly has reduced the total herd increase from 1948 to 104 head at $250 per head, or $26,000. This concession was based on the testimony of one of the agents that he calculated that petitioners, starting in 1941 with 15 head of cattle, could not have acquired more than 100 head of cattle58 by December 31, 1948, and therefore, of the 224 head at least 124 had to have been acquired during 1949; which, when adjusted for an inventory increase of 20 per cent due to births, resulted in purchases of at least 104 head. The principal fault with the Commissioner's present position is that there is no evidence of the manner in which the revenue agent arrived at his figure of no more than 100 head on hand as of the close of 1948. Actually, that figure seems to be the result of nothing more than a mathematical computation, which the agent admitted was a "rough calculation." Moreover, the agent first referred to the 100 head as the maximum number which could have been raised by petitioners as of the close of 1948. However, he subsequently referred to the 100 head as the maximum number which could have been acquired as of that date either by birth or by purchase. In light of these facts, we must reject the Commissioner's arguments with respect to 1949. However, on the basis of the statement of petitioners' counsel alluded to above, we have found that an inventory increase for 1949 in the net amount of $2,100 was the direct result of purchases made by petitioners during that year. 59 No issue has been made with respect to the additions to tax under section 291(a), section 294(d)(1)(A), and section 294(d)(2), and they are sustained subject to recomputation in light of our holding on the above issue. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621251/	PACIFIC FLUSH TANK CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Pacific Flush Tank Co. v. CommissionerDocket No. 28415.United States Board of Tax Appeals17 B.T.A. 896; 1929 BTA LEXIS 2217; October 14, 1929, Promulgated 2217 T. M. Mather, Esq., for the respondent. VAN FOSSAN 896 In this proceeding petitioner asks to be relieved of a deficiency of $282.03 in income taxes for the year 1922, alleging error of the respondent in disallowing a deduction of $2,100 claimed to represent either an annuity paid to the widow of its former president or a loss incurred in the operation of its business. FINDINGS OF FACT. The following facts were stipulated and are all of the facts in evidence: (1) That the taxpayer corporation was duly organized December 30, 1905, under the laws of the State of Illinois and is engaged in the manufacture, selling and installing of sewage disposal apparatus. (2) That the petitioner filed a return for 1922 and deducted from gross income as an ordinary and necessary business expense an item designated as follows: "Ida K. Miller (per minutes of 1905) $2,100.00." The above amount represents a payment to the widow of Sidney W. Miller, president of the corporation, who died in the year 1910, and was made in accordance with a contract made pursuant to a resolution adopted by the board of directors on December 30, 1905. (3) That said resolution is contained2218 in the minute book of the petitioner corporation on pages 101, 102 and 103, which are offered in evidence as petitioner's Exhibit 1, without objection. (4) That the amount of $2,100 claimed as a deduction by the petitioner for the year 1922 was disallowed by the Commissioner of Internal Revenue, as shown in the deficiency letter and statement, a copy of which is attached to the petition and marked Exhibit A. The resolution referred to in paragraph 3 above is as follows: This agreement made this thirtieth day of December A.D. 1905 by and between Pacific Flush Tank Company, a corporation duly organized under the laws of the State of Illinois, and having its principal office in Chicago in said State, party of the first part, and Sidney W. Miller of said city and State, party of the second part, WITNESSETH: Whereas: Said second party has been the manager of the business of Sidney W. Miller and Brother, copartners heretofore for upward of ten years trading as and under the name "Pacific Flush Tank Company" and conducted the same with such recognized skill and ability that from small beginnings the business of said firm grew steadily to so large and prosperous proportions, 897 2219 that it was deemed wise to form a stock company to take over the business and assets of said firm and Whereas: The said party of the first part has elected said second party as its president and expects to retain him as such indefinitely, and desires to own and control all patents, inventions and improvements of every kind which said second party may at any time acquire or make, that may be used or applied in the business of said first party, and Whereas: The salary of the president of said company as fixed by its by-laws is recognized as inadequate compensation for the services of said second party as president of the company and for the products of his inventive and engineering ability, Now Therefore, in consideration of the mutual covenants herein by the parties hereto, and in consideration of one dollar ($1.00) in hand paid, each to the other the receipt whereof is severally acknowledged by each to the other, the parties hereto have covenanted and have agreed and do hereby covenant and agree as follows: First: Said party of the second part as long as he owns or he and his wife together own, a majority of the capital stock of said company, shall assign and transfer to said2220 company all patents, inventions and improvements of every kind which he may hereafter acquire or make, that can be used or applied in the business of said company as determined by its objects set forth in its charter and future amendments thereto, for which said company shall be required to pay only the actual cost thereof to said second party and the expenses of the assignment thereof to said company. Second: Said party of the first part in consideration of the benefit to it, growing out of the foregoing covenant, shall pay to said party of the second part Twenty (20%) per cent of the net earnings of said company, semiannually, during the first week of June and of December of each and every year for and during his natural life, so long as he owns or he and his wife together own, a majority of the capital stock of said company, and after the death of said second party, said party of the first part shall pay to the widow of said party of the second part, the sum of one hundred and seventy-five ($175.00) dollars a month, payable to her monthly, for and during the remainder of her natural life, so long as she is the owner of a majority of the capital stock of said company, or so long2221 as what she owns and what is held in trust for her constitutes a majority of the capital stock of said company. This contract is made pursuant to a resolution duly passed by the Board of Directors of said corporation on the Thirtieth day of December, A.D. 1905. In Testimony whereof the said party of the second part has hereunto set his hand and seal and said party of the first part has caused these presents to be signed in its name by Walter H. Miller its vice president, and its corporate seal to be affixed hereto and attested by Lester E. Rein its secretary, the day and year first above written. PACIFIC FLUSH TANK COMPANY, BY WALTER H. MILLER, Vice President.Attest: LESTER E. REIN, Secretary.OPINION. VAN FOSSAN: Petitioner contends that the payments to Ida K. Miller under the terms of the above contract were either an ordinary and necessary expense or a loss. We find ourselves unable to catalog the item in either category. 898 The payments to the widow were provided for in the contract made by the husband and the principles underlying payment to both are inextricably interwoven. As to the husband, the payment of 20 per cent of net earnings*2222 was either primarily in the nature of payment for capital assets (patents and improvements usable in petitioner's business) and so not allowable as expense () or a distribution of profits, equally unallowable (). The designation of the widow as the recipient of part of the payments to be made did not alter the character of the payments. Such payments would be, nevertheless, in consideration of the services and contributions of the husband. Nor is the difficulty removed by denominating the payments as annuities. In the alternative, petitioner contends that the payments to the widow were a loss. Before this conclusion could be reached, however, it would be necessary for petitioner to establish the value of the patents acquired, their respective terms, and the proportionate part of the payments heretofore made properly to be allocated thereto, none of which facts are before us. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621252/	LOUIS TELFEYAN AND LYNN TELFEYAN, Petitioners v. COMMISSIONER INTERNAL REVENUE, RespondentTelfeyan v. CommissionerDocket No. 10621-87United States Tax CourtT.C. Memo 1988-425; 1988 Tax Ct. Memo LEXIS 452; 56 T.C.M. (CCH) 96; T.C.M. (RIA) 88425; September 7, 1988Louis and Lynn Telfeyan, pro se. Monica J. Miller, for the respondent. GALLOWAYMEMORANDUM OPINION GALLOWAY, Special Trial Judge: This case was heard pursuant to the provisions of section 7443A(b) of the Internal Revenue Code of 1986, and Rule 180 et seq. 1Respondent determined deficiencies in, and additions to, petitioners' 1983 Federal income tax as follows: Additions To Tax SectionsDeficiency6653(a)(1) 6653(a)(2)$ 4,520.66$ 266.0350% of theinterest dueon $ 4,5-0.66454 After a concession 2 by petitioners, the issues for decision are: (1) whether petitioner's rights were violated when the Court refused to allow a non-attorney not admitted to practice before this Court to represent them as counsel or assist them in presenting their case at trial; (2) whether petitioners are entitled to a deduction for contributions allegedly made to the Universal Life Church; (3) whether petitioners are entitled to a deduction for other contributions totaling $ 60; (4) whether petitioners are entitled to deduct Schedule C expenses in excess of the amount allowed by respondent; (5) whether petitioners are liable for additions to tax under sections 6653(a)(1) and 6653(a)(2); and (6) whether petitioners are liable for damages pursuant to section 6673. Petitioners were residents of 1300 Bridlebrook Drive, Casselberry, Florida at the time their petition was filed. A stipulation of facts was not filed with the Court when this case was called for trial at Jacksonville, Florida on October 5, 1987. Respondent however, filed a trial memorandum455 and a motion to dismiss and for damages pursuant to section 6673. After trial commenced, the parties agreed to stipulate into the record petitioners' 1983 tax return and respondent's notice of deficiency mailed to petitioners on January 28, 1987. 1. Representation By Or Assistance From Person Not Admitted To Practice Before The Tax CourtWhen the case was first called for trial from the trial calendar, petitioners were not present. Scott Slayback (Slayback) answered on petitioners' behalf. Slayback is petitioners' non-attorney tax consultant who prepared their 1983 tax return. Slayback advised the Court that he had conferred with petitioners the previous day and that they were en route to Jacksonville from their home at Casselberry, a suburb of Orlando, about 130 miles away. At trial, respondent moved and the Court granted respondent's motion that Slayback not be permitted to represent petitioners or sit at the counsel table and assist petitioners in the presentation of their case. Petitioners objected and renewed their objection by written brief, claiming "petitioners had sore need of his advice and counsel during the course of the trial. Petitioners could not afford456 to hire the type of counsel proscribed (sic) by the Rules of the Court. Long ago the U.S. Supreme Court had said that the Rules of any Court should not take presidence (sic) over the service of Justice. The best possible presentation of the Petitioners (sic) case was not possible under this handicap." In Cupp v. Commissioner,65 T.C. 68">65 T.C. 68, 85 (1975), affd. without published opinion 559 F.2d 1207">559 F.2d 1207 (3d Cir. 1977), we refused to allow the taxpayer "counsel of his own choosing" with respect to a person not admitted to practice before this Court who was not an attorney admitted to practice before any Court. 3 In Ruggere v. Commissioner,78 T.C. 979">78 T.C. 979 (1982), a taxpayer's non-attorney son not admitted to practice before this Court was not allowed to represent his father before us by signing documents. However, the son was allowed to sit at the taxpayer's counsel table for the purpose of assisting the taxpayer present his case. 457 In granting respondent's motion that Slayback not be allowed to assist petitioners present their case, we gave careful consideration to respondent's detailed memorandum filed in support of his motion to dismiss and motion for damages, which states in part: 2. By letter dated June 24, 1985, respondent contacted petitioners, informed petitioners that their federal income tax return for 1983 had been selected for examination and requested that they call or write the Internal Revenue Service office to schedule an appointment. 3. Petitioners did not schedule an appointment and in the months that followed petitioners were contacted on eight additional occasions including service of a summons on December 3, 1986. 4. In spite of numerous opportunities to do so, petitioners did not provide the requested documentation (except with respect to a few items) or an explanation to respondent with regard to their 1983 federal tax return at that time or at any time since. 5. Petitioners refused to consent to extend the statute of limitations with regard to the 1983 tax year. Therefore, a notice of deficiency was issued for the 1983 tax year on January 28, 1987. The notice of deficiency458 reflected acceptance of most of the substantiation presented by petitioners. The notice of deficiency made three adjustments: it disallowed a $ 9,264.00 charitable contribution to the Universal Life Church, disallowed Schedule C expenses and asserted unreported income of $ 1,947.00. Additions to tax under the provisions of I.R.C. section 6653(a)(1) and 6653(a)(2) were also asserted. 6. A petition was filed on April 24, 1987 in response to the notice along with the same inappropriate motions that this Court had denied in all cases where Mr. Slayback is involved (Motion for Jury Trial and Motion for Representation of Petitioner's Choice). 7. Based upon respondent's past experience with petitioners, District Counsel's office regained jurisdiction from the Appeals Office after referral but before the Appeals Office had met with petitioners, District Counsel then offered petitioners a "Branerton" conference by letter dated July 1, 1987. In addition, this letter and all subsequent letters sent by District Counsel's office encouraged petitioners to cooperate so as not further delay resolution of the issues and included cases wherein this Court had determined that the Universal459 Life Church issue was a frivolous one. 8. Petitioners' response to respondent's July 1, 1987 letter was a request for an Appeals conference in Orlando. This request was made, in spite of the fact that petitioners were offered an Appeals conference prior to the issuance of the notice which was canceled by petitioners. 9. Consequently, on July 22, 1987 respondent served petitioners with Request for Admissions and Request for Production of Documents * * . 10. Petitioners' responses * * to formal discovery were incomplete, evasive and inadequate and contradicted sworn testimony previously given by them. Petitioners also complained that they should be allowed to produce the requested documents in Orlando. In light of the fact that petitioners were not represented by counsel, respondent, by letter dated September 8, 1987, provided petitioners with an opportunity to present the documentation in the Internal Revenue Service office in Orlando, provided petitioners with a detailed explanation as to why their responses were inadequate, and again reiterated that petitioners' position with respect to the Universal Life Church issue was frivolous. A stipulation of Facts was also460 included with this letter. 11. Petitioners did not respond to the September 8, 1987 letter. Therefore, a subpoena was served upon petitioners on September 10, 1987. This subpoena requested all documents which were the subject of respondent's Request for Production of Documents: 12. By Letter dated September 29, 1987, respondent express mailed to petitioners: (a) First Supplemental Stipulation of Facts; (b) a copy of the transcripts of petitioners' sworn testimony taken during an interview among petitioners, their attorneys and two Internal Revenue Service special agents which respondent intends to introduce at trial; and (c) a copy of a recent Tax Court decision, Burwell v. Commissioner, 89 T.C. No. 41">89 T.C. No. 41 (1987). 13. As of October 2, 1987 respondent has not been contacted by petitioners and has received no documentation or executed stipulations in this case. Petitioners reluctantly admitted that Slayback prepared the petition in this case. 4 We are convinced that all documents furnished by petitioners in this case were prepared by Slayback and that Slayback's presence at the counsel table with petitioners would have constituted representation of petitioners461 by a person unauthorized to practice before this Court rather than mere assistance of a taxpayers by his tax preparer. Slayback is well-known in the Jacksonville, Florida, area for his attempts to frustrate respondent's administration of the tax laws by his obstinate attempt to represent taxpayers before the Internal Revenue Service without proper authorization. See Mulvaney v. Commissioner,T.C. Memo. 1988-243, slip opinion p. 7, 8. It is clear to us that petitioners were continuously aided and abetted by Slayback in their stubborn refusal to cooperate with respondent in preparing this case for trial. Moreover, to allow Slayback to assist petitioners at the counsel table would have further disrupted an already difficult trial. 2. Universal Life Church Contributions Deduction462 Petitioners claimed and respondent disallowed a charitable contribution to the Universal Life Church of Modesto, California (ULC Modesto) in the amount of $ 16,409.72 5 In Burwell v. Commissioner,89 T.C. 580">89 T.C. 580, 597 (1987), we stated, "Since 1980, this Court alone has considered more than 130 cases involving claimed charitable contributions to ULC Modesto substantially identical in nature to those at bar. The claimed deduction has not been allowed in any of these cases." We find this case to be no different than any of the previous 130 plus cases. The record discloses that Mr. Telfeyan filed a business Schedule C in 1983, reporting gross income of $ 6,475.26 and a net loss of $ 7,742.29. He also reported taxable capital gain from sales of stocks totaling $ 26,296.23 prior to his marriage to Lynn Effer on September 17, 1983. Mrs. Telfeyan reported W-2 earnings in 1983 of $ 98.31. Mr. Telfeyan became a member of ULC Modesto in August 1983, receiving charter463 No. 4355 as a "minister" of that church. After their marriage, petitioners opened and made deposits 6 in a checking account in a Casselberry, Florida bank in the name of Universal Life Church, chart No. 21355. 7 Petitioners wrote checks during the remainder of 1983 on these accounts for mortgage, household and other personal expenses to "U.L.C.," which totaled $ 16,409.72. Only petitioners were authorized to sign checks on their ULC account. Petitioners never communicated with ULC Modesto in California. It is well established that deductions are a matter of legislative grace, and that taxpayers must satisfy the specific statutory requirements for the deductions they claim. Davis v. Commissioner,81 T.C. 806">81 T.C. 806, 815 (1983), affd. without published opinion 464 767 F.2d 931">767 F.2d 931 (9th Cir. 1985). Taxpayers bear the burden of proving their entitlement to the deductions they claim. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142 (a). A deduction is allowable under the provisions of section 170 when a contribution or gift is made to a qualified organization which is organized and operated exclusively for religious or charitable purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual. Here, petitioners' dominion and control over their Florida ULC account precludes a finding that petitioners have made a charitable contribution or "gift." See Davis v. Commissioner,81 T.C. at 817. Furthermore, because of petitioners' adamant refusal to stipulate facts, there is no documentary evidence supporting the formation and operation of petitioners' ULC "church" or chapter, only petitioners' self-serving incredible testimony. Neither petitioner has a religious background or training. On occasion, each has attended the Lutheran Church. Mr. Telfeyan testified that the purpose of forming petitioners' "church" was "not for a tax deduction" but "to practice our465 religion" or "personal ministry" as he and Mrs. Telfeyan desired, in contravention to "a lot of people (who) attend churches in this country * * * for a lot of the wrong reasons." It is clear that petitioners have failed to prove that their "church" was "organized and operated exclusively for religious purposes." Sec. 170 (c)(2)(B). See Calvin K. of Oakknoll v. Commissioner,69 T.C. 770">69 T.C. 770, 773 (1978), affd. without published opinion 603 F.2d 211">603 F.2d 211 (2d Cir. 1979). Finally, no deduction is allowable when the ULC account deposits, as here, inure to the benefit of the taxpayers in question. Sec. 170(c)(2)(C); McGahen v. Commissioner,76 T.C. 468">76 T.C. 468, 482-483 (1981), affd. without published opinion 702 F.2d 664">702 F.2d 664 (3d Cir. 1983). Respondent is sustained as to this issue. 3. Other ContributionsIn addition to the ULC Modesto deduction, petitioners claimed unidentified cash contributions of $ 60. At trial, Mrs. Telfeyan testified that she wrote six $ 10 checks in 1983 to an alleged charitable organization called "Hunger Project," whose purpose was to "end world hunger." She failed to produce the checks. Since petitioners' testimony466 lacks documentary corroboration, the deduction is disallowed. See Fixel v. Commissioner,T.C. Memo. 1974-197, affd. without opinion 511 F.2d 1400">511 F.2d 1400 (5th Cir. 1975). 4. Schedule C ExpensesPetitioners reported a 1983 business C loss as follows: Gross Income$ 6,475.26 Advertising $ 831.22Bank Service Charges * 38.10Car and Truck Expenses1,259.57Depreciation2,248.30Dues and Publications39.91Freight * 88.05Insurance546.68Interest on Bus. Indebtedness512.67Legal and Professional Services * 30.00Office Expense * 604.14Rent on Business Property3,609.47Repairs and "T.B.A."787.97Travel and Entertainment631.12Utilities and Telephone1,051.39Tolls and Parking * 33.70Postage * 125.40Education (Sales) * 780.508 $ 14,218.19Loss9 $ (7,742.29)467 At trial, respondent's attorney objected to the introduction by petitioners of any additional receipts or other evidence purporting to verify Schedule C expenses in excess of $ 3,377 allowed by the Appeals Division officer. Respondent's attorney alleged that she (as set forth in respondent's motion) had served petitioners with a request to produce documents verifying claimed Schedule C expenses on July 22, 1987, as to which petitioners failed to comply. In opposing respondent's objection, petitioners argued that they had in their possession numerous receipts which, when presented to the Court, would prove the deductibility of the disallowed expenses. The Court then ruled that petitioners were precluded from submitting the additional receipts or other documents which had not been previously made available to respondent. After receipt and review of the transcript and the case file, the Court issued an order on November 9, 1987, reopening the record to allow petitioners, in the interest of fairly presenting their case, 10 the opportunity to submit original copies of canceled checks, receipts and other documents to support Schedule C expenses claimed and not previously allowed468 by respondent. In addition, petitioners were ordered to explain the nature of the business disclosed on Schedule C and advise the Court how the expenses claimed related to the conduct of their business. The checks, receipts and other information received by the Court are summarized as follows: Amount of Checks orReceipts ReceivedPetitioners'in SupportExhibitAmount inof ClaimedDesignationControversyDeductionsCar and truck expensesA$ 1,259.57$ 1,216.52Depreciation (5/12 of 38% of $ 14,200B2,248.30-0- DuesC39.9111 39.91FreightD88.0512 88.05InsuranceE546.68546.48InterestF512.6713 -0- RentG3,609.473,655.57RepairsH787.97744.67Travel and EntertainmentI631.12535.27Utilities and TelephoneJ1,051.39610.42469 Petitioners furnished the following explanation of their business and how the checks and receipts submitted related to their business: As to the explaination (sic) of the nature of business: Its location was indeed the Petitioners' home. The insurance was on the vehicle The utilities was (sic) the phone bills used for the phone, and the utilities paid were in lieu of partial rent for the premises. The rent and repairs claimed were for vehicle(s) only, and were not part of maintenance of office space in residence. The depreciation was for a partial year in which an owned vehicle was in use. The remainder of470 the year a new vehicle was rented for the business use. The office in home served multiple purposes. It was there to maintain client files, prepare presentations for potential clients, and for meeting with potential clients and recruit and train potential salespeople. One cannot sell insurance, securities, or health products without these expenses. In Winter v. Commissioner,T.C. Memo. 1983-118 (involving a Florida resident), we stated "In evaluating whether petitioner has carried his burden through the mere submission of numerous receipts, etc., we are cognizant of a governing opinion by the Fifth Circuit 14 in Dowell v. United States,522 F.2d 708">522 F.2d 708 (5th Cir. 1975). Consequently we thoroughly examined the evidence although we believe that we are entitled to hold petitioner responsible for his failure to correlate the evidence and to arrange it in a comprehensible form; we do not perceive it to be our duty to serve as his accountant." See T.C. Memo. 1983-118, 45 T.C.M. (CCH) 897">45 T.C.M. 897, 899, 53 P-H Memo T.C. para. (3, 118). 471 In Dowell v. United States,522 F.2d 708">522 F.2d 708, 714 (5th Cir. 1975), the Fifth Circuit held that the Federal District Court for the Northern District of Texas erred in finding that a "blizzard" of bills, chits, etc., established the amounts, dates and places of the claimed expenditures rather than requiring that the taxpayers substantiate each such expenditure with the specificity required by statute. We have similar circumstances here, although perhaps a light snowfall rather than the blizzard described in Dowell, at least with respect to car and truck expenses and entertainment expenses claimed in the respective amounts of $ 1,259.57 and $ 631.12. Petitioners have submitted approximately 87 cash gas receipts. With the exception of 6-7 undated receipts, most of these were written on credit card slips as gas station/convenience stores from January through November 1983. Some of the receipts indicate travel overnight since they represent gas purchases in Mississippi, Tennessee, Louisiana, Texas, Missouri, Kansas, and Colorado. 15472 Deductibility of overnight travel and entertainment expenses is governed by section 274(d), which disallows deductions for travel and entertainment expenses unless the taxpayer "substantiates by adequate records or by sufficient evidence corroborating his own statement" the amount of the claimed expense, the time and place of the travel or entertainment, the business purpose of the expense and the business relationship of the taxpayer to the persons entertained. These four elements must be established for each separate expenditure. Sec. 1.274-5(c)(1), Income Tax Regs. Respondent argues that all claimed expenses for travel overnight and entertainment cannot be allowed 16 since petitioners have failed to comply with the rigid substantiation requirements of section 274(d). We agree. Petitioners furnished no explanation of the auto overnight travel on the receipts or otherwise. Likewise, the entertainment receipts are inadequate. Some are undated, only one bears the name of either petitioner, and none of the receipts clearly indicated valid business purpose nor state the business relationship to petitioners of the persons entertained as specifically required by section 274(d)(4)(D). 473 Petitioners are no better off with respect to receipts purportedly verifying other claimed expenses of the Schedule C business. In fact, all we know of Mr. Telfeyan's Schedule C business activity, aside from the expenses listed on Schedule C, is the information on the receipts and petitioners' vague statement in their response to the Court's November 9, 1987, order that "One cannot sell insurance, securities, or health products without these expenses." Yet, petitioners would have us accept as adequate substantiation of business automobile expenses a multitude of receipts for gasoline, repairs and insurance, as well as automobile leasing expenses, utilities and telephone expenses without furnishing any information about their business operation or making any attempts to allocate the474 obviously large amount of inherently personal expense in these claimed deductions. As previously stated, petitioners have the burden of proving they are entitled to the deductions claimed. We are not required to accept a taxpayer's uncorroborated argument as proof that disputed expenses are deductible. Archer v. Commissioner,227 F.2d 270">227 F.2d 270, 273 (5th Cir. 1955), affg. a Memorandum Opinion of this Court. Nor do the statements or bare assertions of a taxpayer that his return is correctly filed satisfy his burden of proof. Halle v. Commissioner,7 T.C. 245">7 T.C. 245, 247-248 (1946), affd. 175 F.2d 500">175 F.2d 500, 503 (2d Cir. 1949); Roberts v. Commissioner,62 T.C. 834">62 T.C. 834, 839 (1974). Since most of the gas receipts were issued in the local Orlando area, it is possible that Mr. Telfeyan incurred some business automobile use that was local in nature and not subject to the stringent requirements of section 274(d). However, when taxpayers fail to provide any evidence by which we can determine the allocable business and personal portions of auto usage, no deduction is allowable. 475 Cobb v. Commissioner,77 T.C. 1096">77 T.C. 1096, 1101 (1981). This same rule applies equally to automobile repairs, insurance, depreciation, 17 and auto leasing payments. There is nothing in the record to indicate that the automobile expenses were not incurred for nondeductible commuting and pleasure trips. The telephone bills and canceled checks disclose that most of the claimed utilities/telephone expenses were incurred at a Lakeland, Florida, apartment used by petitioners Louis Telfeyan and Lynn Effer for the early part of 1983. Sometime in April or May, they move to 2701 Red Bug Drive, Casselberry, before acquiring their residence at Bridlebrook Drive, Casselberry. The telephone bills contain numerous long-distance calls to other Florida cities. As with the other expenses, none are allowable. Petitioners have furnished no information correlating476 these calls to business activities nor, assuming some of this expense is business related, have they produced evidence of the respective business and personal portions of these claimed expenses. See Cobb v. Commissioner, supra at 1101. To summarize, petitioners have had the opportunity to furnish to the Court, receipts excluded at trial which petitioners claimed would have shown they were entitled to expenses which generated the large net loss reflected on their tax return. Petitioners furnished many receipts, but only for a portion of the expenses disallowed. However, they failed to present other evidence satisfactorily establishing the business purpose of the receipts submitted. Moreover, assuming some expenses were business-related, petitioners completely failed to provide information necessary to determine the respective business and personal portions of the amounts claimed. Petitioners have consistently resisted furnishing respondent with any information regarding most of the expenses which generated the large business net loss. When given the opportunity to furnish the Court receipts and other information necessary to establish that the receipts were477 business-related, they were unwilling or unable to do so. A party's failure to produce evidence within his control gives rise to the presumption that the evidence, if produced, would be unfavorable. See Wichita Terminal Elevator Co. v. Commissioner,6 T.C. 1158">6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513">162 F.2d 513 (10th Cir. 1947). Petitioners have utterly failed to show that they are entitled to Schedule C expenses in excess of the amount of $ 3,377 allowed by respondent. 5. Additions to Tax Under Sections 6653(a)(1) and 6653(a)(2)Respondent has determined that petitioners' underpayment of tax is due to negligence or the intentional disregard of rules and regulations and has asserted additions to tax under Section 6653(a). It is well established that petitioners bear the burden of proof on this issue. Bixby v. Commissioner,58 T.C. 757">58 T.C. 757, 791-792 (1972). This Court has repeatedly sustained these additions to tax in cases involving purported charitable contributions to "churches" that simply represent the use of funds for personal and family expenses. See 478 Davis v. Commissioner, supra at 820-821. See also Adamson v. Commissioner,T.C. Memo. 1986-489; Riggs v. Commissioner,T.C. Memo. 1986-317; Zollo v. Commissioner,T.C. Memo. 1986-60. Petitioners have failed to present credible evidence on this issue. Nor have they shown that they made a reasonable effort to properly document their other deductions. Accordingly, respondent is sustained. Damages Under Section 6673Section 6673 provides an award for damages to the United States in an amount not in excess of $ 5,000 with respect to all actions commenced after December 31, 1982, when it appears to us that the proceedings have been instituted or maintained by the taxpayer's position in these proceedings is frivolous or groundless. We now consider respondent's motion for damages in the amount of $ 5,000 filed on October 5, 1987. When this case was called for trial, respondent requested that a pre-trial conference be held with respect to the issues to be decided. Petitioners were accompanied by tax preparer Slayback. The Court had its possession a copy of 479 Burwell v. Commissioner,89 T.C. 580">89 T.C. 580 (1987), which had been filed on September 16, 1987 as 89 T.C. No. 41. Petitioners and Slayback were advised that all judges on this Court were familiar with and had tried cases involving the ULC Modesto charitable contributions issue present in the case before the Court, and that, as stated in Burwell, the Court had never allowed ULC Modesto deductions. Petitioners acknowledged receiving a copy of the Burwell case from respondent and that they had read the opinion. Nevertheless, petitioners insisted on trial, claiming that their case was different from the 130 cases mentioned in Burwell that had been decided adversely to taxpayers. The Court advised petitioners that respondent's motion for damages would be given serious consideration should the Court find that the decision in this case with respect to the disputed ULC Modesto contribution issue would be controlled by Burwell and many other cases previously decided. During trial and on brief, petitioners maintained their stubborn position before this Court that a deduction of their personal living expenses made to their ULC Modesto "church" bank480 account was allowable under the tax laws despite the Court's decision in Burwell and many previous ULC Modesto cases. In petitioners' 6-page brief, replete with protester and irrelevant procedural contentions, they argue as follows: The Court then referred to this case as similar to 130 cases. This is no (sic) the case here. The Court said other Churches are recognized, the U.L.C. is not. This is not correct. For the year in question, the U.L.C. is a 170 organization. The Chief, Tax Exempt Division letter submitted to the Court, recognizes that, and further recognizes the Church's privilege of having accounts anywhere that may serve the purposes (sic) of the Church. Petitioners refused to meet with respondent or furnish documentary evidence necessary to the audit of their return; refused to meet or cooperate with respondent with respect to stipulating facts for trial; were advised of, but repeatedly refused to recognize other similar cases involving the nondeductibility of ULC Modesto contributions; and furnished the Court with nothing but repetitious and frivolous arguments which have been repeatedly rejected by this and other courts. We believe the delays and additional481 work resulting to respondent and the Court from petitioners' frivolous position in this matter warrant an award damages to respondent in the amount of $ 2,500. 18Decision will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated. All Rule references are to the Tax Court Rules of Practice and Procedure unless otherwise provided. ↩2. Petitioners conceded by brief unreported income determined in respondent's notice of deficiency in the amount of $ 1,947. ↩3. Our Rule 24, subparagraph (4) of paragraph (1), provides as follows: (4) Counsel Not Admitted to Practice: No entry of appearance by counsel not admitted to practice before this Court will be effective until he shall have been admitted, but he may be recognized as counsel in a pending case to the extent permitted by the Court and then only where it appears that he can and will be promptly admitted. * * Rule 200 (d)↩ provides that written examinations for nonattorney applicants will be held every two years. There is no evidence in this record that Slayback ever presented himself or applied to take the non-attorney's written examination. Accordingly, there is no way that Slayback could be recognized as counsel for petitioners in this case. 4. Compare petitioners' evasive answer to respondent's request for admissions, no. 25: "Mr. Scott Slayback prepared the petition, request for place of trial, and motion for jury trial filed in this case." Petitioners replied "whomever the petitioners ask for aid in their preparation, is of no consequence as to whether they owe taxes as shown on the Notice of Deficiency." ↩5. The total amount disclosed on petitioners' Schedule A-Itemized Deductions was $ 16,409.72 less a carryforward to 1984 of $ 7,145.60, leaving a net amount claimed on the 1983 return of $ 9,264.12. ↩6. A few of the checks were apparently drawn on a Universal Life Church account in the names of Harry and Sheila Effer, Mrs. Telfeyan's parents, as to which petitioners were also signatories. ↩7. The largest such deposit was a check for $ 7,000 which was deposited on October 12, 1983. ↩8. Expenses were erroneously totaled. The correct amount of expenses listed is $ 13,218.19. At trial, respondent's attorney requests of petitioners for verification of the above expenses. Finally, Slayback brought in some documentary data. Based on the evidence submitted, respondent allowed the above expenses marked by asterisk, which total $ 2,5532.01. This amount allowed includes freight of $ 88.95 rather than the amount claimed by petitioners. An Appeals Division officer reviewed the examiner's report and increased the expenses allowed from $ 2,532.01 to $ 3,377. The revised expense allowance was based on a profit rate calculated from Dunn & Bradstreet's Norms and Key Business Ratios. ↩9. Incorrect total due to mathematical error. Correct total is $ 6,742.93. ↩10. Cf. Dunn v. Commissioner,T.C. Memo. 1988-45, a case in which we refused to allow checks and receipts into evidence which were not presented to respondent 15 days before trial. Here, unlike Dunn v. Comminssioner, supra,↩ our pretrial order did not include a provision requiring the parties, before trial, to exchange or stipulate documents intended to be entered into evidence at trial. 11. Petitioners furnished checks for magazine subscriptions to Redbook, Sporting News, Cosmopolitan, etc. Since no explanation was furnished as to what business purpose these magazine purchases served, the expenses are unallowable. ↩12. The Court's order on November 9, 1987, erroneously included this amount as requiring substantiation by check or receipt. It had previously been allowed by respondent's auditor. See footnote 8. ↩13. Although petitioners designated exhibit F as including receipts for interest, they failed to submit receipts for interest expense. ↩14. This case is appealable to the Eleventh Circuit, which in Bonner v. City of Prichard,661 F.2d 1206">661 F.2d 1206, 1209↩ (11th Cir. 1981), adopted as precedent decisions of the former Fifth Circuit Court prior to October 1, 1981. 15. It appears from receipts issued in these states that petitioners traveled to and from Colorado from June 5th-20th, and overnight in that state for approximately 7-8 days. ↩16. Respondent claims that some of the gas receipts are suspect as to authenticity. For example, respondent questions how petitioners can reasonably expect this Court to believe that petitioners could buy gas in Dalhart, N. Texas and High Springs, Florida (northwest of Gainesville) on June 20, 1983, a distance of approximately 1160 miles. See Rand McNally Standard Highway Mileage Guide (1985). ↩17. Petitioners furnished no substantiation of the cost basis, description of or other information of a vehicle alleged to be Accelerated Cost Recover System (ACRS) 3-year property and used for 5/12 of the year. Exhibit B is simply an additional copy of the Form 4562 depreciation schedule attached to their 1983 return. ↩18. We have consistently awarded damages to the government in cases involving the issue of claimed charitable deductions to ULC Modesto. Burwell v. Commissioner,89 T.C. 580">89 T.C. 580, 597-599 (1987). See also Mulvaney v. Commissioner,T.C. Memo. 1988-243; Meade v. Commissioner,T.C. Memo. 1988-108; Webb v. Commissioner,T.C. Memo. 1988-80. We have also awarded damages in cases where the taxpayer asserted a frivolous ULC argument and another argument. See Mulvaney v. Commissioner, supra,↩ and cases there cited.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/1640536/	449 F.Supp. 990 (1978) HORRY COUNTY, a Political Subdivision of the State of South Carolina, Plaintiff, v. UNITED STATES of America, Defendant. Civ. A. No. 77-1685. United States District Court, District of Columbia. May 4, 1978. 991 992 Before WRIGHT, Circuit Judge, and HART and ROBINSON, District Judges. FINDINGS OF FACT AND CONCLUSIONS OF LAW Findings of Fact 1. Plaintiff Horry County is a political subdivision of the State of South Carolina, chartered by the State pursuant to Article VIII, Section 1, of the South Carolina Constitution to exercise the power and authority vested in political subdivisions by Section 4-1-10 of the Code of Laws of South Carolina, 1976, which include the power "to sue and be sued." Complaint, paragraph 1.[1] 2. For many years, including the period from November 1, 1964 through November 2, 1976, Horry County was administered by a Board of Commissioners composed of six members and a chairman. The Board was a non-legislating, non-taxing body which performed limited administrative functions. Complaint, paragraph 5; Defendant's Statement of Additional Facts as to Which There is No Genuine Issue, paragraph 3. 993 3. Prior to November 2, 1976 the six-member Board of Commissioners of Horry County was appointed by the Governor of South Carolina upon the recommendation of the county legislative delegation to the South Carolina General Assembly composed of the Senator and the three members of the House delegation. Section 14-2311 of the former Code of Laws of South Carolina (1962), as amended by Act No. 573 of the 1971 Joint Acts and Resolutions of the State of South Carolina. Complaint, paragraph 5. 4. The commissioners could be removed from office by the Governor upon the written request of a majority of the county legislative delegation. Section 14-2313 of the 1962 Code. Defendant's Statement of Additional Facts, paragraph 2. 5. The chairman of the Board of Commissioners of Horry County was separately elected at large by all citizens of Horry County eligible to vote in such elections pursuant to Section 14-2314 of the former Code of Laws of South Carolina (1962), as amended. Complaint, paragraph 4. 6. Prior to November 2, 1976 the governmental affairs of Horry County were regulated annually to a large extent by the so-called Horry County Supply Bills, acts that provided for operation of the government of Horry County and for levy of taxes to support governmental operations and which appropriated designated amounts of funds for specific county purposes. Defendant's Statement of Additional Facts, paragraph 3. 7. Prior to November 2, 1976 it was a well-known practice of the South Carolina General Assembly to enact local supply bills upon the agreement of the legislative delegation of the county involved. The Horry County legislative delegation performed the legislative, executive, and taxing functions for the county. Public funds in Horry County were disbursed pursuant to letters of authorization to the County Treasurer signed by the Senator and a majority of the members of the House delegation. Defendant's Statement of Additional Facts, paragraph 4. 8. Prior to November 2, 1976 all Horry County employees employed by the Board of Commissioners not involved in construction, repair, and maintenance of roads and bridges could be employed or discharged only with the written consent of the Senator and a majority of the county legislative delegation. Section 14-2318 of the 1962 Code, as amended. Defendant's Statement of Additional Facts, paragraph 5. 9. Prior to November 2, 1976 the chairman of the Horry County Board of Commissioners had direct charge of construction and repair of all roads and bridges in the county, the chain gang, and all road machines and hired help engaged in such work, subject to the general direction and authority of the Board. He had authority to employ and discharge any employee working on construction, repair, and maintenance of roads and bridges in the county, subject to approval of a majority of the Board. The chairman appointed all road overseers. Section 14-2318, as amended by 1964(53)2202, of 1962 Code. Defendant's Statement of Additional Facts, paragraph 6. 10. On May 13, 1975 the Circuit Court of South Carolina, Fifteenth Judicial Circuit, held in Booth v. Grisson that the form of government described in Findings 2 through 9 supra was in violation of the Constitution of South Carolina. 11. Home rule legislation was adopted in 1972, amending Article VIII of the South Carolina Constitution. As amended Article VIII provides in Section 7 that the General Assembly "shall provide by general law for the structure, organization, powers, duties, functions, and the responsibilities of counties * . Alternative forms of government, not to exceed five, shall be established." Complaint, paragraph 6. 12. Pursuant to Article VIII of the South Carolina Constitution, the General Assembly of South Carolina enacted Sections 14-3701 et seq. of the South Carolina Code of Laws, 1962, recodified as Sections 4-9-10 et seq. of the Code of Laws of South Carolina, 1976, providing for five alternative 994 forms of elected county government. The General Assembly therein provided that "[e]ach county * * * may prior to July 1, 1976, conduct a referendum to determine the wishes of the qualified voters as to the form of government to be selected * * ." Complaint, paragraph 7. 13. On August 26, 1975 Horry County conducted a referendum to determine the form of government that should be established within the county and to determine the manner in which the members of the governing body of the county should be elected. Complaint, paragraph 8. 14. The voters in the referendum voted to adopt the council-administrator form of government for Horry County, with a council of eight members and a chairman, and to adopt the at large method of electing the members and chairman of the County Council. Complaint, paragraph 8. 15. The results of the Horry County referendum were reported to the General Assembly of the State of South Carolina, which thereupon enacted Act R546 of the 1976 General and Permanent Laws, ratifying the Horry County council-administrator form of government. Act R546 subsequently became law without the signature of the Governor of the State, pursuant to operation of state law. 16. Act R546 established the number of members, terms of office, and manner of electing the County Council of Horry County under the council-administrator form of government, and provided for at large election of the eight members and the separately elected chairman for terms of two years. Complaint, Exhibit 1. 17. Act R546 implemented home rule in Horry County by establishing the Horry County Council to conduct the taxation, legislative, and administrative affairs of Horry County that were formerly performed by the county's delegation to the South Carolina General Assembly, elected officials. Section 4-9-30, Code of Laws of South Carolina, 1976; Complaint, Exhibit 1. 18. Under the council-administrator form of government implemented by Act R546 the administrative functions formerly performed by the chairman of the County Board of Commissioners are performed by the administrator employed by the Council. Section 4-9-630. The separately elected chairman of the Council is assigned no powers or authority different from those of other Council members except that he may call special meetings on 24 hours notice. Section 4-9-110, Code of Laws of South Carolina, 1976. Defendant's Statement of Additional Facts, paragraph 7. 19. The office of chairman of the former Horry County Board of Commissioners ceased to exist with implementation of Act R546 and the office of chairman of the Horry County Council established by the Act is a distinctly different, new elective office. Defendant's Statement of Additional Facts, paragraph 7. 20. Each member of the House delegation was elected from a different electoral district within Horry County, as provided in Code of Laws of South Carolina, § 2-1-10. 21. Act R546 was submitted to the Attorney General for consideration under Section 5 of the Voting Rights Act and received on March 16, 1976. On May 17, 1976 the Attorney General requested additional information which was received on July 8, 1976. The information necessary to make the submission complete was received by the Attorney General on September 13, 1976. On November 12, 1976, within 60 days of completion of the Act R546 submission, the Attorney General interposed his objection to that Act pursuant to Section 5. Complaint, Exhibit 4 and paragraphs 10, 11, and 12; Defendant's Statement of Additional Facts, paragraph 10. 22. In response to this objection, on behalf of the Attorney General of the State of South Carolina Assistant Attorney General Treva G. Ashworth, in a letter dated November 19, 1976, requested that the Attorney General reconsider his decision to object to Act R546 and further requested that the County Attorney for Horry County have an opportunity to meet with representatives of the Justice Department to discuss additional information to be submitted concerning 995 Act R546. Complaint, Exhibit 3 and paragraph 13. 23. In a letter dated January 24, 1977 then Assistant Attorney General J. Stanley Pottinger informed the State that, after further review, "we have not found a basis for withdrawal of the Attorney General's objection. Therefore, on behalf of the Attorney General, I must decline to withdraw the objection." Complaint, paragraph 14 and Exhibit 4. 24. On November 2, 1976 eight members of the Horry County Council were elected in a general election, together with a chairman of the Council, from the county at large, in accordance with Act R546. Complaint, paragraph 14. Conclusions of Law 1. The State of South Carolina is subject to the special provisions of the Voting Rights Act of 1965. 30 Fed.Reg. 9897; South Carolina v. Katzenbach, 383 U.S. 301, 318, 86 S.Ct. 803, 15 L.Ed.2d 769 (1965). 2. In enacting the Voting Rights Act of 1965 Congress intended that "any state enactment which altered the election law of a covered state in even a minor way" would be subject to the pre-clearance requirements of Section 5 of the Act, 42 U.S.C. § 1973c. Allen v. State Board of Elections, 393 U.S. 544, 566, 89 S.Ct. 817, 832, 22 L.Ed.2d 1 (1969); Perkins v. Matthews, 400 U.S. 379, 387, 91 S.Ct. 431, 27 L.Ed.2d 476 (1971); United States v. Board of Comm'rs of Sheffield, ___ U.S. ___, ___, 98 S.Ct. 965, 974-975, 55 L.Ed.2d 148 (1978). 3. Congress intended to subject all such legislation which affects voting in even a minor way to federal scrutiny "because the change [has] the potential to deny or dilute the rights conferred by § 4(a)" of the Act. United States v. Board of Comm'rs of Sheffield, supra, ___ U.S. at ___, 98 S.Ct. at 975. See also City of Richmond v. United States, 422 U.S. 358, 95 S.Ct. 2296, 45 L.Ed.2d 245 (1975); Beer v. United States, 425 U.S. 130, 140-141, 96 S.Ct. 1357, 47 L.Ed.2d 629 (1976). 4. State enactments which require that a governing body which was formerly appointed would in the future be elected constitute a new voting standard, practice, and procedure within the state and if such new standard, practice, and procedure were not in force or effect as of November 1, 1964, such new standard, practice, and procedure is subject to the pre-clearance requirements of Section 5. Allen v. State Board of Elections, supra; United States v. Board of Comm'rs of Sheffield, supra; Perkins v. Matthews, supra; City of Richmond v. United States, supra. 5. Plaintiff would have this court draw a legal distinction between state enactments which change a present method of electing public officials and enactments which result in electing public officials who were formerly appointed. However, both types of enactments "have the potential to deny or dilute the rights conferred by § 4(a)" of the Voting Rights Act and thus both types of enactments must be subjected to the federal scrutiny set out in Section 5. United States v. Board of Comm'rs of Sheffield, supra, ___ U.S. at ___, 98 S.Ct. at 975; Beer v. United States, supra. 6. An alternate reason for subjecting the new method of selecting the Horry County governing body to Section 5 preclearance is that the change involved reallocates governmental powers among elected officials voted upon by different constituencies. Such changes necessarily affect the voting rights of the citizens of Horry County, and must be subjected to Section 5 requirements. Cf. Perkins v. Matthews, supra; Allen v. State Board of Elections, supra. 7. The duties of the chairman of the former Horry County Board of Commissioners and those of the chairman of the Horry County Council under Act R546 are sufficiently different that in this respect also Act R546 constitutes a change in electoral practices requiring pre-clearance under Section 5 of the Voting Rights Actunlike the two at large council seats in Beer v. United States, supra, 425 U.S. at 139, 96 996 S.Ct. 1357, which underwent no change at all. 8. Act R546 of the General and Permanent Laws of the State of South Carolina established voting qualifications or prerequisites to voting, or standards, practices, or procedures with respect to voting, different from those in force or effect in Horry County, South Carolina on November 1, 1964 with respect to election of the members of the Horry County Council and its separately elected chairman. 9. Act R546 is subject to the pre-clearance requirements of Section 5 of the Voting Rights Act of 1965, as amended, 42 U.S.C. § 1973c. An order consistent with the foregoing Findings of Fact and Conclusions of Law has been entered today. ORDER On consideration of the plaintiff's motion for summary judgment, the memoranda and affidavits submitted in support thereof and in opposition thereto, and the oral argument on the motion, and In accordance with the findings of fact and conclusions of law filed this day, it is ORDERED by the court that the plaintiff's motion for summary judgment is hereby denied, and it is FURTHER ORDERED by the court, sua sponte, that partial summary judgment is hereby granted to the defendant, to the extent that the court hereby declares that Act R546 of the 1976 General and Permanent Laws of the State of South Carolina is subject to the preclearance requirements of Section 5 of the Voting Rights Act of 1965, as amended 42 U.S.C. § 1973c. MEMORANDUM AND ORDER ON PLAINTIFF'S APPLICATION FOR INTERIM DECLARATION OF RIGHTS On January 26, 1978 plaintiff Horry County filed an "application for interim declaration of rights" requesting a declaration that it was entitled to hold 1978 primary and general elections for County Council under Act R546 of the 1976 General and Permanent Laws of the State of South Carolina, although that Act has not yet been cleared under Section 5 of the Voting Rights Act. On April 5, 1978 Horry County filed a suggestion that the application for interim relief had become moot. We conclude that the application for interim relief is not moot and that it should be denied on its merits. On March 21, 1978 the three-judge District Court in the District of South Carolina which had heard McCray v. Hucks, Civil Action No. 76-2476, entered an order[1] allowing the 1978 elections, notwithstanding the Voting Rights Act, "subject to any contrary or modifying order that may be entered by any court in the District of Columbia Circuit having jurisdiction." We are troubled by this order because it was entered ex parte in an action which appears to have been dismissed on January 9, 1978 after having been abandoned by its plaintiffs several months earlier. But in any event, the South Carolina court's explicit recognition of our power to enter a superseding order prevents the issue from becoming moot in this court. We have determined to enter an order enjoining the 1978 primary and general elections for Horry County Council pending final judgment in this case. Section 5 of the Voting Rights Act states plainly that an enactment subject to its provisions may not be enforced unless and until either this court or the Attorney General gives preclearance. The Supreme Court has recognized the equitable power of the District Courts to permit enforcement of such statutes pendente lite notwithstanding Section 5. Georgia v. United States, 411 U.S. 526, 541, 93 S.Ct. 1702, 36 L.Ed.2d 472 (1973); Perkins v. Matthews, 400 U.S. 379, 396-397, 91 S.Ct. 431, 27 L.Ed.2d 476 (1971). 997 But it has also made clear the equitable discretion of the courts not to permit use of electoral statutes not yet pre-cleared. In Georgia v. United States, supra, a three-judge District Court enjoined state legislative elections under a reapportionment plan which had not obtained pre-clearance. The Supreme Court granted a stay to allow the holding of one election under the challenged reapportionment plan. On the merits the Supreme Court then affirmed the injunction, validating the one election which had been held, but making clear that no new elections could be held until a reapportionment plan received pre-clearance under Section 5. See also Moore v. Leflore County Board of Election Comm'rs, 351 F.Supp. 848 (N.D. Miss. 1971) (three-judge court). We do likewise. The council presently in office was elected in 1976 under Act R546, which we today hold is subject to Section 5 pre-clearance but has not yet received it. We agree with the Department of Justice that in the circumstances the lesser evil is to allow the council members elected in 1976 to hold over beyond the scheduled end of their terms, if necessary, rather than allow a second election to be held under Act R546, a statute to which the Attorney General has refused pre-clearance. The intent of Section 5 is clear: black voters are not to be made to wait through election after election under untested and potentially discriminatory laws. That intent would be best served here by enjoining the holding of the 1978 primary and general elections.[2] Therefore, on consideration of plaintiff's application for interim declaration of rights, the opposition thereto, and the suggestion of mootness, it is ORDERED by the court that plaintiff and all its agents and employees, and all persons acting in concert therewith or under its direction, are enjoined from conducting the scheduled 1978 primary and general elections for Horry County Council pending termination of this action or further order of this court. The present members of the County Council shall continue in office, notwithstanding the expiration of their elected terms, until such a time as their successors have been lawfully elected. Vacancies in the membership of the Council due to death, resignation, or other causes may be filled in the manner prescribed under Act R546. NOTES [1] References to the Complaint are to those allegations which have been admitted in the Answer of the United States. [1] This order is not to be confused with the prior order of the same court dated March 22, 1977. See note 2 infra. [2] We emphasize that the choice we face is considerably different from that faced by the three-judge District Court in South Carolina in its order of March 22, 1977. The only options open to it were the council elected in 1976 under Act R546 and the indirectly-elected form of government which had been held unconstitutional in 1975. It understandably chose the council elected under Act R546, notwithstanding the Voting Rights Act. On the other hand, by enjoining the 1978 elections we permit continuation in office of a body which, whatever else may be said of it, was directly elected by popular vote and whose constitutionality has not, to our knowledge, been challenged.	01-04-2023	10-30-2013
https://www.courtlistener.com/api/rest/v3/opinions/4621281/	APPEAL OF W. F. SEVERA CO.W. F. Severa Co. v. CommissionerDocket No. 1702.United States Board of Tax Appeals3 B.T.A. 664; 1926 BTA LEXIS 2590; February 11, 1926, Decided Submitted October 20, 1925. 2590 Evidence held insufficient to establish value of good will. Additional salaries disallowed. W. T. Frame, Esq., and P. L. Billings, E. G. Prouty, and I. B. McGladrey, C.P.A.'s, for the taxpayer. Ward Loveless, Esq., for the Commissioner. GRAUPNER 664 Before GRAUPNER, TRAMMELL, and PHILLIPS. This is an appeal from the determination of a deficiency in income and profits taxes in the amount of $13,021.06 for the calendar year 1918. It is alleged that the Commissioner erred: (1) in refusing to allow claimed additional salaries amounting to $12,000; (2) in adjusting taxpayer's opening inventory for the year; and (3) in refusing to permit the inclusion in invested capital of an amount claimed to represent the purchase price of good will. In the petition the taxpayer also claimed the right to assessment under sections 327 and 328 of the Revenue Act of 1918, but it withdrew this claim. FINDINGS OF FACT. The taxpayer is an Iowa corporation, with its principal office at Cedar Rapids, and is engaged in the manufacture of proprietary medicines. 665 Upon its organization in 1903, the taxpayer purchased the business which2591 W. F. Severa had operated as an individual since 1880, issuing in exchange therefor its capital stock in the amount of $50,000. The assets taken over by the corporation, exclusive of the good will here claimed, amounted to approximately $41,000. Good will was not shown on the books of Severa, nor has it ever been recorded on the taxpayer's books. About 1908 earnings of the taxpayer were added to its original investment, as shown on its books, which were continued in the same manner as they had been kept by Severa, and by this means its capital was brought up to the amount of $50,000. The taxpayer has always been a close corporation, its stock being held by W. F. Severa and members of his family and by J. H. Vosmek. In 1918 the directors drew the following salaries: W. F. Severa, president$6,000Lumir Severa, vice president and treasurer3,000J. H. Vosmek, secretary3,000Lumir Severa was in the military service in 1918 and, with the exception of a part of the month of December, was absent from the taxpayer's place of business during the entire year. He was advised by correspondence concerning the business of the taxpayer, and at times he gave his opinions2592 and suggestions in regard to the taxpayer's affairs. The president and secretary, at an informal meeting held in the summer of 1918, expressed the belief that the salaries then being paid by the taxpayer to its directors, who were also its managing officers, were not in keeping with the salaries paid by other firms, doing a similar kind and amount of business, to their officers. There was no record made of this meeting in the corporate minute book. No definite decision was reached at that time as to any changes to be made in salaries, but the secretary thereafter, in November or December, 1918, inquired of the president of the Proprietary Association as to the salaries paid by other firms. This association is an organization of about 250 of the largest manufacturers of proprietary medicines in the United States. The president of the association informed Vosmek that they had no information on the subject which he was at liberty to reveal, but that the association was then preparing to secure such information in some form that could be made available to members, and that, upon being acquired, it would be furnished the taxpayer. The taxpayer closed its books on December 31, 1918, without2593 making provision thereon for any additional salaries. Sometime after 1918, but prior to March 14, 1919, the taxpayer received from the Proprietary Association compilations showing average salaries paid by other manufacturers of proprietary medicines 666 to their principal officers, arranged according to the volume of business transacted and the amount of stock owned by the officers. Upon receipt of this information by the taxpayer, a meeting of the board of directors was held, at which it was decided that, as fair salaries for the year 1918, W. F. Severa was entitled to $12,000 and Lumir Severa and J. H. Vosmek to $6,000 each. On and under date of March 14, 1919, an entry was made in the taxpayer's ledger charging surplus with $12,000, with the notation "correction in salaries of officers compared with corporations in like business and same volume of business which pay to their officers." The same amount, $12,000, was credited to back salaries in a column dated December 31, 1918. Prior to 1918 it had been the custom of the taxpayer to inventory its manufactured package goods by reducing the selling price by an arbitrary percentage. The opening and closing inventories2594 of package goods for 1918 were taken by this method, but a closing inventory was also taken on the basis of cost. In filing its income-tax return for 1918 the taxpayer reported as the opening inventory the arbitrary figure based on selling price, and as the closing inventory reported the cost figure. It later revised its opening inventory for that year to a cost basis, which was $9,727.60. The Commissioner, as a result of a revenue agent's investigation, reduced the opening inventory to $9,145.25, by application of an arbitrary percentage. DECISION. The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 15 days' notice, under Rule 50. OPINION. GRAUPNER: The taxpayer contends that it should be permitted to include in invested capital as good will the amount of $9,088.90, representing the difference between the value of tangible assets taken over upon organization and the par value of the capital stock issued in exchange for the business. The only evidence directed toward establishing the value of good will was testimony that W. F. Severa had conducted the business since 1880; that the volume of business for2595 1901 was about $71,000, and for 1902, $78,000; and that the annual profits of the business ran between $12,000 and $15,000. The minutes of the meeting of stockholders of the taxpayer on July 1, 1903, state that the meeting was held to elect officers and "to assume all stocks, moneys and credits, good will and liabilities" of 667 the business of W. F. Severa. The good will claimed to have been acquired at that time was not entered on the taxpayer's books, nor has it ever been entered. So far as the record shows, no effort was made by the incorporators to determine the value of the good will upon any sound basis; they merely assumed that the par value of stock in excess of the ammount determined upon as the value of tangibles acquired must have been issued for good will. This is not sufficient to establish value for invested capital purposes. . The principal question for determination on the claim for additional salaries of $12,000 is whether any liability for payment of this amount was incurred by the taxpayer in 1918. The substance of the testimony of the taxpayer's witnesses was that a directors' meeting2596 was held some time in 1918, at which time the question arose whether the officers were drawing proper salaries, and it was agreed that the salaries were to be increased if information could be obtained showing that other firms doing a similar business, in kind and volume, were paying their officers higher salaries than the taxpayer. Certainly such an agreement could not bind the corporation to pay additional salaries. The fallacy of the taxpayer's argument on this question is shown by the testimony of the principal witness, which is to the effect that if it had been learned that other firms were paying no higher salaries than the taxpayer, then the salaries of the taxpayer's officers would not have been increased. The books were closed for 1918 with no entry relating to additional salaries, and it was not until March 14, 1919, that the increase was finally agreed upon and entered and charged to surplus. On the evidence, we must approve the action of the Commissioner in disallowing for 1918 the additional salaries claimed. ; 2597 ; . The method adopted by the taxpayer in valuing its inventories is set forth in the findings of fact. Upon making an investigation of the taxpayer's records, the Commissioner attempted to bring the opening inventory for 1918 down to cost, which was the basis upon which the taxpayer reported its closing inventory for that year. He accordingly reduced the opening inventory to $9,145.25, which increased the income for that year by $3,048.42. The correct amount of the opening inventory on the basis of cost was $9,727.60. This results in a difference of $582.35, and the income of the taxpayer for 1918, as determined by the Commissioner, should be decreased by this amount.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621283/	LUCKY STORES, INC., AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentLucky Stores v. CommissionerDocket No. 4446-93.United States Tax Court105 T.C. 420; 1995 U.S. Tax Ct. LEXIS 65; 105 T.C. No. 28; December 19, 1995, Filed 65 An appropriate order will be issued directing entry of decision under Rule 155 upon completion of proceedings resolving the remaining issue in this case, and sustaining respondent's hearsay objection. P made donations of its surplus bread inventory to food banks which qualified as permissible charitable donees under sec. 170(e)(3)(A), I.R.C., and claimed charitable contribution deductions based upon full retail prices for the bread. R determined the fair market value to be approximately 50 percent of full retail prices. Held, fair market value of P's bread contributions redetermined. Eric W. Jorgensen, Grady M. Bolding, and Russell D. Uzes, for petitioner. Alan Summers and Kevin G. Croke, for respondent. NIMS, Judge NIMS420 NIMS, Judge: Respondent determined the following deficiencies in petitioner's Federal income tax: Taxable Year Ending (TYE)DeficiencyJan. 30, 1983$ 8,797,328Feb. 3, 19852,175,135Feb. 2, 198648,255,017421 Unless otherwise indicated, all section references are to sections of the Internal Revenue Code in effect for the years at issue, and all Rule references are to Tax Court Rules of Practice and Procedure. This case involves a number of 66 issues that are being handled in proceedings that are separate from the one under present consideration. In this proceeding, the parties dispute the fair market value of bakery products, unsold canned goods, and other general merchandise contributed to food banks by petitioner during the years in issue. On its Federal income tax returns for TYE February 3, 1985 and TYE February 2, 1986, the charitable contribution years in issue, petitioner claimed deductions for the above charitable contributions in the amounts of $ 576,258 and $ 909,055, respectively. The parties agree that the cost basis of the contributed bakery inventory for purposes of section 170(e)(3)(B) was $ 1,753,495 for TYE February 3, 1985, and $ 3,471,236 for TYE February 2, 1986. For the taxable years in issue, petitioner concedes the portions of its claimed deductions relating to its contribution of unsold canned goods and other general merchandise. The amount of petitioner's charitable deduction that relates to unsold canned goods and other general merchandise is $ 85,040 for TYE February 3, 1985 and $ 198,286 for TYE February 2, 1986. For TYE February 3, 1985, petitioner concedes the charitable deduction amount67 of $ 91,624 relating to its contributions from its stores in Florida. After these concessions, the only contributions at issue are the 4-day-old bread and other "aged" bakery goods from petitioner's California and Nevada stores. At the trial, the parties focused almost entirely on the 4-day-old bread, so we proceed upon the assumptions that the dollar amounts of the donations of other bakery products were relatively insignificant, and that our conclusion as to the value of the 4-day-old bread will establish the method for valuing these items. The parties also appear to agree that (1) after petitioner's concession of the portions of its claimed deductions for the Florida donations and the donations of canned goods and other general merchandise, (2) after adjusting the cost basis for the remaining contributed bakery inventory, and (3) after the reduction required under section 170(e)(3)(B), the 422 amounts of charitable deductions in dispute are $ 663,855 for TYE February 3, 1985 and $ 1,300,558 for TYE February 2, 1986, based on the retail price of the contributed bakery inventory at the time of contribution. Petitioner is a Delaware corporation. At the time it filed its petition, its68 principal place of business was Dublin, California. FINDINGS OF FACT Some of the facts have been stipulated. During the years in issue, petitioner operated bakeries in northern and southern California that baked several varieties of white and wheat bread, muffins and buns, and other bakery products. Petitioner sold these private label products in its retail stores under the "Harvest Day" label. In addition, petitioner's bakeries purchased from unrelated bakeries other bakery products, including tortillas, fried pies, doughnuts, and dinner, gourmet, and brown and serve rolls, and other items, for sale in its stores. Commercial bakers generally use one of three processes for preparing commercially baked bread: the sponge dough method, the liquid sponge method and the liquid brew method. These methods differ significantly in terms of ingredients and baking times. The method used affects the aroma, keeping quality, and texture of the bread. Petitioner used the sponge dough method during the tax years at issue. The sponge dough method is the most time-consuming baking process of the three general methods. Petitioner's baking process resulted in a high quality bread, with good aroma, 69 keeping quality, and texture. Petitioner used no preservatives or inhibitors in the manufacture of this bread. During the years in issue, petitioner closed its bread bags with a flat plastic disc called a "Kwik Lok." Petitioner date stamped each Kwik Lok with a date that was 4 days after the bakery delivered the bread to a specific store. For example, petitioner date stamped the Kwik Loks for bread delivered to a store on September 16, 1985 (a Monday) with the date "Sep 20" (a Friday). The date was stamped on the Kwik Lok in very small print. The Kwik Lok contained no other words, such as "sell by," "fresh through," or the like. 423 Petitioner delivered to its stores each morning, except on Wednesdays and Sundays, bread and other bakery products that had been baked either earlier the same morning or after 6 p.m. the previous day. Bakery products that had been acquired by petitioner's bakeries were also delivered at the same time. Each of petitioner's stores determined its need for delivery of fresh bread on a daily basis, based on amounts of bread on hand and anticipated sales. Each store transmitted its daily order to the bakery, which then adjusted its production to accommodate store70 orders. Petitioner's goal was to supply each store with 5 percent more bread on hand than was actually expected to be sold. In fact, store orders exceeding actual sales were in the 6 percent range during the years in issue. Petitioner's in-store employees placed the newly delivered bread either on the store shelves or in the stock room. If the bread were placed in the stock room, petitioner's employees later placed it on the shelves. Petitioner's bread shelves are generally 20 inches deep. In the front part of the shelf, a store's merchandisers typically stacked loaves of bread two-high, with the label, or "gusset," end facing out, and the date coded Kwik Lok facing in. In the back part of the shelf the loaves were also stacked two-high, but in this case the loaves were stacked parallel with the customer aisle. The older bread would be placed on the top layer; the newer bread on the bottom or in the back. Thus, the customer would have access to the oldest bread first, unless he/she deliberately "dug through" and "read the codes" to find the newest bread. A customer could buy a loaf of petitioner's bread on the third or fourth day after delivery, take it home, put it in a bread box71 or leave it on the counter for a week to 10 days, and still have a good, edible product. The customer could further extend the life of the bread by freezing it. Bread that sits on the store shelf for 5 days does not lose nutritional value or taste, but does lose moisture, so the bread firms up a little bit, losing some "squeezeability." During the years at issue, petitioner did not offer age-related discounts on its bread or other bakery products. Petitioner regularly sold 4-day-old bread at full retail price on Sundays during the years in issue. In addition, individual stores sometimes sold 4-day-old bread on other days of the week. This would happen if a store found itself with an oversupply 424 of bread inventory, in which case the store would cut off its order for new bread, and sell the 4-day-old bread instead. On the five bread delivery days (Monday, Tuesday, Thursday, Friday, and Saturday) petitioner's policy was to remove any unsold bread on the fourth day after delivery. For example, bread that was delivered on the morning of Monday, September 16, 1985 (and date stamped "Sep 20", a Friday) if unsold, would be removed on the morning of Thursday, September 19, 1985, before the72 Thursday bread delivery. As to petitioner's Southern California stores, pick-up vehicles from charitable organizations went to each store and picked up the unsold bread and other bakery products on the same day the unsold bread and other bakery products were removed from the shelves. As to petitioner's Northern California stores, petitioner's delivery drivers loaded the removed bread and other bakery products into the delivery trucks and returned them to petitioner's San Leandro bakery. Pick-up vehicles from charitable organizations then picked up the unsold bread and other bakery products at the bakery that same day. Petitioner incurred significant additional labor costs as a result of its charitable food donation program (i.e., the labor necessary to return the 4-day-old bread to the bakery). The following chart is based upon petitioner's self-baked bread rotation schedule for the Northern California stores during the years at issue. LUCKY STORESBREAD SCHEDULEPRODUCT INFORMATIONDELIVERY, PICKUP, DONATION INFORMATIONBREADKWIK LOKLAST SALEBREADREMOVEDREMOVEDBAKED BETWEENCOLORDAY PERDELIVEREDBREADBREADKWIK LOKTO STORESPICKEDPICKED UPDATEUP FROMBYSTORESCHARITABLEORGANIZATIONS6:00 pm SaturdayBrownFridayBy 9:00 amBy 9:00 amBy 2:00 pmto 5:00 pm SundayMondayThursdayThursday6:00 pm SundayPinkSaturdayBy 9:00 amBy 9:00 amBy 2:00 pmto 5:00 pm MondayTuesdayFridayFriday6:00 pm TuesdayWhiteMondayBy 9:00 amBy 9:00 amBy 2:00 pmto 5:00 pmThursdayMondayMondayWednesday6:00 pm WednesdayWhiteTuesdayBy 9:00 amBy 9:00 amBy 2:00 pmto 5:00 pmFridayMondayMondayThursday6:00 pm ThursdayGreenWednesdayBy 9:00 amBy 9:00 amBy 2:00 pmto 5:00 pm FridaySaturdayTuesdayTuesday73 425 As the chart reveals, white Kwik Loks were used for both Thursday and Friday deliveries. Each of the other three delivery days had its own Kwik Lok color. Petitioner's Southern California stores generally adhered to the same schedule as the Northern California stores, except that petitioner's Southern California stores used different colored Kwik Loks and the charitable organizations picked up the bread at the Southern California stores rather than at the bakery. More than 75 percent of the donated bread products consisted of 4-day-old bread, and the remaining percentage consisted of tortillas, fried pies, doughnuts, bagels, brown and serve rolls and English muffins. Petitioner began its policy of donating unsold 4-day-old bread and claiming a deduction based on its full retail price in 1983. Prior to 1983, petitioner removed, or "pulled," bread from its shelves two days a week--Mondays and Thursdays. Prior to 1983, petitioner offered its pulled bread for sale, which included three, 4- and 5-day-old bread (depending on the pull day), on discount racks. Bread that did not sell after being on the discount rack for 24 hours was either destroyed or donated. Under petitioner's pre-198374 policy the pulled bread was discounted approximately 50 percent, for one day only, before it was discarded or donated. Regional and national bakers, such as Continental (Orowheat), Kilpatrick's, and Campbell-Taggertt (Wonder Bread), which have a substantial share of the California pan bread market, sell their pan bread, after that bread is pulled from the retail selling shelves of supermarkets and other retailers, at thrift or bakery outlets at discounts ranging from 20 to 70 percent. Petitioner's donations of bakery products to charitable organizations were "qualified contributions" of inventory 426 under section 170(e)(3)(A) and section 1.170A-4A(b), Income Tax Regs. The retail price of the contributed bakery inventory for purposes of section 170(e)(3)(B) was $ 3,081,204 for TYE February 3, 1985, and $ 6,072,353 for TYE February 2, 1986. OPINION Neither party has brought to our attention any prior case involving the application of section 170(e)(1) and (3) to charitable contributions of rapidly perishable inventory, and we know of none. However, Rev. Rul. 85-8, 1 C.B. 59">1985-1 C.B. 59 deals with the application of section 170(e)(3) to charitable 75 contributions of dated products, and is discussed infra. The relevant provisions of section 170(e), in effect for the years in issue, are as follows: (e) Certain Contributions of Ordinary Income and Capital Gain Property.-- (1) General Rule.--The amount of any charitable contribution of property otherwise taken into account under this section shall be reduced by the sum of (A) the amount of gain which would not have been long-term capital gain if the property contributed had been sold by the taxpayer at its fair market value (determined at the time of such contribution), and * * * (3) Special Rule for Certain Contributions of Inventory and Other Property.-- (A) Qualified Contributions.--For purposes of this paragraph, a qualified contribution shall mean a charitable contribution of property described in paragraph (1) or (2) of section 1221, by a corporation (other than a corporation which is an S corporation) to an organization which is described in section 501(c)(3) and is exempt under section 501(a) (other than a private foundation, as defined in section 509(a), which is not an operating foundation, as defined in section 4942(j)(3)), but only if-- (i) the use76 of the property by the donee is related to the purpose or function constituting the basis for its exemption under section 501 and the property is to be used by the donee solely for the care of the ill, the needy, or infants; (ii) the property is not transferred by the donee in exchange for money, other property, or services; (iii) the taxpayer receives from the donee a written statement representing that its use and disposition of the property will be in accordance with the provisions of clauses (i) and (ii); and (iv) in the case where the property is subject to regulation under the Federal Food, Drug, and Cosmetic Act, as amended, such property 427 must fully satisfy the applicable requirements of such Act and regulations promulgated thereunder on the date of transfer and for one hundred and eighty days prior thereto.(B) Amount of Reduction.--The reduction under paragraph (1)(A) for any qualified contribution (as defined in subparagraph (A)) shall be no greater than the sum of-- (i) one-half of the amount computed under paragraph (1)(A) (computed without regard to this paragraph), and (ii) the amount (if any) by which the charitable contribution deduction under this section77 for any qualified contribution (computed by taking into account the amount determined in clause (i), but without regard to this clause) exceeds twice the basis of such property.Thus, section 170(e)(1) limits the deduction for charitable contributions of ordinary income property to the basis of the property. However, section 170(e)(3) allows a limited deduction in excess of basis for charitable contributions of inventory and other property to qualified donees. (As previously stated, we have found (based upon the parties' stipulation) that petitioner's contributions were qualified contributions under section 170(e)(3)(A)). If the inventory contributed to qualified donees has appreciated in value, the reduction of the deduction otherwise required under section 170(e)(1) is limited to one-half of the ordinary income that would be recognized on a sale of the property for its fair market value, except that the deduction may not exceed twice the taxpayer's adjusted basis for the property. See Bittker & Lokken, Federal Taxation of Income, Estates and Gifts, par. 35.2.2., at 35-25 (2d ed. 1990). Section 170(e)(3) was added to the Internal Revenue Code by section 2135(a) of the Tax 78 Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1520, 1928. The committee report notes that under prior law (section 170(e) before amendment) the donor of appreciated ordinary income property (property the sale of which would not give rise to long-term capital gain) could deduct only his/her basis in the property rather than its full fair market value. The purpose of section 170(e) as originally enacted in 1969 was to prevent high-bracket taxpayers from donating substantially appreciated ordinary income property to charities so as to be better off after tax than if they had simply sold the property. Staff of Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1976, at 672 (J. Comm. Print 1976), 3 C.B. 1">1976-3 C.B. 1, 684. 428 The conference report goes on to explain the reasons for the change: The rule that the donor of appreciated ordinary income property could deduct only his basis in the property effectively eliminated the abuses which led to its enactment; however, at the same time, it has resulted in reduced contributions of certain types of property to charitable institutions. In particular, those charitable organizations that provide food, 79 clothing, medical equipment, and supplies, etc., to the needy and disaster victims have found that contributions of such items to those organizations were reduced. Congress believed that it was desirable to provide a greater tax incentive than in prior law for contributions of certain types of ordinary income property which the donee charity uses in the performance of its exempt purposes. However, Congress believed that the deduction allowed should not be such that the donor could be in a better after-tax situation by donating the property than by selling it. [Id., 1976-3 C.B. at 684-685.]The Committee Report thus reflects Congressional intent to allow a modified deduction, in limited situations, consisting of the taxpayer's basis plus a fraction of the unrealized ordinary income inherent in the donated property, but subject to an overall limitation of twice adjusted basis. Section 1.170A-1(c), Income Tax Regs., deals with the valuation of a charitable contribution in property. Section 1.170A-1(c)(2) and (3) provide: (2) The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, 80 neither being under any compulsion to buy or sell and both having a reasonable knowledge of relevant facts. If the contribution is made in property of a type which the taxpayer sells in the course of his business, the fair market value is the price which the taxpayer would have received if he had sold the contributed property in the usual market in which he customarily sells, at the time and place of the contribution and, in the case of a contribution of goods in quantity, in the quantity contributed. The usual market of a manufacturer or other producer consists of the wholesalers or other distributors to or through whom he customarily sells, but if he sells only at retail the usual market consists of his retail customers. (3) If a donor makes a charitable contribution of property, such as stock in trade, at a time when he could not reasonably have been expected to realize its usual selling price, the value of the gift is not the usual selling price but is the amount for which the quantity of property contributed would have been sold by the donor at the time of the contribution.In the case before us, petitioner argues that it could have sold to its regular customers at full 81 retail prices the same 429 quantity of bread that it donated to food banks. Respondent argues that the donated bread was surplus inventory that petitioner could have sold only at a 50-percent discount, which would have brought the selling price below petitioner's adjusted basis. Section 1.170A-1(c)(2), Income Tax Regs., after reciting the familiar general definition of "fair market value," provides the method for establishing fair market value in the case of donated inventory. Under the regulation, the fair market value is the price which the taxpayer would have received "if he had sold the contributed property in the usual market in which he customarily sells," in the quantity contributed. Sec. 1.170A-1(c)(2), Income Tax Regs. If the taxpayer sells only at retail (as here), the "usual market" consists of the taxpayer's retail customers. Section 1.170A-1(c)(3), Income Tax Regs., limits the scope of the preceding section in those cases where it cannot be established that the taxpayer could have realized his usual selling price. In this situation, the value of the gift is not the usual selling price, but rather the amount for which the quantity of property contributed could have been82 sold at the time of contribution. It is our task in this case to match the facts against the set of hypotheses specified by the regulations so as to determine the fair market value of petitioner's donated bread. Fair market value is not to be determined in a vacuum. To the contrary, it must be determined with respect to the particular property in question at the time of contribution, subject to any conditions or restrictions on marketability. Cooley v. Commissioner, 33 T.C. 223">33 T.C. 223, 225 (1959), affd. per curiam 283 F.2d 945">283 F.2d 945 (2d Cir. 1960). Viewing the approach taken by the parties in presenting this case, we can perceive no principled basis upon which we could reach a compromise value that lies somewhere between petitioner's claim of full retail price, and respondent's claim of 50 percent of full retail price, nor do we think it would be appropriate to do. We think respondent's proposed application of the regulations in question is unduly restrictive and inconsistent with Congressional intent. In the years at issue, petitioner contributed about 6 percent of its private label bread production to food banks. Contributions of83 excess inventory that is not obsolete could seldom be valued at full retail price under respondent's view of the regulations because in most cases if 430 a taxpayer could have sold contributed excess inventory at the time and in the quantity contributed, it would have done so. In this case, petitioner deliberately overproduced its private label bread so to protect its stores against the possibility of empty shelves. We do not believe it should be penalized for doing so. The parties focus mainly on the characteristics of the donated bread. Was there something about the 4-day-old bread that made it unsalable in petitioner's stores at full retail price? Petitioner's bakery delivered bread to the stores every day except Wednesdays and Sundays. Any unsold bread was removed from the shelves at the beginning of the fourth day after delivery, except for bread delivered on Thursdays, which was removed on Mondays. The bread wrappers were closed with color coded Kwik Loks indicating the so-called "pull date." Each delivery day of the week had its own color code except for Thursdays and Fridays. For both of these days, white Kwik Loks were used indicating a Monday pull date for both. While the 84 white Kwik Loks for bread delivered on Thursday and Friday bore different date codes, the date codes were significant only to someone deliberately seeking to distinguish between Thursday and Friday bread. The date codes were of no significance to the store merchandisers, who relied on the colors on the Kwik Loks to determine pull dates. (The date codes could presumably have had significance to the store operators if week-old bread somehow got scrambled with fresh bread; e.g., the date codes would have been useful to distinguish between Monday's bread from Week One and Monday's bread from Week Two.) The bread donated to the food banks was "4-day" bread except on Mondays, when the donation was a combination of 4- and 5-day bread (a combination of Thursday and Friday deliveries). The parties focus their attention on Sunday sales, since that was the day on which sales of 4-day bread were most likely to be made. Respondent argues that petitioner has not proved that any Thursday (4-day) bread was sold, and that even if some 4-day bread was sold, the quantity sold was insignificant. Petitioner has no records that would establish the quantity of Thursday bread sold on Sundays, or85 delivered to food banks on Mondays. The maintenance of such records would 431 have required the reading and counting of the minutely printed date codes early on Sunday and Monday mornings, and would have served no apparent corporate purpose. When the store merchandisers periodically stocked the shelves, they placed the older bread on the top layer in the front of the shelves, where the older bread was more likely to be sold than the newer bread that was placed under the older bread or in the back of the shelves, perpendicular to the bread in front whose labels faced the customers. But the Thursday and Friday bread eventually were intermingled, since both bear white Kwik Loks and the store merchandisers are indifferent to the date codes, which the Court has found, based upon actual observation of a sample Kwik Lok, to have been obscurely printed and hard to read. At trial the Court observed that petitioner's own bakery chief, Alvin Lewis, had trouble reading the date code on the specimen in evidence without adjusting his glasses. It also appears unlikely that many customers would have rejected the Thursday bread merely on the basis of "squeezeability". Mr. Lewis testified that while 86 "one day" bread is distinctive in feel from 3- and 4-day bread, since it contains more moisture, "from the third and fourth [day] you [can] probably never tell any difference." Respondent argues that even admitting for the sake of argument that petitioner sold Thursday--4-day--bread on Sundays, the amount sold was small because Friday and Saturday deliveries intervened, and the quantity of Thursday bread remaining for Sunday sale necessarily had to be small. Referring to the phrase "quantity contributed" in section 1.170A-1(c)(2), Income Tax Regs., respondent seeks to compare unfavorably the quantity of 4-day bread sold on Sunday to the quantity of 4-day bread petitioner normally contributed on other days. We do not think this argument holds water. Obviously, the amount of Thursday bread available for sale on Sundays, after Friday and Saturday sales of Thursday bread had depleted the supply, would be less than the amount of 4-day bread donated to the food banks on other days. The significant fact is that 4-day bread was sold on Sundays at the usual retail price, not the quantity that was sold, which necessarily had to be smaller than the Friday and Saturday bread remaining on 87 the shelves. 432 Respondent asserts that it is "industry practice" to pull bread after 3 days and that other grocery chains sell it at a 50-percent discount on discount racks or in thrift stores. Even though petitioner chose to do otherwise, respondent argues, the industry practice establishes the price, and therefore the fair market value, at which petitioner could have sold the donated bread at the time of the contribution. Respondent points to section 1.170A-1(c)(3), Income Tax Regs., which limits the fair market value of contributed inventory to the amount for which the quantity of property in question could have been sold at the time of the contribution. Petitioner disputes respondent's assumption as to what is industry practice. While respondent's argument has some force on this point, we do not believe industry practice, such as it is, establishes the price for which petitioner could have sold the donated bread. First, the record does not establish when other supermarket chains pulled their bread for sale at discount. Mr. Lewis testified that he was uncertain what practice petitioner's competitors followed regarding the time bread was left on the shelf, although he believed that88 during the years in issue one of the competitors, Alpha Beta, left its bread on its shelves a little longer than did petitioner. He conceded, however, that petitioner makes an effort to remain abreast of the competition, so it stands to reason that petitioner would try to avoid getting a reputation for selling stale bread by leaving it on the shelves longer than its competition did. The parties stipulated that regional and national bakers that have a substantial share of the California pan bread market sell their bread, after it is pulled from the shelves, at thrift or bakery outlets at discounts ranging from 20 to 70 percent. Undoubtedly petitioner could have sold its bread at thrift outlets had it chosen to do so, but this fact does not establish that petitioner could not sell its 4-day bread at regular retail prices. At best it merely tends to show that petitioner could have sold "old" bread at a discount when it had in effect announced to the public that the bread being offered at a discount was old. Respondent points to the general definition of fair market value contained in the first sentence of section 1.170A-1(c)(2), Income Tax Regs., and argues that 4-day bread could not89 have been sold to "fully informed consumers," that common 433 sense forces the conclusion that the Sunday sales were the product of "ignorance on the part of the customer," and "compulsion; i.e., the older bread was all that was left and the customer had no other choice." But by focusing solely on the first sentence of the regulation, as respondent has done, it is necessary to disregard the rest of the regulation which, as we have already pointed out, provides the specific method by which fair market value is determined in the context of contributed inventory. Accordingly, generalized concepts such as respondent would have us apply must give way in this instance to specific rules. Rev. Rul. 85-8, 1 C.B. 59">1985-1 C.B. 59, as noted above, deals with charitable contributions of dated products. Neither party discusses, or even cites, this ruling, but for completeness we deem it necessary to consider it. Revenue Rulings are not accorded the force of precedent in the Tax Court. Rather, they represent the position of the Commissioner on a given issue, and we deal with Rev. Rul. 85-8 in that light. Estate of Lang v. Commissioner, 64 T.C. 404">64 T.C. 404, 406-407 (1975),90 affd. in part and revd. in part on other grounds 613 F.2d 770">613 F.2d 770 (9th Cir. 1980). Rev. Rul. 85-8 holds that when a corporation donates products in inventory to a charitable organization shortly before the products' expiration date, the amount allowable as a charitable contribution deduction is equal to the taxpayer's basis in the property plus one-half of the unrealized appreciation, not to exceed twice the taxpayer's basis in the property. The ruling, however, presupposes the fact that we are charged with determining, namely, the amount of "unrealized appreciation." We quote the "facts" of the ruling as follows: Corporation X, which is not an S corporation as defined in section 1361(a)(1) of the Internal Revenue Code, is a pharmaceutical manufacturer. X manufactures products that are subject to the requirement that an "expiration date" be imprinted on the product or its container. The products may not be legally sold after the expiration date. Shortly before the expiration date of products that ordinarily were sold by X for 10x dollars, X made a qualified contribution of such products within the meaning of section91 170(e)(3)(A) of the Code. On its Federal income tax return, X claimed a deduction of 10x dollars for this contribution. At the time of the donation, if X had sold the products in the usual market in which it sold such products, X would have realized only 5x dollars. X could not reasonably have been expected to realize its usual selling 434 price for the products due to the imminence of the expiration date after which the products could not be sold legally. X's basis in the products was 1x dollars. [Rev. Rul. 85-8, 1985-1 C.B. at 59.]It will be seen that under the postulated facts an "expiration date" was required, presumably by law, and the products could not be legally sold after the expiration date. In the case before us an expiration date was not a legal requirement, nor is there any legal impediment related to the expiration date. We recognize, of course, that market forces would no doubt impose a practical impediment to retail sales after the date on the Kwik Lok, except at a substantial discount at thrift stores or on discount racks. The ruling assumes that because the expiration date was imminent, "X could not reasonably have 92 been expected to realize its usual selling price". Id. We think our case is different. Here, we are dealing with donations of rapidly perishable inventory which petitioner had on hand for sale for a very short time, so that the bread donations on the pull date--the day before the date code expiration date--have to be viewed in a context different from that of the ruling. This was not inventory which had been on hand for a considerable period of time before it was donated. Instead, it was very much "fast in, fast out," inventory. Consequently, while we do not necessarily quarrel with the Commissioner's conclusions in Rev. Rul. 85-8, based upon its specific facts, we do not believe the revenue ruling suggests that similar conclusions necessarily need be reached in this case. Petitioner retained Professor Daniel L. Rubinfeld to furnish an expert opinion as to the value of the 4-day-old bread that petitioner donated. Professor Rubinfeld teaches law and economics at the University of California at Berkeley and is a principal with the Law and Economics Consulting Group. His expert report is a statistical analysis based upon a physical count 93 of petitioner's bread sales over a 2-week period in six representative stores. Professor Rubinfeld concludes from his statistics that, if bread is only a few days old, consumers are indifferent to its age and will pay full retail price for it. Neither party addresses Professor Rubinfeld's statistical analysis on brief (although respondent does attack certain perceived defects in the "survey" upon which it is based). Professor Rubinfeld's conclusion is founded upon certain 435 statistical averages referred to in his report. This report, however, fails to explain why these statistical averages are reliable estimates; the standard deviations of these averages are left uninterpreted. Without some assistance from the parties, therefore, we are unwilling to undertake the kind of detailed analysis that would permit us to determine whether Professor Rubinfeld's analysis supports the opinion he expresses or rejects it. We have therefore not relied upon his report in deciding this case. Our review of the facts convinces us that on Sundays, and occasionally on other days, petitioner could and did sell 4-day bread at regular retail prices, and in sufficient quantities so as to constitute meaningful94 sales. Congress, by enacting section 170(e)(3), intended to encourage donations of the type in question for the direct use of a special and narrowly limited class of recipients; namely, the ill, the needy, and infants. Section 170(e)(3)(A). As the Conference Committee Report quoted above notes, before the addition of section 170(e)(3), contributions of food, clothing, medical equipment, and supplies for the benefit of such persons had dried up as a result of the limitations imposed by section 170(e)(1). We think section 170(e)(3) and sections 1.170A-1(c)(2) and (3), Income Tax Regs., should not be interpreted in such a restrictive way as to unnecessarily inhibit donations of the type Congress meant to encourage, and certainly petitioner's bread donations are of that type. Furthermore, we again note that Congress was careful to draft section 170(e)(3)(B) in such a way as to prevent the situation where a taxpayer would be better off, after tax, by donating the property than it would have been if it had sold the donated property and retained all the after-tax proceeds of the sale. Staff of Joint Comm. on Taxation, General Explanation of the Tax Reform Act of 1976, at 672 (J. Comm. Print95 1976), 1976-3 C.B. at 684. Thus, petitioner's donations do not present an opportunity for the type of tax avoidance unintended by Congress. For the foregoing reasons, we agree with petitioner that its bakery product donations to food banks should be valued at full retail prices, and we so hold. At the trial, petitioner sought to have a letter stipulated into evidence to which respondent raised a hearsay objection. See Fed. R. Evid. 801(a). The letter was addressed to a revenue 436 agent, and was obtained by petitioner from respondent in the course of informal discovery. Petitioner did not call the author of the letter as a witness, nor did petitioner attempt to account for his unavailability. The Court reserved judgment as to the admissibility of the letter. After further consideration, the Court now rules that respondent's objection is sustained. Informal discovery is used, in part, to lead the discovering party to admissible evidence, not to automatically validate it. Zaentz v. Commissioner, 73 T.C. 469">73 T.C. 469, 471-472 (1979). To reflect the foregoing, and to give effect to settled issues and the issue remaining to be resolved, 96 An appropriate order will be issued directing entry of decision under Rule 155 upon completion of proceedings resolving the remaining issue in this case, and sustaining respondent's hearsay objection.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621285/	Frank J. Kalchthaler, Petitioner, v. Commissioner of Internal Revenue, RespondentKalchthaler v. CommissionerDocket No. 9207United States Tax Court7 T.C. 625; 1946 U.S. Tax Ct. LEXIS 96; August 20, 1946, Promulgated 96 Decision will be entered for the respondent. Petitioner separated himself from his wife and failed to provide for her support. She obtained a judgment of nonsupport against him, with an order to him to pay a sum weekly for her support and separate maintenance. The support order was not a decree of legal separation, with separate maintenance. Petitioner's wife was not legally separated from him. Held, that petitioner is not entitled to a deduction under section 23 (u) of the Internal Revenue Code because the payments to his wife were not includible in her gross income under section 22 (k). Daniel F. McCarthy, Esq., for the petitioner.R. Bruce Jones, Esq., for the respondent. Harron, Judge. HARRON 625 This proceeding involves a deficiency in income and victory tax of $ 60.24 for the year 1943. Petitioner deducted from his gross income $ 272, the total of payments which he made to his wife in 1943 under circumstances set forth hereinafter. The deduction was disallowed. The only question is whether petitioner is entitled to deduction under section 23 (u) of the Internal Revenue Code. The question must be determined with reference to section 22 (k), which provides that in the case of a wife who is divorced or legally separated from her husband, certain payments, described therein, shall be included in the gross income of the wife.Petitioner filed his return with the collector for the twenty-third district of Pennsylvania.The facts have been stipulated.FINDINGS OF FACT.Petitioner resides in Pittsburgh, Pennsylvania, 98 and follows the occupation of butcher. He reported gross income for 1943 in the amount of $ 1,863.44.Frank J. Kalchthaler and Anna E. Kalchthaler were married April 27, 1909, in Pittsburgh, Pennsylvania, and lived together as man and wife until February 10, 1935, on which date Frank J. Kalchthaler left his wife because of a disagreement, and he has not lived with his wife since.At no time has there been any written contract or agreement for support or maintenance between husband and wife, and the parties are still married, no divorce having been obtained.On May 16, 1935, Anna E. Kalchthaler, wife of petitioner, filed an information return in the County Court of Allegheny County, Pennsylvania, for an order on her husband for support, and on June 5, 1935, the court made an order on the husband, Frank J. Kalchthaler, to pay his wife the sum of $ 36 per month.626 On December 9, 1937, by agreement of both parties, the order of June 5, 1935, was suspended by the court, for the reason that Frank J. Kalchthaler was then unemployed and the wife, Anna E. Kalchthaler, was able to secure employment with a W. P. A. sewing project.On April 19, 1943, Anna E. Kalchthaler filed a petition99 in the said county court for reinstatement of the order for support, and on May 4, 1943, the court passed an order on the husband, Frank J. Kalchthaler, to pay $ 8 per week for the support of his wife.The order of the court recites that the parties to the proceeding are "Commonwealth v. Frank J. Kalchthaler"; that the charge is "Desertion and Non-support"; that the defendant is adjudged guilty of nonsupport; that he is ordered to pay to the desertion probation officer of the court the sum of $ 8 per week "for the support of his wife"; that the money shall be turned over by the probation officer to Anna E. Kalchthaler, "wife of defendant"; that further order is made that the defendant enter his own recognizance in the sum of $ 300; that the defendant shall be imprisoned in the county jail of Allegheny County in the event of his default of compliance with the order; and that the costs of the proceedings shall be paid by the county.On August 31, 1944, a petition was filed in behalf of said Frank J. Kalchthaler, praying for an amendment nunc pro tunc of the order of May 4, 1943, by adding the words "for the support and separate maintenance of his wife," and the order as 100 requested was passed or signed by the court on the same day.The original order of May 4, 1943, stated that the defendant was ordered to pay the sum of $ 8 per week "for the support of his wife." The amendment of August 31, 1944, enlarged upon such words by the addition of the words "and separate maintenance."During the year 1943 petitioner, pursuant to the order of the court of May 4, 1943, as amended August 31, 1944, paid to his wife for support and separate maintenance the sum of $ 272.OPINION.Petitioner seeks a deduction under section 23 (u) of the Internal Revenue Code for payments he made to his wife in the taxable year for her support. Whether petitioner is entitled to a deduction depends upon whether the payments to his wife come within section 22 (k). Both sections are set forth in the margin. 1101 These sections were added to the Internal Revenue Code by the Revenue Act of 1942. See subsections (a) and (b) of section 120, 627 Revenue Act of 1942. Section 22 (k) is a new provision which has been added to section 22 (relating to gross income) under which a new class of income must be included in the gross income of a wife, or a husband, as the case may be. The new subsection (k) was added to section 22 "in order to provide in certain cases a new income tax treatment for payments in the nature of or in lieu of alimony or an allowance for support as between divorced or legally separated spouses." (Italics added.) Ways and Means Committee Rept. No. 2333, p. 71; Senate Finance Committee Rept. No. 1631, p. 83; 77th Cong., 2d sess. With respect to the husband, from whom the wife receives payments, complementary provision is made for the deduction from his income of any amount included in such wife's income under section 22 (k), by the addition of a new subsection, (u), to section 23 (relating to deductions from gross income). Thus, in some instances, payments received from a husband by a wife must be included in her income; and the husband is entitled to a deduction102 therefor.It is apparent that these provisions are novel in the system of income tax because, until they were enacted, a husband's payments to his wife during marriage and after divorce were, generally speaking, neither deductible by him nor taxable to his wife.Under section 24 (a) (1) of the Internal Revenue Code, no deduction shall in any case be allowed in respect of "personal, living, or family expenses." Section 120 of the Revenue Act of 1942 did not amend section 24 (a) (1). It stands unaffected. It must be taken into account in considering the issue presented, because if the payments made by petitioner to his wife which are here in question do not come within the new section, section 22 (k), then section 24 (a) (1) applies; i. e., if the payments remain in the class of family or personal expenses, no deduction is allowable.It is petitioner's contention that, since the payments in question were for support and separate maintenance and were made under a court order, they come within subsection (k). Petitioner's contention is made under a brief argument which is not only very limited in its text, but is also entirely lacking in any discussion of the marital status of petitioner103 and his wife in the taxable year. For example, in his brief, petitioner does not present any argument on whether or not he and his wife were legally separated. It is stipulated that the parties 628 were not divorced in the taxable year, that no divorce has been obtained, and that the parties are still married. It is also stipulated that petitioner and his wife have never entered into any written contract for support or separate maintenance.Section 22 (k) is limited in its application to payments made to "a wife who is divorced or legally separated from her husband under a decree of divorce or of separate maintenance." (Italics added.) The obvious plan of the section, as shown by the entire section, is to deal with payments which are made incident to divorce or legal separation. If the meaning of section 22 (k) is not clear, in the provision which reads "a wife who is divorced or legally separated from her husband under a decree of divorce or of separate maintenance," it is of assistance to refer to the discussion of the term "separate maintenance" in Words and Phrases, vol. 38, p. 629, wherein it is pointed out that "in many jurisdictions courts have authority to make104 an allowance to a wife who is living separate and apart from her husband, without being legally separated or divorced, and this allowance * * * is often called 'separate maintenance'." (Italics added.) Dyer v. Dyer, 194 S.E. 278">194 S. E. 278.The construction which must be placed upon section 22(k) with respect to the question presented here is that it relates to periodic payments made under a decree of separate maintenance to a wife who is legally separated or divorced from her husband, but that it does not apply to a decree of separate maintenance made to a wife, who is not legally separated or divorced.An action for separate maintenance is not an action for legal separation, generally speaking. The object of the former is to compel a husband to provide support, and the decree of separate maintenance and/or support does not expressly authorize the wife to live apart from her husband. On the other hand, a decree of separation from bed and board authorizes a wife to live apart from her husband. See Words and Phrases, supra.In this case, the facts are that petitioner left his wife and lived apart from her, and that he did not provide for her 105 support. She filed an action for support. Petitioner was adjudged guilty of nonsupport and ordered to pay $ 8 per week to his wife for her support and separate maintenance. The proceeding was instituted in the quarter sessions court of a county. See section 4733 of the Penal Code of 1939, Purdon's Pennsylvania Statutes Annotated, title 18, p. 529, and the annotations under section 4733, and particularly the reference to Eckert v. Eckert, 3 Berks. 113, 116 (1910); and Carey v. Carey, 223">25 Pa. Super. 223 (1904), where it is said:If support of the wife only, as distinguished from separation with support, is the object aimed at by the libellant, the appropriate proceedings would not be in the divorce court, but in the quarter sessions under this statute.629 In Pennsylvania jurisdiction over a proceeding for legal separation lies in courts of common pleas. See Title 23 -- Divorce -- par. 15, Purdon's Pennsylvania Statutes Annotated, p. 268; see also Commonwealth v. Scholl, 39 Atl. (2d) 719; and Rutherford v. Rutherford, 32 Atl. (2d) 921.106 The support order here in question was not issued by a court of common pleas, but was issued by a quarter sessions court. It was not a decree of legal separation with support, but was only a support order. The payments which petitioner made to his wife in the taxable year were made under an order or decree of separate maintenance which does not come within section 22(k) because, although it made an allowance to his wife for her separate maintenance, the status under Pennsylvania law of petitioner and his wife was that he was living apart from his wife, and she was not legally separated from him. Since the wife was not legally separated from petitioner, the sums paid to her are not includible in her gross income under section 22(k). It follows that petitioner is not entitled to the deduction claimed under section 23 (u). It is so held. Respondent's determination is sustained.Decision will be entered for the respondent. Footnotes1. Sec. 22. (k) Alimony, Etc., Income. -- In the case of a wife who is divorced or legally separated from her husband under a decree of divorce or of separate maintenance, periodic payments (whether or not made at regular intervals) received subsequent to such decree in discharge of, or attributable to property transferred (in trust or otherwise) in discharge of, a legal obligation which, because of the marital or family relationship, is imposed upon or incurred by such husband under such decree or under a written instrument incident to such divorce or separation shall be includible in the gross income of such wife, and such amounts received as are attributable to property so transferred shall not be includible in the gross income of such husband. * * *Sec. 23↩. (u) Alimony, Etc., Payments. -- In the case of a husband described in section 22 (k), amounts includible under section 22 (k) in the gross income of his wife, payment of which is made within the husband's taxable year. If the amount of any such payment is, under section 22 (k) or section 171, stated to be not includible in such husband's gross income, no deduction shall be allowed with respect to such payment under this subsection.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621286/	JOEL V. MILLER, JR., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentMiller v. CommissionerDocket No. 25479-81.United States Tax CourtT.C. Memo 1983-476; 1983 Tax Ct. Memo LEXIS 305; 46 T.C.M. (CCH) 1054; T.C.M. (RIA) 83476; August 15, 1983. 305 Held, in these circumstances, respondent's determinations of income tax deficiencies and additions to the tax under secs. 6653(b) and 6654, I.R.C. 1954, sustained. Held further, on the Court's own motion, damages are awarded to the United States in the amount of $500 since this proceeding was instituted merely for delay. Sec. 6673, I.R.C. 1954. Joel V. Miller, Jr., pro se. Ralph W. Jones, for the respondent. DAWSON306 MEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Chief Judge: This case was assigned to Special Trial Judge Francis J. Cantrel for the purpose of considering and ruling on respondent's Motion for Summary Judgment filed herein. After a review of the record, we agree with and adopt his opinion which is set forth below. 1OPINION OF THE SPECIAL TRIAL JUDGE CANTREL, Special Trial Judge: This case is before the Court on respondent's Motion for Summary Judgment filed pursuant to Rule 121, Tax Court Rules of Practice and Procedure, on March 29, 1983. Therein respondent seeks summary adjudication307 in his favor on the legal issues at bar, i.e., the determined income tax deficiencies and the additions to the tax under sections 6653(b) and 6654. 2Respondent, in his notice of deficiency issued to petitioner on August 13, 1981, determined deficiencies in petitioner's Federal income tax and additions to the tax for the taxable calendar years 1977 and 1978 in the following respective amounts: Additions to Tax, I.R.C. 1954YearsIncome TaxSec. 6653(b)Sec. 66541977$1,574.00$787.00$46.8419781,904.00952.0056.22The sole income adjustments determined by respondent in his deficiency notice are for wages received by petitioner in 1977 and 1978 in the respective amounts of $11,561.28 and $12,920.00. Petitioner timely filed his petition herein on October 8, 1981. Petitioner at paragraphs 4. and 5. of the petition recites: 4. The determination of tax set forth in the said notice of deficiency is based upon the following errors: A. The amount allowed by the Commissioner for lawful deductions and expenses is incorrect. 5. The facts upon which308 the Petitioner relies, as the basis of his case, are as follows: A. Petitioner had more lawful deductions and expenses than what was allowed by the Commissioner. 3* * * Respondent filed his answer on December 7, 1981 wherein at paragraphs 7.(a) through (j) he makes affirmative allegations of fact in support of his determinations for the additions to the tax under section 6653(b). Petitioner filed no reply, the time for the filing of which expired on January 18, 1982. Hence, the affirmative allegations of fact contained in respondent's answer are deemed denied. However, the pleadings are deemed closed and respondent's motion was filed more than 30 days after the pleadings were closed. See Rules 34, 36, 37, 38, and 121. When respondent's attempts to make arrangements with petitioner for informal consultations or communications proved unsuccessful, 4 he, on December 21, 1982, served a Request for Admissions on petitioner. 5 While petitioner maintains he served answers on respondent within the time provided by Rule 90(c) no proof of that fact is in this record. Petitioner admits that he did not timely file309 the original of any such answers with the Court as provided by Rule 90(c). In such circumstances, each matter contained in respondent's Request for Admissions is deemed admitted and conclusively established. Freedson v. Commissioner,65 T.C. 333">65 T.C. 333, 335 (1975), affd. 565 F.2d 954">565 F.2d 954 (5th Cir. 1978); Rules 90(c) and (e). 6On April 29, 1983 petitioner filed a Motion to Vacate Deemed Admissions, which was denied by the Court on May 3, 1983. 7 Also, on April 29, 1983, the Court received from petitioner a document entitled "Responses to Request for Admissions" which was filed on that date. A careful review of that document discloses each response to be frivolous. The following findings of fact are based upon the record310 as a whole, the allegations of respondent's answer admitting allegations in the petition and those matters deemed admitted and conclusively established with respect to respondent's request for admissions. FINDINGS OF FACT Petitioner's legal address on the date he filed his petition was Rt. 6, Box 98B, Idaho Falls, Idaho. He filed no Federal income tax returns for the taxable years 1977 and 1978 with the Internal Revenue Service. During each of the taxable years 1977 and 1978 petitioner was employed as a meat cutter by Golden Valley Packers (hereinafter sometimes called Golden Valley) at Roberts, Idaho. He was an unmarried individual who had no dependents. In 1977 and 1978 petitioner received wages from Golden Valley in the respective amounts of $11,561.28 and $12,920.00. In both years he was paid by check. He cashed the checks he received and secreted the currency. Golden Valley provided petitioner with wage and tax statements (Forms W-2) for both 1977 and 1978 reflecting the wages paid to him in those years. 8Petitioner filed a Form W-4 (Employee's311 Withholding Allowance Certificate) dated January 3, 1975 with Golden Valley wherein he claimed one allowance. He filed a Form W-4 with Golden Valley on or about January 21, 1977 claiming ninety-nine allowances.On or about May 10, 1977 he filed a Form W-4E (Exemption from Withholding) with his employer claiming he was exempt from the withholding of Federal income tax. On or about January 1, 1978 petitioner filed a Form W-4 with his employer on which he claimed twenty-two allowances. 9Golden Valley withheld taxes from petitioner's wages on occasion but upon complaint of petitioner to Charles Hayes, Vice-President of Golden Valley, and upon petitioner's insistence that the withheld taxes be refunded to petitioner, Golden Valley refunded certain withholdings to petitioner. Petitioner informed Mr. Hayes that he did not want any tax withheld from his wages because he filed and paid his tax at year's end. For each of the taxable years 1974 and 1975 petitioner filed valid Federal income tax returns and reported thereon the income he received. He submitted a 1976 Form 1040 to the Internal312 Revenue Service on which no income was reported and on which frivolous constitutional contentions were stated. He submitted an amended 1976 Form 1040 to the Internal Revenue Service on which no income was reported. Every line of that Form contained the language "Object Self-Incrimination". Forms 1040, containing the same language and reporting no information pertaining to income, were submitted to the Internal Revenue Service by petitioner for the taxable years 1977 and 1978 (the years before the Court). A similar Form 1040 was submitted by petitioner to the Internal Revenue Service for the taxable year 1980. Sometime in 1979 petitioner submitted a Form W-4 to Golden Valley. He advised therein that he was single and in response to the total number of allowances he was claiming he stated "Don't hold anything". Golden Valley provided petitioner with a Form W-2 reflecting the wages paid to petitioner in 1979 ($8,745). That Form discloses that no Federal income tax was withheld from petitioner's wages in 1979. Petitioner fraudulently, and with intent to evade tax, submitted false Forms W-4 and a false Form W-4E to Golden Valley to eliminate the withholding of Federal income313 tax from his wages in 1977 and 1978. He fraudulently, and with intent to evade tax, failed to file Federal income tax returns for 1977 and 1978. The Forms 1040 submitted for those years did not constitute "returns". Petitioner failed to report taxable income which he received for the taxable years 1977 and 1978 in the respective amounts of $11,561.28 and $12,920.00. He failed to report and pay his income tax liabilities for those years in the amounts of $1,574.00 and $1,904.00, respectively. A part of the underpayment of tax which petitioner was required to show on an income tax return for the taxable years 1977 and 1978 is due to fraud with intent to evade tax. OPINION Rule 34(b) provides in pertinent part that the petition in a deficiency action shall contain "clear and concise assignments of each and every error which the petitioner alleges to have been committed by the Commissioner in the determination of the deficiency or liability" and "clear and concise lettered statements of the facts on which petitioner bases the assignments of error * ". (Emphasis added.) It is abundantly clear, upon review of the petition filed herein, the pertinent parts of which314 are recited hereinabove, that no justiciable error has been alleged with respect to the Commissioner's determinations respecting the wage income petitioner received and the additions to the tax under sections 6653(b) and 6654. 10While petitioner has asserted error respecting "lawful deductions and expenses", which may have impacted on the income tax deficiencies, he has alleged not a single justiciable fact in support of that allegation of error. We are not advised as to what the deductions and expenses were or the amounts thereof. It appears from this record that petitioner refuses315 to produce any records to respondent unless he is granted immunity. See Martindale v. Commissioner,692 F.2d 764">692 F.2d 764 (9th Cir. 1982), 11 affg. without published opinion an unreported order and decision of this Court. See also Goodrich v. Commissioner,T.C. Memo 1983-414">T.C. Memo. 1983-414. Therefore, petitioner's claim must be taken as wholly frivolous. Petitioner in refusing to properly plead his case has, regrettably and fatally, concentrated his attack on raising frivolous contentions, which have oft been rejected by this and other Courts and which we answer hereinbelow. 12The decision whether to grant immunity rests with the United States, not with the Tax Court. 18 U.S.C. Sections 6000-6005 (1976). McCoy v. Commissioner,696 F.2d 1234">696 F.2d 1234 (9th Cir. 1983), affg. 76 T.C. 1027">76 T.C. 1027 (1981); Hartman v. Commissioner,65 T.C. 542">65 T.C. 542, 547-548 (1975).316 To invoke the Fifth Amendment privilege, petitioner must be faced with substantial hazards of self-incrimination that are real and appreciable, and must have reasonable cause to apprehend such danger. The privilege may not itself be used as a method of evading payment of lawful taxes. Edwards v. Commissioner,680 F.2d 1268">680 F.2d 1268, 1271 (9th Cir. 1982), affg. per curiam an unreported decision of this Court; McCoy v. Commissioner,supra.13 There is nothing in this record remotely indicating that petitioner is faced with substantial hazards of self-incrimination or that he has reasonable cause to apprehend such danger. The determinations made by respondent in his notice of deficiency respecting the income tax deficiencies and the additions317 to the tax under section 6654 are presumed correct; the burden is on petitioner (not respondent) to show those determinations are wrong, and the imposition of the burden of proof is constitutional. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rockwell v. Commissioner,512 F.2d 882">512 F.2d 882, 887 (9th Cir. 1975); Rule 142(a). Petitioner has not even attempted to carry that burden; he has failed to allege any fact or legal theory that would tend to show that the Commissioner's determinations are incorrect. See Knighten v. Commissioner,702 F.2d 59">702 F.2d 59 (5th Cir. 1983), affg. per curiam an unreported order and decision of this Court. This Court generally (as is the case here) will not look behind a deficiency notice to examine evidence used or the propriety of the Commissioner's motives or of the administrative policy or procedures involved in making his determinations. Greenberg's Express, Inc. v. Commissioner,62 T.C. 324">62 T.C. 324, 327 (1974). Gross income means all income from whatever source derived including (but not limited to) wages. It includes income realized in any form, whether in money, property, or services. Section 61. Income318 as defined under the Sixteenth Amendment is "gain derived from capital, from labor, or from both combined". Eisner v. Macomber,252 U.S. 189">252 U.S. 189, 207 (1920). Section 61 encompasses all realized accessions to wealth. Commissioner v. Glenshaw Glass Co.,348 U.S. 426">348 U.S. 426 (1955). See United States v. Buras,633 F.2d 1356">633 F.2d 1356, 1361 (9th Cir. 1980), where the Court said--"* * * 'the earnings of the human brain and hand when unaided by capital' are commonly treated as income" and "* * * the Sixteenth Amendment is broad enough to grant Congress the power to collect an income tax regardless of the source of the taxpayer's income". [Citations omitted.] "One's gain, ergo his 'income,' from the sale of his labor is the entire amount received therefor without any reduction for what he spends to satisfy his human needs". Reading v. Commissioner,70 T.C. 730">70 T.C. 730, 734 (1978), affd. 614 F.2d 159">614 F.2d 159 (8th Cir. 1980). "Although the wages [gross income] received by [petitioner] may represent no more than the time-value of his work, they are nonetheless the fruit of his labor, and therefore represent gain derived from labor which319 may be taxed as income". [Emphasis added.] See Rice v. Commissioner,T.C. Memo 1982-129">T.C. Memo. 1982-129, and cases cited therein. See also Rowlee v. Commissioner,80 T.C. 1111">80 T.C. 1111, 1119-1122 (1983), and cases cited therein. Petitioner reported no figures for income or deductions on the Forms 1040 submitted for 1977 and 1978. On both Forms he took the Fifth Amendment. Neither constituted a return for purposes of the Internal Revenue Code. United States v. Klee,494 F.2d 394">494 F.2d 394, 397 (9th Cir. 1974); Jarvis v. Commissioner,78 T.C. 646">78 T.C. 646, 653-655 (1982); Ammen v. Commissioner,T.C. Memo. 1982-476. We next consider the additions to the tax under section 6653(b). The burden of proof with respect to the fraud issues is upon respondent to prove, by clear and convincing evidence, that some part of the underpayment of tax was due to fraud with an intent to evade tax. Section 7454(a); Rule 142(b); Imburgia v. Commissioner,22 T.C. 1002">22 T.C. 1002 (1954). That burden can be satisfied by respondent through those facts deemed admitted and conclusively established pursuant to Rule 90. 14 Here, material factual allegations320 in respondent's request for admissions have been deemed admitted and conclusively established. In our view, those facts, which we have set forth hereinbefore in our findings of fact, clearly and convincingly establish fraud with intent to evade tax and we rely on them in sustaining respondent's determinations under section 6653(b). Rule 121 provides that a party may move for summary judgment upon all or any part of the legal issues in controversy so long as there are no genuine issues of material fact. Rule 121(b) states that a decision shall be rendered "if the pleadings * * * admissions, and any other acceptable materials, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law." The summary judgment procedure is available even though there is a dispute under the pleadings if it is shown through materials in the record outside the pleadings that no genuine issue of material fact exists. 15321 The record here contains a complete copy of the notice of deficiency, the petition, answer, and respondent's request for admissions with attached exhibits. Respondent has amply demonstrated to our satisfaction that there is no genuine issue as to any material fact present in this record and, thus, that respondent is entitled to a decision as a matter of law. In such posture, summary judgment is a proper procedure for disposition of this case. Respondent's Motion for Summary Judgment will be granted in every respect. The final matter we consider is whether, in the circumstances here extant, we should, on our own motion, award damages to the United States under section 667316 and, if so, in what amount. We addressed the very heart of this matter in September of 1977 in Hatfield v. Commissioner,68 T.C. 895">68 T.C. 895, 899 (1977), when we stated in clear and unequivocal language: In recent times, this Court has been faced with numerous cases, such as this one, which have been commenced without any legal justification but solely for the purpose of protesting the Federal tax laws. This Court has before it a large number of cases which deserve careful consideration as322 speedily as possible, and cases of this sort needlessly disrupt our consideration of those genuine controversies. Moreover, by filing cases of this type, the protesters add to the caseload of the Court, which has reached a record size, and such cases increase the expenses of conducting this Court and the operations of the IRS, which expenses must eventually be borne by all of us. Many citizens may dislike paying their fair share of taxes; everyone feels that he or she needs the money more than the Government. On the other hand, as Justice Oliver Wendell Holmes so eloquently stated: "Taxes are what we pay for civilized society". Compania de Tabacos v. Collector,275 U.S. 87">275 U.S. 87, 100 (1927). The greatness of our nation is in no small part due to the willingness of our citizens to honestly and fairly participate in our tax collection system which depends upon self-assessment. Any citizen may resort to the courts whenever he or she in good faith and with a colorable claim desires to challenge the Commissioner's determination; but that does not mean that a citizen may resort to the courts merely to vent his or her anger and attempt symbolically to throw a wrench at the323 system. Access to the courts depends upon a real and actual wrong--not an imagined wrong--which is susceptible of judicial resolution. General grievances against the policies of the Government, or against the tax system as a whole, are not the types of controversies to be resolved in the courts; Congress is the appropriate body to which such matters should be referred. 17324 While we did not award damages in Hatfield we issued this warning--"* * * but if tax protesters continue to bring such frivolous cases, serious consideration should be given to imposing such damages". [Citations omitted.] Similar warnings were promulgated in Crowder v. Commissioner,T.C. Memo. 1978-273 and Clippinger v. Commissioner,T.C. Memo 1978-107">T.C. Memo. 1978-107. Tax protest petitions continued to be filed with this Court with increased frequency and, finally, upon motion of respondent, we began awarding damages to the United States in appropriate cases. See Wilkinson v. Commissioner,71 T.C. 633">71 T.C. 633 (1979) and Greenberg v. Commissioner,73 T.C. 806">73 T.C. 806 (1980). 18 Shortly after we issued Greenberg we, for the first time, awarded damages in a proper circumstance on our own motion. Syndes v. Commissioner,74 T.C. 864">74 T.C. 864, 870-873 (1980), affd. 647 F.2d 813">647 F.2d 813 (8th Cir. 1981). 19 Petitions filed merely for delay continued to overburden this Court's docket. In recognition of this fact, on June 15, 1981, we aptly stated-- It may be appropriate to note further that this Court has been flooded with325 a large number of so-called tax protester cases in which thoroughly meritless issues have been raised in, at best, misguided reliance upon lofty principles. Such cases tend to disrupt the orderly conduct of serious litigation in this Court, and the issues raised therein are of the type that have been consistently decided against such protesters and their contentions often characterized as frivolous. The time has arrived when the Court should deal summarily and decisively with such cases without engaging in scholarly discussion of the issues or attempting to soothe the feelings of the petitioners by referring to the supposed "sincerity" of their wildly espoused positions. [McCoy v. Commissioner, 76 T.C. 1027">76 T.C. 1027, 1029-1030 (1981), affd. 696 F.2d 1234">696 F.2d 1234 (9th Cir. 1983).Emphasis added.] 326 This Court is not the only Court that has considered awarding damages or other costs, either on its own motion or on motion of the Commissioner, in a proper case. In a tax protester situation, where one of the frivolous issues was whether the U.S. Constitution forbids taxation of compensation received for personal services, the Fifth Circuit Court of Appeals stated in late 1981-- Appellants' contentions are stale ones, long settled against them. As such they are frivolous. Bending over backwards, in indulgence of appellants' pro se status, we today forbear the sanctions of Rule 38, Fed. R. App. P. We publish this opinion as notice to future litigants that the continued advancing of these long-defunct arguments invites such sanctions, however. [Lonsdale v. Commissioner,661 F.2d 71">661 F.2d 71, 72 (5th Cir. 1981), affg. T.C. Memo. 1981-122.]20In Knighten v. Commissioner,supra,327 the Court of Appeals following its warning took action. There, damages were not sought nor awarded in our Court. Damages were sought by the Commissioner and double costs were awarded in the Court of Appeals. The Court of Appeals for the Ninth Circuit has, in a summary and decisive manner, awarded double costs (under Rule 38, Fed. R. App. P.) in several tax protester cases on its own motion. On July 7, 1982, in Edwards v. Commissioner,supra at 1271, the Court said-- Meritless appeals of this nature are becoming increasingly burdensome on the federal court system. We find this appeal frivolous,Fed. R. App. P. 38, and accordingly award double costs to appellee [the Commissioner of Internal Revenue]. [Citations omitted.] [Emphasis added.] Accord, McCoy v. Commissioner,supra; Barmakian v. Commissioner,698 F.2d 1228">698 F.2d 1228 (9th Cir. 1982), affg. without published opinion an unreported order and decision of this Court; Martindale v. Commissioner,supra.21328 Here, petitioner has instituted these proceedings and has asserted as his defense to the Commissioner's determinations nothing but frivolous contentions. Petitioners with genuine controversies have been delayed while we considered this case. In these circumstances, petitioner cannot and has not shown that he, in good faith, has a colorable claim to challenge the Commissioner's determinations. Indeed, he knew when he filed his petition that he had no reasonable expectation of receiving a favorable decision. There has been no change in the legal climate and in view of the extensive and long well settled case precedents, no reasonably prudent person could have expected this Court to reverse itself in this situation. 22"When the costs incurred by this Court and respondent are taken into consideration, the maximum damages authorized329 by the statute ($500) do not begin to indemnify the United States for the expenses which petitioner's frivolous action has occasioned. Considering the waste of limited judicial and administrative resources caused by petitioner's action, even the maximum damages authorized by Congress are wholly inadequate to compensate the United States and its other taxpayers. These costs must eventually be borne by all of the citizens who honestly and fairly participate in our tax collection system. * ". Sydnes v. Commissioner,supra at 872-873. Since we conclude that this case was brought merely for delay, the maximum damages authorized by law ($500) are appropriate and will be awarded pursuant to section 6673. To reflect the foregoing An appropriate order and decision will be entered.Footnotes1. Since this is a pre-trial motion and there is no genuine issue of material fact, the Court has concluded that the post-trial procedures of Rule 182, Tax Court Rules of Practice and Procedure↩, are not applicable in these particular circumstances. This conclusion is based on the authority of the "otherwise provided" language of that rule. All rule references are to the Tax Court Rules of Practice and Procedure.2. All section references are to the Internal Revenue Code of 1954, as amended.↩3. This is the sum and substance of petitioner's case.↩4. See Odend'hal v. Commissioner,75 T.C. 400">75 T.C. 400↩ (1980); Rule 90(a). 5. The original of that request was filed with the Court on December 27, 1982. Rule 90(b). ↩6. See Uptain v. Commissioner,T.C. Memo 1982-737">T.C. Memo. 1982-737; McKinnon v. Commissioner,T.C. Memo. 1982-229↩.7. A copy of the Court's Order denying petitioner's motion was served on the parties by the Court on May 3, 1983.↩8. Copies of Golden Valley's wage records, the checks petitioner received and the Forms W-2 are in this record.↩9. Copies of the Forms W-4 and the Form W-4E duly signed by petitioner are in this record.↩10. In such circumstance, Rule 34(b)(4) states, in part--"Any issue not raised in the assignment of errors shall be deemed to be conceded". See Jarvis v. Commissioner,78 T.C. 646">78 T.C. 646, 658 (1982). Moreover, we said in Gordon v. Commissioner,73 T.C. 736">73 T.C. 736, 739↩ (1980)--" * * Any issue, including addition to tax for fraud under section 6653(b), not raised in the assignment of errors is deemed conceded by the petitioner. Rule 34(b)(4)". Notwithstanding, here, we prefer to rely on those matters deemed admitted in sustaining all of respondent's determinations.11. We observe that venue on appeal of this case lies in the United States Court of Appeals for the Ninth Circuit.↩12. As we view this record, petitioner is yet another in a seemingly unending parade of tax protesters bent on glutting the docket of this Court and others with frivolous claims.↩13. See also, Martindale v. Commissioner,692 F.2d 764">692 F.2d 764 (9th Cir. 1982), affg. without published opinion an unreported order and decision of this Court, United States v. Carlson,617 F.2d 518">617 F.2d 518, 523 (9th Cir. 1980), cert. denied 449 U.S. 1010">449 U.S. 1010 (1980), and United States v. Neff,615 F.2d 1235">615 F.2d 1235, 1238 (9th Cir. 1980), cert. denied 447 U.S. 925">447 U.S. 925↩ (1980).14. See Hindman v. Commissioner,T.C. Memo. 1983-389↩.15. Such outside materials may consist of affidavits, interrogatories, admissions, documents or other materials which demonstrate the absence of such an issue of fact despite the pleadings. See Note to Rule 121(a), 60 T.C. 1127">60 T.C. 1127↩.16. Sec. 6673 provides-- "Whenever it appears to the Tax Court that proceedings before it have been instituted by the taxpayer merely for delay, damages in an amount not in excess of $500 shall be awarded to the United States by the Tax Court in its decision. Damages so awarded shall be assessed at the same time as the deficiency and shall be paid upon notice and demand from the Secretary and shall be collected as a part of the tax". We observe that in proceedings commenced after December 31, 1982 this Court is permitted to impose damages up to $5,000 where those proceedings have been instituted or maintained by the taxpayer primarily for delay or where taxpayer's position in such proceeding is frivolous or groundless. See secs. 292(b) and (e)(2), Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, 96 Stat. 574. ↩17. The language in the first paragraph quoted above, so true when stated, is all the more impelling today because of the ever increasing caseload of this Court.↩18. See also, Goodrich v. Commissioner,T.C. Memo. 1983-414; Cornell v. Commissioner,T.C. Memo. 1983-370; Stamper v. Commissioner,T.C. Memo. 1983-248; Sommer v. Commissioner,T.C. Memo. 1983-196, on appeal (7th Cir. July 12, 1983); Jacobs v. Commissioner,T.C. Memo. 1982-198; Senesi v. Commissioner,T.C. Memo. 1981-723, affd. F.2d (6th Cir. 1983); Swann v. Commissioner,T.C. Memo. 1981-236↩, dismissed (9th Cir. 1981). We note that the predecessor of the statute we now consider, which in essence, contained virtually identical language, was enacted by Congress in 1926. 19. See also Vickers v. Commissioner,T.C. Memo. 1983-429; Mele v. Commissioner,T.C. Memo. 1983-387; Ballard v. Commissioner,T.C. Memo. 1982-56; and Graves v. Commissioner,T.C. Memo. 1981-154, affd. without published opinion 698 F.2d 1219">698 F.2d 1219↩ (6th Cir. 1982), where damages were awarded on our own motion.20. Rule 38, Federal Rules of Appellate Procedure, provides-- DAMAGES FOR DELAY. If a court of appeals shall determine that an appeal is frivolous, it may award just damages and single or double costs to appellee.↩21. In none of the four cases decided by the Ninth Circuit were damages sought or awarded in this Court.↩22. "* * * [A] person's intent in performing an act includes not only his motive for acting (which may be defined as the objective which inspires the act), but also extends to include the consequences which he believes or has reason to believe are substantially certain to follow." Greenberg v. Commissioner,73 T.C. 806">73 T.C. 806, 814↩ (1980).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621287/	Junius R. Judson v. Commissioner.Judson v. CommissionerDocket No. 7365.United States Tax Court1947 Tax Ct. Memo LEXIS 285; 6 T.C.M. (CCH) 242; T.C.M. (RIA) 47050; March 4, 1947285 Scott Stewart, Jr., Esq., 31 Exchange St., Rochester 4, N. Y. for the petitioner. Harold D. Thomas, Esq., for the respondent. HILL Memorandum Findings of Fact and Opinion HILL, Judge: Respondent determined a deficiency in petitioner's gift tax liability for the calendar year 1942 in the amount of $7,813.10. The question is whether a beneficial interest in a trust created by petitioner in favor of his former wife (pursuant to a property settlement agreement contemplating divorce, which agreement was adopted in the Nevada divorce decree) constituted a gift, as respondent contends, or was for an adequate consideration in money or moneys worth as petitioner contends. Petitioner filed a gift tax return for the year 1942 with the collector for the twenty-eighth district of New York. With the exception of one exhibit, petitioner's 1942 gift tax return, the case was submitted on the pleadings under which respondent admitted, with few exceptions, the facts relied on by petitioner in the petition. The facts pleaded by petitioner and admitted by respondent are hereby adopted. Findings of Fact Petitioner and his former wife, Bessie F. Judson, were married on February 17, 1906 and286 resided together in Rochester, New York until shortly prior to January 25, 1938 on which date they entered into a written separation agreement. Under this separation agreement petitioner undertook, among other things, to pay Bessie $500 a month for her support and maintenance. During the latter part of 1940 and early 1941, petitioner and his wife, through their respective attorneys, entered into negotiations initiated by petitioner to determine whether his wife would consider a divorce and if so, on what terms. No agreement was reached as a result of these negotiations. In the spring of 1942 petitioner wanted to marry another woman and initiated negotiations again with Bessie through their respective attorneys looking towards a property settlement. In connection with these negotiations an inventory was made of petitioner's estate on or about June, 1942. This inventory revealed that petitioner's net estate amounted to over $300,000. As a result of these negotiations petitioner and Bessie entered into an agreement dated October 1, 1942. This agreement recited that petitioner and Bessie had been living apart pursuant to a separation agreement and that immediate divorce was contemplated. 287 Petitioner agreed to establish a trust in favor of Bessie, the form of such trust being attached to the October first agreement. It was further agreed that: Except as otherwise specifically provided in the preceding paragraph Second hereof, each of the parties hereto shall retain his or her own property and hereby expressly releases to the other party any and all right or claim of any kind in and to the property of the other. The wife hereby releases the husband of and from all obligations which the husband might otherwise owe to the wife for her support and maintenance, and hereby agrees that she will not in any manner, and particularly in any action or proceeding demand, by way of alimony, or otherwise (except counsel fees in the divorce proceeding hereinabove referred to), any sums or payments in addition to or exceeding in any manner the provisions made for her in said agreement hereto annexed and marked "Exhibit A." Each of the parties hereto expressly releases the other party from any right to administer the estate of the other, and from any and all obligations of any kind whatsoever except as herein expressly provided. Each of said parties waives any right of election to take288 any intestate's share of any portion or share of the estate of the other under any relevant provision of law of any and all jurisdictions. On October 17, 1942 the Second Judicial Court of Nevada granted Bessie a final and absolute decree of divorce and further ordered that * * * said agreement entered into by the plaintiff and the defendant under date of October 1, 1942, a copy of which was introduced in evidence in this case and marked "Plaintiff's Exhibit A," be and the same is hereby approved and adopted by the Court; and that said parties be and they are hereby ordered and directed to comply therewith and to execute the terms thereof. Pursuant to the agreement of October 1, 1942 and the above quoted court decree, petitioner as settlor executed a trust agreement as of November 1, 1942. Subject to the terms of the trust petitioner transferred to the trustees the following property which was valued for gift tax purposes as indicated: Shares845 J. Hungerford Smith Stock$76,050.00170 U.S. Steel Common Stock8,430.94450 Rochester Button Common4,680.00200 R. H. Macy Co. Common4,006.25100 Loew's Inc. Common4,406.2530 Corn Exchange Bank1,029.387 U.S. Steel Preferred784.88$99,387.70289 The trustees were directed to pay Bessie during her lifetime as beneficiary the income from the trust quarterly, semi-annually or annually, as Bessie might request. If such income should be less than $8,000 for any year, the trustees were directed, if requested in writing by Bessie, to sell such part of the corpus as might be necessary to bring the distributable amount up to $8,000 for that year. At Bessie's death the trustees were to pay the corpus as then constituted over to other persons in a manner not here material. Petitioner on his gift tax return for 1942 reported as a gift the amount of $65,612.78 on account of the property transferred to the trust created by him as of November 1, 1942. This amount represents the value of the remainder interest in the trust and excludes the value of Bessie's life interest therein. Bessie was born February 17, 1878, and her age as of her birthday nearest in time to the date of the gift in trust, i.e., November 1, 1942, was sixty-five years. Based on American mortality tables the value of the remainder interest in the trust as computed by petitioner and not questioned by respondent, was $65,612.78, or $99,387.70 (the value of the property290 conveyed to the trust) multiplied by.66017. Respondent determined that the value of the taxable gift resulting from petitioner's creation of the November 1, 1942 trust was $100,337.70. This amount consists of the sum of $99,387.70 (the agreed value of the property transferred to the trust) and an amount of $950. It appears from a list attached to petitioner's gift tax return that the amount of $950 represented a note due to petitioner from his son, Thomas F. Judson, which note petitioner transferred to his wife as part of the divorce settlement. Respondent in the statement attached to the deficiency notice explained his determination as follows: It is held that the surrender by your former wife of her marital rights in consideration of the creation of a trust for her benefit does not constitute an adequate and full consideration in money or money's worth within the meaning of Sec. 1002 of the Internal Revenue Code. Accordingly, the full value of the property transferred to the trust, including the note due from Thomas F. Judson for $950.00, has been included for gift tax purposes. Bessie's release of petitioner from his legal obligation to support and maintain291 her constituted a full and adequate consideration in money's worth for petitioner's transfer in trust in her behalf. Opinion Respondent has filed no brief in the instant case. At the hearing respondent stated that essentially the same issue as is presented by the instant case was decided against him in the case of Edmund C. Converse, 5 T.C. 1014">5 T.C. 1014. Respondent stated at the hearing that he believes the Converse case to have been erroneously decided. This Court has followed the Converse case in the cases of Matthew Lahti, 6 T.C. 7">6 T.C. 7, and Clarence B. Mitchell, 6 T.C. 159">6 T.C. 159. Petitioner relies on these cases. Shortly prior to the hearing of the instant case the Bureau released E.T. 19 (1946-16-12367). This ruling distinguishes between a wife's inheritance rights such as dower and courtesy on the one hand, and her rights to support and maintenance on the other. Relying on Commissioner v. Wemyss, 324 U.S. 303">324 U.S. 303 and Merrill v. Fahs, 324 U.S. 308">324 U.S. 308, the Bureau in E.T. 19 [1946CB 166] considers a wife's relinquishment of her inheritance rights in her husband's property as not constituting full and adequate consideration for a transfer292 of property by the husband pursuant to an agreement incident to divorce. In this connection E.T. 19 [1946-2 CB 166] states "* * * a transfer to a wife under such a decree in settlement of inheritance rights is a present transfer of what would otherwise constitute a major portion of the husband's estate on death." But E.T. 19 [1946-2 CB 166] states that a wife's support or maintenance can be regarded as consideration for such a transfer because it "amounts to the liquidation of a presently existing obligation, the satisfaction of which does not have the effect of diminishing or depleting a husband's estate to any greater extent than the payment of other existing legal obligations." The ruling also discusses the question of allocating the value of the transfer between the release of inheritance rights and the release of support and maintenance rights. Assuming without deciding that E.T. 19 [1946-2 CB 166] represents the correct interpretation of the law, its application to the instant case would indicate that the transfer in question was not a gift. Under the agreement of October 1, 1942 petitioner's wife relinquished, among other things, 293 her right to support and maintenance. No attempt has been made by respondent to determine the value of this right or to allocate any portion of the transfer to its release. We have found as a fact that Bessie's release of her right to support and maintenance of and by itself constituted full and adequate consideration for petitioner's transfer in trust on her behalf. Petitioner was a man of substantial means. The inventory of his estate made on or about June, 1942, indicated a net estate of over $300,000. Under the original separation agreement of January 25, 1938 petitioner undertook to pay Bessie $500 a month in satisfaction of his obligation to support and maintain her, the equivalent of $6,000 a year. Under these circumstances we are satisfied and have so found, that petitioner's transfer in trust designed to secure to his ex-wife an annual income of $8,000 was supported by full and adequate consideration by virtue of Bessie's release of her right to support and maintenance. We conclude that the instant case, in so far as it relates to the November 1, 1942 trust, is governed by the Converse case, supra, and furthermore that it comes within the nongift features of E.T. 19 [294 1946-2 CB 166]. We hold that respondent erroneously determined that the wife's life interest in the trust was a taxable gift. Respondent determined that the amount of $950 representing a note due from Thomas Judson to petitioner and which petitioner transferred to Bessie, constituted a taxable gift. Petitioner has not assigned error in this connection and has made no mention of it on brief. Respondent's determination in this respect being presumptively correct, must stand and we so hold. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621289/	Warren H. Brown, et al., 1 Petitioners, v. Commissioner of Internal Revenue, RespondentBrown v. CommissionerDocket Nos. 50179, 50180, 50181, 50182, 50183United States Tax Court27 T.C. 27; 1956 U.S. Tax Ct. LEXIS 67; 27 T.C. No. 3; October 18, 1956, Filed 67 Decisions will be entered under Rule 50. 1. Petitioner corporation acquired assets from a partnership pursuant to an installment sales contract under the terms of which the consideration was to be paid in 10 equal annual installments. Title to the assets was reserved in the partners until the full purchase price was paid. Held, the sales contract was not stock or securities within the meaning of section 112 (b) (5), I. R. C. 1939, and the gain realized by the transferors on the transaction was recognized.2. Held, further, the basis to the transferee corporation of the assets acquired by it is the cost of the assets. Sec. 113 (a), I. R. C. 1939.3. Useful lives and salvage values of certain items of equipment used in logging and sawmilling business determined. W. D. Eberle, Esq., for the petitioners.John H. Welch, Esq., and Wilford H. Payne, Esq., for the respondent. Withey, Judge. WITHEY27 The respondent has determined deficiencies in petitioners' income tax for the years and in the amounts as follows:NameDocket No.YearDeficiencyWarren H. Brown501791947$ 2,024.20Jayne J. Brown5018319472,024.20Warren H. Brown and Jayne J. Brown5017919484,419.8250183194910,811.69Carl E. Brown5018019471,980.6619481,873.67Ida H. Brown5018219471,980.6619481,910.17Carl E. Brown and Ida H. Brown50180194910,653.1450182Brown's Tie & Lumber Co50181194726,805.56194825,049.84194930,095.41In addition to the foregoing, respondent in amended answers has claimed increased deficiencies against petitioners for 1947 and 1948 as follows:NameYearIncrease indeficiencyWarren H. Brown1947$ 3,732.9119487,494.92Carl E. Brown19473,674.9619483,455.78Ida H. Brown19473,672.9519483,494.92Jayne J. Brown19473,732.9119487,494.92Brown's Tie & Lumber Co19479,198.1019488,278.3069 28 The issues presented for our determination are the correctness of the respondent's action (1) in determining that the assets acquired by petitioner Brown's Tie & Lumber Company retained the same basis as they had in the hands of the partners prior to the transfer; (2) in determining that the installment agreement executed by Brown's Tie & Lumber Company on January 2, 1947, was without substance and in the nature of stock or securities within the meaning of section 112 (b) (5) of the Internal Revenue Code of 1939; and (3) in disallowing a portion of the deductions taken by Brown's Tie & Lumber Company as depreciation on equipment used in its business during the taxable years in question.FINDINGS OF FACT.Some of the facts have been stipulated and are found accordingly.Petitioners filed their income tax returns for 1947, 1948, and 1949 with the then collector of internal revenue for the district of Idaho. In addition, a partnership information return was filed on behalf of Brown's Tie & Lumber Company, a partnership, for each of the foregoing years.Brown's Tie & Lumber Company, a copartnership, hereinafter referred to as the partnership, was formed on January 1, 1938, to70 engage in the business of logging, milling, and marketing of lumber and other wood products. The partners were Carl E. Brown and Ida H. Brown who owned a one-half interest in the partnership as their community property, Warren H. Brown and Jayne J. Brown who owned a one-eighth interest as their community property, and Dorothy C. Brown, Margaret J. Brown, and Elizabeth Brown Harwood, the children of Carl and Ida Brown, each of whom also owned a one-eighth interest. On December 31, 1945, Warren acquired the one-eighth interest of each of the other children and thereby became the owner of a one-half interest. Carl was designated manager and Warren assistant manager of the partnership.During 1946 there developed a serious disagreement between Carl and his son, Warren, as to the management of their business. The basis for the disagreement between the two was insistence by Warren upon the extensive expansion of their business, while Carl, fearful that adverse economic variations in business generally might and probably would endanger the continued existence of the business, especially since it was conducted largely upon the basis of borrowed funds, was consistently insistent that no71 expansion program be adopted. As a result of the friction, they attempted to sell their lumber business and conducted negotiations with two prospective purchasers during the latter part of 1946. In connection with the foregoing negotiations, Warren and Patrick J. Hayes, the office manager 29 of the partnership, appraised the assets of the business and prepared an itemized list showing the market value of each asset.During 1946 the partnership frequently borrowed from the First Security Bank of Idaho amounts ranging from $ 50,000 to $ 160,000. Such loans for the most part were unsecured, short-term obligations maturing in not more than 90 days. J. L. Driscoll, president of the First Security Bank of Idaho, had advised and assisted Carl and Warren in business matters for many years. In the fall of 1946, Driscoll urged the Browns to incorporate their partnership business. Driscoll was particularly concerned with possible difficulty in the collecting of loans of the bank in the event of the death of either of the partners or their wives since the partnership interests would then become involved in probate and inheritance tax proceedings.Driscoll recommended to the partners72 that they consult J. L. Eberle, an attorney practicing in Boise, Idaho, with respect to the incorporation of their partnership business. The Browns authorized Driscoll to contact Eberle and to authorize him on their behalf to incorporate their business. The articles of incorporation subsequently were prepared and executed and were filed at Boise, Idaho, on December 30, 1946.Brown's Tie & Lumber Company, hereinafter referred to as the corporation, is a corporation organized under the laws of Idaho with its principal place of business at McCall, Idaho. The authorized capital of the corporation is $ 500,000, divided into 5,000 shares of common stock of $ 100 par value per share. The two principal stockholders, officers, and directors of the corporation at the time of its formation and at all times here material were Carl, president, and Warren, secretary.The first meeting of the shareholders and officers of the corporation was held on December 31, 1946, and at that time the proposed transfer of the partnership assets was considered. Carl then refused to consent to the conveyance of the logging and milling equipment to the corporation for additional stock because he feared that73 he would by so doing jeopardize his investment by subjecting all of the assets of the partnership to the risk of an expansion program to which he was bitterly opposed.Upon the refusal of Carl on December 31, 1946, to consent to the transfer of all of the partnership assets to the corporation, the petitioners, Carl and Warren, on behalf of the partnership, transferred current assets, including cash, accounts receivable, and inventory, and certain land and timber of the partnership, to the corporation. The assets which were transferred were sufficient to enable the corporation to conduct a lumber sales and marketing business had the directors desired to lease or contract the logging and milling operations, as was the general practice among timber operators in Idaho at that time.30 The total book value of the foregoing assets on the date of transfer was $ 358,448.96. The fair market value of the assets transferred on December 31, 1946, was $ 451,228.44, the difference of $ 92,779.48 representing appreciation in the value of the timber. The corporation assumed all of the partnership liabilities as of December 31, 1946, totaling $ 181,067.75, set up an open account payable to74 the partnership for $ 181.21, and issued to the partners jointly a stock certificate for 1,772 shares of its common stock having a par value of $ 177,200. Thus, valuing the timber and other assets at their fair market value, the corporation issued stock for assets having a net worth of approximately $ 270,000. The stock received by the partners in exchange for the assets conveyed to the corporation on December 31, 1946, was in proportion to their interests in the property prior to the exchange.Immediately following the first meeting of the shareholders of the corporation, Carl consulted J. L. Eberle regarding possible methods of arranging for the use of the remaining assets. Carl was advised that the partnership might contract with another party to handle the logging and milling operations and let the corporation market the lumber, or lease the logging and milling equipment to another logger and sawmill operator to cut and process the timber on behalf of the corporation. He was advised, as a third alternative, that the partners might sell the logging and milling equipment on a retaining contract, reserving title to themselves until the purchase price was paid.On January 2, 1947, 75 Carl informed J. L. Eberle that he would be willing to arrange for the transfer of the remaining partnership assets to the corporation on an installment sales contract. Thereupon, on behalf of the corporation, an installment agreement was executed bearing the date of January 2, 1947, and providing for the sale of the remaining assets of the partnership to the corporation for $ 605,138.75, payable in 10 equal annual installments, with interest at the rate of 4 per cent per annum. Payments were to be made to the partners without regard to the earnings of the corporation. No agreement was made by the partners not to enforce collection of the foregoing payments and interest. Title to the property transferred thereunder was reserved in the partners as seller. The corporation was given the right to anticipate the payments and to discharge its outstanding obligation at any time. Further, the corporation was required to keep the transferred assets insured for the benefit of both the buyer and seller as their interest might appear.On January 2, 1947, under the installment contract the partnership transferred to the corporation its remaining assets, including the millsite, sawmill and76 equipment for the logging and milling of timber, trucks, automobiles, and other assets formerly used by the partnership. The book value to the partnership of the assets so transferred was $ 270,480.73. The adjusted basis of the foregoing assets was 31 $ 279,602.60. The difference, in the amount of $ 9,121.87, between the book value of the foregoing assets to the partnership and their adjusted basis represents an adjustment by the respondent for depreciation taken for prior years. The fair market value of these assets on January 2, 1947, was $ 605,138.75. The valuation figures assigned to the assets sold to the corporation were the same figures as determined in the appraisal made by Warren H. Brown and Patrick J. Hayes in the summer of 1946 when the partners were contemplating a sale of their partnership business to another lumber company.All of the installment payments with interest provided in the installment agreement executed January 2, 1947, which became due during the years in issue have been paid.The sale of the assets by the partnership to the corporation which was contracted on January 2, 1947, has been consistently treated as a sale by the parties thereto, and77 the proceeds received under the installment sales contract executed on that date have been reported by the partners on their income tax returns as long-term capital gains.After the incorporation of the partnership business, the First Security Bank of Idaho extended additional credit to the corporation by raising its borrowing limits to approximately $ 300,000. This extension of bank credit enabled the corporation to purchase additional equipment and timberland which it had previously been unable to obtain. Accordingly, the business activities of the corporation subsequently were expanded. More than $ 600,000 was invested by the corporation in equipment during the period 1947 through 1949. During those years the corporation realized an average net profit of approximately $ 170,000 annually.The useful life of the logging equipment, including trucks, tractors, and automobiles used by the corporation in its logging and sawmill operations, was 4 years. The life of a 45-ton equipment trailer used in the operations was 3 1/3 years. The useful life of mixers, teletalk devices, electric hammers, and boilers was 5 years. The life of bus bodies, lumber carriers, and sundry equipment78 was 4 years. The useful life of office equipment was 7 1/2 years and of camp equipment was 5 years. The sawmill and sawmilling equipment and the automotive and logging equipment used by the corporation in its logging operations had no salvage value because of their distance from market at the time of the expiration of their useful life.OPINION.Petitioners contend that the execution of the installment contract on January 2, 1947, constituted a sales transaction, separate and distinct from the exchange of December 31, 1946, and created a valid debtor-creditor relationship between the partners and 32 the corporation. Petitioners therefore maintain that the gain realized on the transaction should be recognized, and that the corporation is entitled to utilize the fair market value of the assets at the time of the transfer as its basis for depreciation pursuant to section 113 (a) of the 1939 Code. 279 The respondent has taken the position that the exchange of assets for stock which took place on December 31, 1946, and the execution of the installment sales contract on January 2, 1947, together with the transfer of assets pursuant thereto, should be regarded as steps in a single transaction; that the installment contract between the partners and the newly formed corporation was without substance and, in fact, represented equity capital; and that the entire transaction in substance was an exchange of property for stock or stock and securities of a corporation controlled by the transferors. Consequently, the respondent contends that no gain is recognized in the transaction pursuant to the provisions of section 112 (b) (5) of the Code, 380 and that the basis to the transferee corporation of the partnership assets received by it is the same as that in the hands of the transferors immediately prior to the exchange under section 113 (a) (8)4 of the Code.In support of his position, respondent relies on our decisions in Estate of Herbert B. Miller, 24 T. C. 923 (on appeal C. A. 9), and Gooding Amusement Co., 23 T. C. 408,81 affd. 236 F.2d 159">236 F. 2d 159. Both cases 33 involve the incorporation of a partnership, and in each case the partnership assets were transferred to the new corporation in exchange for stock and notes. The noteholders in each instance were partners in the transferor and were in control of the corporation immediately after the exchange.In Estate of Herbert B. Miller, supra, the new corporation was created with a predominant debt structure (86 to 1 debt-stock ratio) and with no apparent business reason for so low a capitalization. The assets transferred by the partners to the corporation in exchange for the notes there in issue constituted substantially everything the corporation owned. Further, we there expressed doubt as to whether the claims of the noteholders were sufficiently secured so as to be upheld against the claims of general creditors. We held that the transferors had no bona fide intention to create a debtor-creditor relationship with the corporation, that the notes executed by the corporation were in fact representative of risk capital and in the nature of stock, and that since the transaction fell squarely within82 the provisions of section 112 (b) (5) of the Code, no gain was recognized to the transferors.In the instant case, however, the petitioners invested assets worth $ 270,000 in capital stock, whereas the installment sales contract created a corporate obligation in the amount of $ 605,138.75. Thus, the corporation was adequately capitalized, there being a debt-stock ratio of approximately 2 to 1. The obvious business reason for the execution of the installment sales contract here in question, and the transfer of the rights to the use and possession of a portion of the partnership assets to the corporation pursuant thereto, reserving title in the transferors, was the categorical refusal of Carl Brown to accept the risks attendant upon a further capital investment in the new corporation.Under Idaho law, the reservation in the transferors of title to personal property sold under an installment sales contract gives the transferor a right to possession and ownership superior to the rights of all other creditors of the transferee. Idaho Code Ann. 1947, sec. 64-801, 802; Sparkman v. Miller-Cahoon Co., 273">282 Pac. 273. The real estate included in the contract83 of sale remains the property of the partners so long as they retain record title. Idaho Code Ann. 1947, sec. 55-812.The Gooding Amusement Co. case, supra, is similarly distinguishable. There, as in Estate of Herbert B. Miller, supra, the corporation issued notes to the partnership, rather than execute a contract of sale reserving title in the transferors, as here. Unlike the sales contract here in question, the notes issued to the transferor by the Gooding Amusement Company were subordinated to the claims of other creditors. 34 Moreover, the majority of the notes there issued remained unpaid long after maturity, whereas the record herein discloses that all the installments due during the years in issue on the sales contract executed by the corporation on January 2, 1947, have been paid, with interest thereon. Further, we placed reliance on the failure of the taxpayers in Gooding Amusement Co., supra, to show that nontax considerations motivated the decision to accept the short-term judgment notes of the corporation in exchange for a portion of the assets transferred to it. We have described heretofore84 the independent business purpose underlying the execution of the installment sales contract here in issue. Finally, the ratio of debt to equity financing in the Gooding Amusement Co. case was 6.5 to 1, as compared with a 2 to 1 ratio here. We there held that no gain or loss was recognized under the provisions of section 112 (b) (5) of the Code on the ground that the notes received by the transferors in exchange for a portion of the assets transferred to the corporation were in fact evidence of equity capital.Respondent insists that the corporation here, as in the two foregoing decisions, could not have operated without all of the partnership assets. The record discloses, however, that Carl E. Brown was advised of the possibility of contracting the partnership logging and milling operations, as was the practice among timber operators in central Idaho at that time, and operating the newly formed corporation as a sales and marketing outlet. The assets transferred to the corporation on December 31, 1946, in exchange for stock were sufficient to enable the corporation to conduct a sales and marketing business. The partnership assets which the partners at that time refused to 85 convey to the corporation in exchange for stock were the logging and milling equipment. Thus, by separating the harvesting and processing operations from the marketing activities, the corporation could have continued to operate as a sales outlet without acquiring the assets purchased by it on January 2, 1947.For the foregoing reasons, we are of the opinion that neither Estate of Herbert B. Miller, supra, nor Gooding Amusement Co., supra, is controlling of the situation presented here.Respondent contends that the installment payments and interest received by the partners and treated by them as the proceeds of a sale actually constitute distributions in the nature of dividends. In support of his argument on this point, respondent calls to our attention the fact that no formal dividends had been declared by the corporation although the corporation had earnings and profits during the years in issue. Accordingly, respondent suggests that, inasmuch as each partner received more than $ 16,000 in payments and interest 35 from the corporation during each of the years in question, no formal dividend declaration was necessary. 86 The record discloses, however, that the corporation invested substantial amounts in additional equipment and timberland, thereby expanding its activities during the years in question, leaving little or no cash available for the payment of dividends.The courts have recognized that the consecutive steps involved in the incorporation of a business, occurring in immediate sequence, may nevertheless be entirely different in nature and therefore separate and distinct legal transactions, although closely related in time and purpose. Sun Properties, Inc. v. United States, 220 F. 2d 171; Marjory Taylor Hardwick, 33 B. T. A. 249; W. A. Hoult, 23 B. T. A. 804. Such a conclusion is strengthened by the additional fact that the consecutive transactions have separate business purposes. See W. A. Hoult, supra.Sun Properties, Inc. v. United States, supra, is directly in point here. There, the taxpayer corporation was formed by its sole stockholder on August 25, 1947. On September 1, 1947, the stockholder conveyed 2 lots to the corporation87 in exchange for 7 shares of stock. On September 15, 1947, the sole owner transferred a warehouse to the taxpayer pursuant to an agreement providing for payment to the transferor of consideration in the amount of approximately $ 125,000, payable at the rate of $ 4,000 semiannually, without interest. The purchase price was equal to the fair market value of the warehouse. The payments to be made to the sole stockholder were not dependent upon the earnings of the corporation and the contract, although unsecured, was not subordinated to the claims of general creditors. The United States Court of Appeals for the Fifth Circuit found, on the entire record, that the transaction consummated on September 15, 1947, constituted a bona fide sale by the stockholder to the corporation, rather than a contribution to capital.The facts apparent from the record before us would seem to require a similar conclusion here. In view of the apparent intention of the parties, the form of contract here in question, the reservation of title in the transferors until the full purchase price is paid, the obvious business considerations motivating the partners to cast the transaction in the adopted form, the88 substantial investment by the transferors in stock of the corporation, the superior position of the transferors' claims to the claims of the other corporate creditors, the fact that the contract price was equal to the stipulated fair market value of the assets transferred thereunder, the contract provision calling for fixed payments to the partners without regard to corporate earnings, the provision requiring the payment of interest to the transferors at a reasonable rate, 36 the absence of an agreement not to enforce collection, and the subsequent payment of all installments which became due under the contract during the years in issue, we are persuaded that the transaction which was consummated on January 2, 1947, was a bona fide sale as petitioners contend.Respondent contends in the alternative that the installment sales contract represents a security under section 112 (b) (5) of the 1939 Code. Securities, as that term is used in section 112 (b) of the Code, have been held to be instruments in the nature of bonds, debentures, or other obligations representing long-term advancements to the issuing corporation. John W. Harrison, 24 T. C. 46,89 affd. 235 F. 2d 587; Camp Wolters Enterprises, Inc., 22 T. C. 737, affd. 230 F. 2d 555; Wellington Fund, Inc., 4 T. C. 185. The question whether an evidence of indebtedness constitutes a security does not depend for its resolution upon a simple determination of the length of time the obligation is to run, but depends rather upon an over-all evaluation of the nature of the debt so as to ascertain whether or not the instrument issued evidences a continuing interest in the affairs of the corporation. Camp Wolters Enterprises, Inc., supra.The installment contract in question was not intended to insure the partners a continued participation in the business of the transferee corporation, but was intended rather to effect a termination of such a continuing interest. We are aware of no decision in which an installment sales contract reserving title in the seller has been held to qualify as a security within the meaning of section 112 (b) (5) of the Code, and respondent has cited none. Although in certain particulars the contract may resemble90 a bond, essentially it partakes of the nature of a contract of sale, and in our view does not constitute a security within the meaning of section 112 (b) (5) of the Code.In view of the foregoing, we hold that the execution of the installment sales contract on January 2, 1947, was a transaction separate and distinct from the exchange which was consummated on December 31, 1946, and created a valid debtor-creditor relationship between the transferors and the corporation. Consequently, under section 113 (a) of the 1939 Code, the basis for depreciation of the assets acquired by the corporation on January 2, 1947, is the cost of the assets to the corporation, which in this case is equal to the far market value thereof on the date of acquisition.Our findings of fact as to the useful lives of various items of equipment used by the corporation during the years in issue and our findings with respect to salvage value as to a portion of such equipment dispose of all matters involved in the issue relating to depreciation.Decisions will be entered under Rule 50. Footnotes1. Proceedings of the following petitioners are consolidated herewith: Carl E. Brown, Docket No. 50180; Brown's Tie & Lumber Company, Docket No. 50181; Ida H. Brown, Docket No. 50182; and Jayne J. Brown, Docket No. 50183.↩2. SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.(a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; * ↩3. SEC. 112. RECOGNITION OF GAIN OR LOSS.(b) Exchanges Solely in Kind. -- * * (5) Transfer to corporation controlled by transferor. -- No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. Where the transferee assumes a liability of a transferor, or where the property of a transferor is transferred subject to a liability, then for the purpose only of determining whether the amount of stock or securities received by each of the transferors is in the proportion required by this paragraph, the amount of such liability (if under subsection (k) it is not to be considered as "other property or money") shall be considered as stock or securities received by such transferor.↩4. SEC. 113 (a). Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that -- * * *(8) Property acquired by issuance of stock or as paid-in surplus. -- If the property was acquired after December 31, 1920, by a corporation -- (A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), or(B) as paid-in surplus or as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621291/	DAYTON WRIGHT AIRPLANE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Dayton Wright Airplane Co. v. CommissionerDocket No. 16915.United States Board of Tax Appeals17 B.T.A. 142; 1929 BTA LEXIS 2348; August 23, 1929, Promulgated 2348 Section 240(a) of the Revenue Act of 1918 does not provide for the filing of consolidated returns of the net income and invested capital of two corporations, one of which owns substantially all of the stock of the other, which corporations were each organized after August 1, 1914, and were not successor to a then existing business, and 50 per cent or more of the gross income of each of which consisted of gains, profits, commissions or other income derived from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive. W. W. Spalding, Esq., for the petitioner. John D. Foley, Esq., and L. W. Creason, Esq., for the respondent. MURDOCK 142 The Commissioner determined a deficiency in income and profits taxes for the calendar year 1919 in the amount of $832,397.63. The petitioner alleges that in making this determination the Commissioner erred (1) in holding that the petitioner and the Dayton Metal Products Co. were not affiliated and should not be permitted to file a consolidated return for 1919; (2) in increasing income by $8,220 representing additional value of 10,960 shares of 6 per cent2349 debenture stock of the General motors Corporation received by the petitioner in 1919; (3) in failing to credit the petitioner with $569,514.53 paid in 1920 on account of its 1919 tax liability, and (4) in failing to deduct the proper amount from invested capital on account of income and profits-tax liability for the year 1918. FINDINGS OF FACT. The petitioner is a corporation organized under the laws of the State of Ohio, with its principal office in Dayton, Ohio. During the taxable period involved herein, the petitioner was engaged in the manufacture of airplanes near Dayton, Ohio. The Metal Products Co. also had a plant in that city where it manufactured war supplies including airplane parts. The officers and directors of the two companies were the same individuals. 143 The Metal Products Co. furnished $1,000,000, the entire amount paid in for the petitioner's capital stock, and also advanced sums of money amounting to several hundred thousand dollars to the petitioner from time to time on open accounts on the books of the two companies when needed by the petitioner for working capital. In order that the petitioner might secure possession of the plant near2350 Dayton, where its operations were subsequently conducted, the Metal Products Co. built a plant at Dayton at a cost in excess of $500,000 for the Domestic Engineering Co., which latter then gave possession of its old plant to the petitioner. The Metal Products Co., by lending its credit and otherwise, assisted the petitioner to borrow money and at one time and for some time loaned the petitioner all of the capital stock of the petitioner which the latter deposited with the War Credit Board as collateral security for the repayment of advances made to the petitioner. The Metal Products Co. also assisted the petitioner in arranging for credit with which to purchase raw materials. The petitioner had contracts with the United States Government for the manufacture of airplanes on a cost-plus basis. Finished parts used in airplane construction were purchased by the petitioner from the Metal Products Co. at cost or less than cost to the Metal Products Co. so that but one profit would be paid by the Government. These transactions ran into hundreds of thousands of dollars and, as a result, the Metal Products Co. suffered an operating loss in 1919. The plant facilities and employees2351 of the Metal Products Co. were loaned by that company to the petitioner whenever they were needed. The parties have stipulated as follows: From January 1, 1918, to December 18, 1919, the Dayton Metal Products Co., a corporation organized under the laws of the State of Ohio, owned directly more than 99 per cent of the outstanding capital stock of the petitioner company, that is, all of such stock except qualifying shares held by members of the board of directors of the petitioner company. The Dayton Metal Products Co. and the petitioner were each organized after August 1, 1914, and neither was the successor to a business existing on that date. The Dayton Metal Products Co. and the petitioner each derived during the period from January 1, 1918, to December 18, 1919, more than 50 per cent of their respective gross incomes, including gains, profits, commissions and other income, from United States Government contracts made between April 6, 1917, and November 11, 1918. In computing the petitioner's invested capital for the 1919 taxable period here involved, the Commissioner deducted from the amount thereof, as otherwise computed, $753,883.53 as the petitioner's 1918 income2352 and profits taxes, in the amount of $1,783,905.96, prorated from the various dates of payment, which 1918 income and profits tax liability was computed by the Commissioner in accordance with his determination that the petitioner and the Dayton Metal Products Co. were not affiliated and should not be permitted to file a consolidated return for 1918. 144 If the Board of Tax Appeals holds that the two companies were affiliated for 1918, the deduction from their consolidated invested capital for taxes of 1918 will be determined under Rule 50 of the Board. If the Board of Tax Appeals holds that the two companies were affiliated for 1919, viz, for the period January 1, 1919 to December 18, 1919, the effect of such decision upon the tax liability of these two corporations for such period during 1919 will also be determined under Rule 50 of the Board. The notice of deficiency herein states that no amount was previously assessed against the petitioner for 1919. However, the petitioner paid $569,514.53 as income and profits taxes for 1919, which amount should be credited on its tax liability as determined in this proceeding. Upon such credit being given, the credit heretofore2353 existing in the amount just named, $569,514.53 in favor of the Dayton Metal Products Co. will be canceled. The Commissioner ruled that the petitioner and the Dayton Metal Products Co. were not affiliated and should not be permitted to file a consolidated return for 1918 or for the 1919 taxable period here involved, and this ruling is reflected in the deficiency letter attached to the petition which computes the tax liability of the petitioner as a separate corporation. At the time the ruling letter of July 7, 1919, (attached to the petition in this appeal) was issued, Hon. Daniel C. Roper was the Commissioner of Internal Revenue and Mr. J. H. Callan was Assistant to the Commissioner of Internal Revenue. Throughout 1926, in which year the deficiency letter was issued, and now, November 5, 1928, Hom. D. H. Blair was and is the Commissioner of Internal Revenue. The petitioner and the Metal Products Co. were not during the years 1918 and 1919 so affiliated within the meaning of section 240 of the Revenue Act of 1918 as to entitle them to file consolidated returns for those years. On December 18, 1919, the 6 per cent debenture stock of the General Motors Corporation had a value2354 of $86.6875 per share. OPINION. MURDOCK: The principal issue in this case is that of affiliation and it turns entirely upon the proper interpretation of section 240(a) of the Revenue Act of 1918. That section is, so far as pertinent hereto, as follows: That corporations which are affiliated within the meaning of this section shall, under regulations to be prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income and invested capital for the purposes of this title and Title III, and the taxes thereunder shall be computed and determined upon the basis of such return: Provided, That there shall be taken out of such consolidated net income and invested capital, the net income and invested capital of any such affiliated corporation organized after August 1, 1914, and not successor to a then existing business, 50 per centum or more of whose gross income consists of gains, profits, commissions, or other income, derived from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive. In such case the corporation so taken out shall be separately assessed on the basis of its own invested2355 capital and net income and the remainder of such affiliated group 145 shall be assessed on the basis of the remaining consolidated invested capital and net income. The petitioner contends that while the proviso above quoted undoubtedly has the effect of separating, for tax purposes, Government war contractors from peace-time industries, it has no effect upon the affiliation of peace-time industries with each other or Government war contractors with each other, therefore, the petitioner and the Dayton Metal Products Co. both being Government war contractors and the one owning directly substantially all of the stock of the other, were affiliated within the meaning of section 240 and entitled to file a consolidated return of net income and invested capital. In support of its contention, the petitioner quotes as follows from : In the first place, it is, as I conceive, a general rule in the interpretation of all statutes levying taxes or duties upon subjects or citizens, not to extend their provisions, by implication beyond the clear import of the language used, or to enlarge their operation so as to embrace matters, 2356 not specifically pointed out, although standing upon a close analogy. In every case, therefore, of doubt, such statutes are construed most strongly against the Government and in favor of the subjects or citizens, because burdens are not to be imposed, beyond what the statutes expressly and clearly import. Revenue statutes are in no just sense either remedial laws or laws founded upon any permanent public policy, and, therefore, are not to be liberally construed. The petitioner also quotes from , as follows (p. 791): The provision of the statute is a relief provision and, under the well known rules of statutory construction, if there is any doubt concerning its meaning, it must be liberally construed in favor of the taxpayer. Language may not be added or an interpretation made which deprives taxpayers of rights which the wording of the section construed in its ordinary meaning grants. It will be noted that the two rules of statutory construction set forth in the above quotations are only to be applied in cases of doubt as to the meaning of a statute. 2357 . Where the language of a statute is clear and free from doubt, there is no reason to apply these rules of statutory construction. In our opinion, section 240(a) very clearly provides that the net income and invested capital of any corporation organized after August 1, 1914, and not successor to a then existing business, 50 per cent or more of whose gross income consists of gains, profits, commissions, or other income, derived from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive, shall be taken out of any consolidated net income and invested capital of which it might otherwise form a part, and in such case, the corporation so taken out shall be separately assessed on the basis of its own invested capital and net income. In the present case there are 146 two such corporations, the net income and invested capital of which must be taken out of what might otherwise be consolidated net income and invested capital, and each of these corporations so taken out must be separately assessed on the basis of its own invested capital and net income. The use of the words "any, 2358 " "corporation," "separately," and "own" is most convincing of the intent which we have attributed to Congress in this connection. The petitioner would have us read the last sentence of the above quoted part of section 240(a) as if a number of the nouns were used in the plural and the sentence were as follows: In such case the corporations so taken out shall be separately assessed on the basis of their own invested capital and net income * * . In our opinion Congress did not intend that this sentence should be read in this way. The fact that section 240(a) further provides that the remainder of such affiliated group shall be assessed on the basis of the remaining invested capital and net income is not inconsistent with the decision we have reached nor does it make the other language of the section, including the proviso, doubtful. In this case there happens to be no remainder. Congress could have provided that the corporations taken out of the consolidated group might, in a proper case, be assessed on the basis of their consolidated invested capital and net income, but so far as we can see it did not so provide and no rule of statutory construction would allow us to extend2359 the provisions of the statute by implication beyond the clear import of the language used or to enlarge their operation so as to embrace matters not specifically pointed out, although standing upon a close analogy. The report of the Committee on Finance, relating to the Revenue Bill of 1918, contained the following language relating to consolidated returns: Provision has been made in section 240 for a consolidated return, in the case of affiliated corporations, for purposes both of income and profits taxes. A year's trial of the consolidated return under the existing law demonstrated the advisability of conferring upon the commissioner explicit authority to require such returns. So far as its immediate effect is concerned consolidation increases the tax in some cases and reduces it in other cases, but its general and permanent effect is to prevent evasion which can not be successfully blocked in any other way. Among affiliated corporations it frequently happens that the accepted intercompany accounting assigns too much income or invested capital to company A and not enough to company B. This may make the total tax for the corporation too much or too little. If the former, 2360 the company hastens to change its accounting method; if the latter, there is every inducement to retain the old accounting procedure, which benefits the affiliated interests, even though such procedure was not originally adopted for the purpose of evading taxation. As a general rule, therefore, improper arrangements which increase the tax will be discontinued, while those which reduce the tax will be retained. 147 Moreover, a law which contains no requirement for consolidation puts an almost irresistible premium on a segregation or a separate incorporation of activities which would normally be carried as branches of one concern. Increasing evidence has come to light demonstrating that the possibilities of evading taxation in these and allied ways are becoming familiar to the taxpayers of the country. While the committee is convinced that the consolidated return tends to conserve, not to reduce, the revenue, the committee recommends its adoption not primarily because it operates to prevent evasion of taxes or because of its effect upon the revenue, but because the principle of taxing as a business unit what in reality is a business unit is sound and equitable and convenient*2361 both to the taxpayer and to the Government. This report does not lead us to believe that section 240(a) as interpreted by us is not exactly what Congress intended. We therefore have found as a fact that the petitioner and the Dayton Products Corporation were not entitled to file a consolidated return under section 240(a) of the revenue Act of 1918. Our findings of fact sufficiently dispose of the question of the value of the General Motors Corporation stock at the time received by the petitioner and also of the question of the credit of $569,514.53 paid on account of its 1919 tax liability. The fourth allegation of error need not be discussed, bucause it only arises in case we hold that the two companies were entitled to file a consolidated return. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621292/	J. BROOKS B. PARKER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Parker v. CommissionerDocket No. 101676.United States Board of Tax Appeals44 B.T.A. 369; 1941 BTA LEXIS 1341; April 30, 1941, Promulgated 1341 A taxpayer, unmarried, who supports and maintains his aged aunt and her family in a residence necessarily apart from his own home, held, entitled as the head of a family to a personal exemption of $2,500. Philip Dechert, Esq., for the petitioner. Paul E. Waring, Esq., for the respondent. STERNHAGEN 369 The Commissioner determined a deficiency of $875 in petitioner's income tax for 1936. He disallowed the claim for personal exemption of $2,500 as head of a family. FINDINGS OF FACT. The petitioner is an individual, residing in Strafford, Pennsylvania. He is engaged primarily as an insurance agent in Philadelphia. He is unmarried. He has long lived in a house left to him by his parents, who had lived in it many years, and entertains frequently, often as an incident of his business. In the house next door, which he owns, he supports his aunt, aged ninety-three, and her family, all of whom are incapable of self-support except one, who earns $25 a week. Petitioner's mother supported this family before her death, and petitioner assumed and has continued such support as an obligation ever since. He is recognized by this family as1342 having the right to exercise family control and has exercised it. It would be inconvenient and impractical for the family to live in petitioner's house. Petitioner needs his house for his business purposes, the house is not large enough to accommodate all the persons of the family, the aunt could not be moved because of her age and physical condition, and her daughter has an illness which requires constant care. The circumstances are such that it is necessary that petitioner, on the one hand, and his aunt and her family, on the other, should live separately. OPINION. STERNHAGEN: The evidence shows that petitioner fulfills all of the qualifications prescribed by the regulations, article 25-4, Regulations 94, of the head of a family, covered by section 25(b)(1), Revenue Act of 1936. He actually supports and maintains one or more individuals who are closely connected with him by blood, has the right to exercise family control and provide for them, and this is based on a 370 moral or legal obligation. The separation of residence is a matter of necessity under the circumstances. The $2,500 personal exemption should have been allowed, *1343 ; ; ; ; ; ; . Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621293/	Georgia School-book Depository, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentGeorgia School-Book Depository, Inc. v. CommissionerDocket No. 108270United States Tax Court1 T.C. 463; 1943 U.S. Tax Ct. LEXIS 252; January 19, 1943, Promulgated 252 Judgment will be entered for the respondent. Petitioner, which was on an accrual basis, was a book broker, acting as a depository and distributor of school books. It represented various publishers in sales made by them of school books to the State of Georgia and was paid by them a percentage commission calculated on the sale prices obtained by the publishers. The state was obligated to pay for the school books only out of a "Free Textbook Fund" created and renewed from an excise tax on beer. During the taxable years this fund was not large enough to pay in full for the books purchased by the state. Held, the commissions payable to petitioner on account of school books sold to the State of Georgia were properly accruable to it in the years in which the sales were made. Leonard Haas, Esq., for the petitioner.J. Marvin Kelley, Esq., for the respondent. Kern, Judge. KERN 463 Respondent has determined deficiencies in petitioner's income tax for petitioner's fiscal years ended March 31, 1938 and 1939, respectively, in the amounts of $ 8,636.11 and $ 1,684.84, and a deficiency in excess profits tax for the year ended March 31, 1938 in the amount of $ 3,534.58. 253 The sole question presented is whether commissions on the sale of school books to the State of Georgia constitute income to petitioner in the year in which the sales were made or in the year of payment by the state, the petitioner being on an accrual basis.FINDINGS OF FACT.The facts herein have been mutually agreed upon by the parties on brief, and we adopt their agreement of facts as our findings herein. We set out herein only those facts which are necessary to an understanding of the problem presented.Petitioner is a corporation, and for the years in question filed its returns with the collector for the district of Georgia. Its books were kept on an accrual basis of accounting.464 Since its organization in 1924 the petitioner has acted as a depository or distributor, on a purely commission basis, of school books published by various publishers.On March 4, 1937, the State of Georgia enacted a Free Textbook Act, under which the state board of education was directed to inaugurate and administer a system of free textbooks for the public schools of Georgia, and to execute contracts therefor. The act provides that the cost of administering the free textbook system and purchasing254 the books shall be paid by the state from such funds as may be provided by the General Assembly for that purpose, and that "If funds sufficient to furnish the free textbooks for all grades shall not be available at any time, the Board shall give preference to the elementary grades." (Act of March 4, 1937; Session Laws, 1937, p. 899.) The Legislature thereupon created a free textbook fund, made up solely from excise taxes on the sale of malt beverages in the state. The act provides that funds derived from taxes on malt beverages shall be apportioned as follows: Not over 3 percent shall be paid to the revenue commission for enforcing the malt beverage act and "the remainder shall be set aside and devoted for the support of the common schools of the state and used for the purpose of furnishing free textbooks to the children attending the common schools"; any excess to be used for other school purposes. (Act of Jan. 17, 1938, Session Laws, 1937-1938, p. 419.)After the enactment of the Free Textbook Act, all school books used in Georgia schools were sold directly to the state by the various publishers, the contracts being made directly by the publishers with the state and all being 255 of a like tenor and effect and for a period of five years.Thereupon, petitioner became, under its contracts with its various publishers the distributor and custodian of the books. The contracts provided that "all books sold and delivered under the contract to the State of Georgia, f. o. b. Atlanta, Georgia, shall be invoiced to the state at the wholesale and/or exchange prices above set out"; but the invoices had on them "Sold to the Georgia School-Book Depository." Petitioner was further obliged to care properly for the books, to see that there was a sufficient number of books on hand at all times to meet the demands of the state, to collect the accounts due by the state for the books, and to deposit all moneys received from the state in a trust fund for the publisher's account, the petitioner being "absolutely responsible for the forthcoming of said monies at the time for remittance thereof * * ." The contract further provided for compensation to petitioner for its services as follows: "The second party [petitioner], at the time of settlement herein provided, shall receive as compensation for its services under this contract, eight 465 percent of the Net Wholesale or Wholesale256 Exchange Prices, respectively, at which the books are sold." Petitioner was required to render quarterly formal reports of all sales during the previous quarter, showing an inventory of all books on hand and the exact balance due the publisher by the petitioner, and it was further provided that: "The Depository shall remit to the publisher its pro rata share of all cash received from the collection of warrants issued by the State of Georgia for books sold to the State when and as such warrants are received." The contract specifically provided that the petitioner should be held accountable and responsible to the publisher for all books supplied on its order or disposed of by it or for their return in salable condition, but that it should "Not be held accountable or responsible for payment of books sold and delivered to the State of Georgia until the second party [petitioner] has received payment from the State of Georgia."Each of the contracts of the State of Georgia with the publishers required the publishers to keep a separate depository of some sort in the state where school books purchased by the state could be had in quantities at all times sufficient to comply with the needs257 of the public schools, and further provided as follows: "It is understood and agreed that the publishers shall be paid for these books from the Free Textbook Fund and all payments will be made pro rata, if not in full."When the State of Georgia purchased the school books, it owed the purchase price to the publishers and paid the publishers through the depository. After deducting its commissions, petitioner deposited the money in a trust fund, and remittances were sent to the publishers from this trust fund to apply on the balance due by the state. Petitioner's president had charge of this trust fund and countersigned the checks.The books were delivered or shipped by petitioner upon requisition or orders from the state department of education.After the execution of these contracts with the publishers large quantities of school books were purchased by the State of Georgia from the various publishers, and through March 31, 1938, the end of petitioner's fiscal year, the state had purchased from petitioner's publishers $ 875,893.88 worth of school books. During the same period petitioner received payments from time to time from the State of Georgia on these books, aggregating258 $ 400,679.57. These payments left a balance due petitioner's publishers by the state as of March 31, 1938 (the end of petitioner's fiscal year), of $ 475,304.31. At the end of the state's fiscal year on June 30, 1938, the state owed petitioner for its publishers $ 483,135.52 and the total owed by the state for all textbooks as of that date was $ 1,006,713.48. On the latter date the total amount of cash in 466 the state department of education available for textbooks was $ 6,297.69, and the total amount in the state treasury in the textbook fund was $ 67,589.77, which was set up as follows on the state books as of June 30, 1938:Balance in Textbook Fund in State Treasury $ 67,589.77. At June 30, 1938, there was due on the purchase of textbooks $ 1,006,713.48, these amounts representing balances on invoices for textbooks purchased, which is due and payable as funds from the State Malt Beverage and Wine tax become available, and for that reason is not listed as a current liability.During the next fiscal year of 1939 the state purchased from petitioner's publishers $ 464,112.80 worth of school books. Payments of $ 336,094.92 were made by the state to the petitioner259 during this time, leaving a balance of $ 603,322.19 due to petitioner's publishers as of March 31, 1939. At the end of the state's fiscal year on June 30, 1939, the state owed the petitioner for its publishers the sum of $ 508,348.52. The state owed all publishers as of this date the sum of $ 821,769.27. As of this same date the state's books showed a cash balance of $ 1,406.12 in the department of education for textbooks, and the amount in the state treasury in the textbook fund was $ 107,701.66, a total of $ 109,107.78, which was set up on the books of the state as follows:Accounts payable for textbooks at June 30, 1939 amounted to $ 821,769.27, which accounts ripen for payment when and as funds become available in the Textbook Fund. These accounts are therefore a present liability only to the amount now in the Textbook Fund, to-wit, $ 109,107.78, and the balance of $ 712,661.49 represents an encumbrance on the Fund's income in the next fiscal year.The following entry appears on page 55a of the Report of the State Auditor of Georgia for the year ended June 30, 1939:There is now a considerable investment in textbooks, probably in excess of two million dollars. Indebtedness260 for textbooks not covered by the reserve in the Textbook Fund, is only an encumbrance on income from the wine and beer tax allocations. The amount over the reserve of June 30, 1939, was $ 712,661.49. It was $ 865,236.25 as of June 30, 1938.The books of account of the state show that during the fiscal year ended June 30, 1938, $ 505,000 was diverted from the free textbook fund and applied to payment of teachers' salaries.Besides the school books sold to the State of Georgia, the petitioner handled for the publishers on a commission basis books on other accounts, books which were not on the state adopted list, and college books. Under these contracts with the publishers, the petitioner is responsible for the collection of all these accounts, and all of petitioner's liabilities on these accounts are accrued at the time of contracting such liabilities. Under petitioner's system it accrued all its income from these accounts at the time of contracting, except the income from the sale of books to the State of Georgia.467 In determining the deficiency against the petitioner the respondent held that the commissions on the sales of the books to the State of Georgia during the years261 1938 and 1939 were earned and accrued as income at the time of the sale of the books and that petitioner had erred in treating the commissions as earned or accrued only when payment for the books was made by the state.OPINION.The question is whether petitioner, which was on an accrual basis, should have accrued certain school book commissions at the time the books were sold by the publishers to the state, or should have returned them as income only when the books were paid for by the state, as petitioner contends.Petitioner was a broker which received an 8 percent commission on all school books purchased by the State of Georgia through it. For this commission it performed certain services of advantage to both parties, such as executing the contracts of the state board of education with various publishers, taking care of the books as a central depository until final distribution, seeing that enough were on hand to meet the state's demands, distributing them, and collecting the moneys in payment from the state and holding them in trust until paid over to the publishers. It was responsible for the return in salable condition of any books not used. It had no title to the books at262 any time, and (except in the case of one publisher) posted a bond with each publisher to guarantee performance of its duties. Petitioner also carried on a somewhat similar business as a book broker of college books not on the state list and under these contracts was responsible for the collection of all accounts.Petitioner did not accrue its commissions on the state books but did accrue its commissions on the college books at the same time that its liability for the books to the publishers was accrued. Under the contracts for state school books it was provided that petitioner should receive its brokerage "at the time of settlement" and this term is explained by the provision that the petitioner shall make quarterly reports "so as to show the exact balance due" the publisher by the petitioner, and shall remit "its pro rata share of all cash received from the collection of warrants issued by the State of Georgia for books sold to the state when and as such warrants are received."The publishers could look for payment from the state, and, consequently, petitioner could look for its commissions only from the "Free Textbook Fund," which was renewed only from the excise laid on beer. 263 During the taxable years 1938 and 1939 this fund was insufficient to pay the petitioner in full. The state, in its accounting, did not treat these large deficits as present liabilities except to the extent that funds were 468 already on hand to meet them, the remainder being considered an encumbrance on the textbook fund in the next year. The "accounts ripen," the auditor reported, "for payment when and as funds become available in the Textbook Fund."Petitioner contends, first, that the brokerage was not earned until payment, and, secondly, that there was no reasonable expectancy that payment ever would be made; and for these reasons, it urges its ultimate contention that the commissions here involved were not properly accruable in the respective taxable years.In so far as appears, all acts which were required of petitioner to earn its brokerage, save one, had been done in the taxable year. It had received the books from the publishers, stored them, and later distributed them to the several schools. All it had not done was to receive the money from the state and pay it out to the publishers. On this account the actual payment of the brokerage may not have been due to264 petitioner until this money was received, but the right to it had accrued by the performance of its duties. . It is the right to receive money which in accrual accounting justifies the accrual of money receivable and its return as accrued income.The Supreme Court said in (p. 184):* * * Keeping accounts and making returns on the accrual basis, as distinguished from the cash basis, import that it is the right to receive and not the actual receipt that determines the inclusion of the amount in gross income. When the right to receive an amount becomes fixed, the right accrues. * * The receipt of the money from the state, the deduction of petitioner's commission, and the transmission of the balance to the publishers were the least of its duties and can not be made the criterion of the arisal of the right. Paragraph 9 of the contract assumes that the publisher's right to payment had arisen, for it requires that the quarterly reports which petitioner was to submit should "show the exact balance due the first party by 265 the second party [petitioner] * * ." See ; ; and .The case of , relied upon by petitioner, may be distinguished on its facts, as it was in We pass, then, to the second question, whether there was a reasonable expectancy that the claim would ever be paid. Where there is a contingency that may preclude ultimate payment, whether it be that the right itself is in litigation or that the debtor is insolvent, the 469 right need not be accrued when it arises. This rule is founded on the old principle that equity will not require a suitor to do a needless thing. The taxpayer need not accrue a debt if later experience, available at the time that the question is adjudged, confirms a belief reasonably held at the time the debt was due, that it will never be paid. 266 (2d Cir.); (9th Cir.), and cases there cited at page 937. On the other hand, it must not be forgotten that the alleviating principle of "reasonable expectancy" is, after all, an exception, and the exception must not be allowed to swallow up the fundamental rule upon which it is engrafted requiring a taxpayer on the accrual basis to accrue his obligations, If this were so, the taxpayer might at his own will shift the receipt of income from one year to another as should suit his fancy. Cf. Clifton Manufacturing Co., I. T. C. 71. To allow the exception there must be a definite showing that an unresolved and allegedly intervening legal right makes receipt contingent or that the insolvency of his debtor makes it improbable. Postponement of payment without such accompanying doubts is not enough. In the case of , the court stated (at page 936) that "the principal issue is the time when the income accrued." Judgments had been given petitioner in May 1927 and December267 1928 by a Federal District Court, pursuant to an act of Congress conferring jurisdiction for the purpose of determining claims of sealers for unlawful seizure of their vessels by the United States in the Bering sea. The Commissioner had included the income in taxpayer's fiscal year ended January 31, 1930, and the Board of Tax Appeals sustained him. The taxpayer had not accrued or returned the adjudged damages as income in its fiscal year 1930, when it was paid and when also the right to appeal expired. The court said (at page 939) in respect of the two issues, legal contingency and reasonable expectancy:With respect to the contention that the absence of an appropriation makes the right conditional, we believe that such fact does not affect the right, but the realization of the right. Even if the judgment remained unpaid, the right would not be impaired. But the absence of an appropriation may be considered in connection with the condition in the general definition hereinabove mentioned, that there must be a reasonable expectancy that the right will be converted into money or its equivalent. Respondent points out that Congress has refused to make an appropriation to satisfy 268 the judgment rendered January 12, 1931, in (75 Cong. Rec., Part 2, pp. 1233, 1307; 79 Cong. Rec., Part 10, p. 10816). Respondent says, however, that he "does not wish even to seem to contend that the legislative branch of the Government does not usually appropriate moneys to satisfy judgments rendered against the United States." It is inconceivable that Congress would go through 470 the idle ceremony of enacting a statute authorizing the suits in question, and subsequently render it nugatory by the failure to make an appropriation. We believe that when the appeal time expired, there was a reasonable expectancy that the right would be converted into money.In conformity with the foregoing, we hold that income from petitioner's claim, on which it recovered judgment, accrued to petitioner during the fiscal year ending January 31, 1930.* * * In (2d Cir.) the question was whether the taxpayer had the right to accrue on its books and to return as income the entire amount awarded it by the German Mixed Claims Commission269 in the year of the award, 1928, and this question, depending on whether there was a reasonable expectancy that payment would be made in due course, was resolved as follows (at p. 267):We believe its [Bureau of Internal Revenue] original view was the correct one, at least to the extent of 80 per cent. of the award. It is true that payment of such awards was not absolutely certain in 1928, for that depended upon the continued willingness and ability of the German government to perform its engagements with the United States and upon the latter's continued co-operation in aiding award claimants to obtain payment; they had no means of enforcing collection for themselves. In this respect the petitioner's position differs from that of a creditor accruing upon his books an ordinary debt payable in the future. But the mere possibility of a change in legislative policy after the enactment of a statute granting compensation to claimants who shall obtain an award thereunder is not enough to prevent the application of the accrual basis of accounting if the facts which determine the claimant's rights are not contingent. ;270 (C. C. A. 2); (C. C. A. 2). In * . The petitioner's right to receive the amount of its award became fixed in 1928, and there then existed reasonable ground to believe that it would ultimately be paid. To the extent of 80 per cent. payment was to be expected within six years. Senate Report 273, p. 37, Seventieth Congress, 1st Sess. Committee on Finance, Settlement of War Claims Bill of 1928. To this extent at least it was proper to accrue it on the books in that year. Hence the inclusion of the sums received in 1929 and 1930 was erroneous.It should be noted that in the Automobile Insurance Co. case a lapse of six years was contemplated before payment, whereas here it is not suggested by petitioner that it would have to wait more than a year or so because of the state's diversion of money from the textbook fund, if that long.Needless to say that there is no analogy between the situation here and that of271 commissions on life insurance policy renewal premiums (see ), for there is no contingency as to obligation involved here.Applying these principles to the instant case, we must conclude that, despite the condition of the treasury of the State of Georgia when the 471 free schoolbook fund was inaugurated and for several years thereafter, there was no reasonable expectation that the sums owed by the state to petitioner's publishers and, consequently, the commissions to petitioner itself, would not ultimately be paid. It would naturally take a few years to establish in full working order a system of such magnitude, but a comparison of the two years before us shows that Georgia was gradually reducing its schoolbook obligations. Georgia is a state possessing great resources and a fine record of fiscal probity, and undoubtedly it can and will meet its obligations. The fact that petitioner, on behalf of its principals, continued to sell and deliver school books to the state indicates that there was no serious doubt as to the ultimate collection of the accounts here involved.We conclude, therefore, that petitioner's272 commissions on all books purchased by the state through it in the taxable years should have been accrued and returned as income in those years.Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621294/	Appeal of GULF COAST MACHINE & SUPPLY CO.Gulf Coast Machine & Supply Co. v. CommissionerDocket No. 1302.United States Board of Tax Appeals1 B.T.A. 757; 1925 BTA LEXIS 2804; March 16, 1925, decided Submitted February 19, 1925. 2804 H. A. Mihills, C.P.A., for the taxpayer. Benjamin H. Saunders, Esq., for the Commissioner. 757 Before JAMES, STERNHAGEN, and TRUSSELL. This appeal is from a proposed additional assessment of income and profits taxes for the year 1920 in the amount of $2,314.18, as set 758 forth in the Commissioner's deficiency letter of November 4, 1924. At the hearing, the Commissioner's answer was amended in respect of the amount of depreciation so as to increase the amount of the deficiency asserted in the 60-day letter. The taxpayer claims a deduction for depreciation, wear and tear, and obsolescence of buildings, machinery, and other business assets, which the Commissioner has disallowed as excessive. From the taxpayer's petition, documentary evidence and oral testimony taken at the hearing, the Board makes the following FINDINGS OF FACT. The taxpayer is a corporation engaged in the business of manufacturing oil well supplies, drilling equipment, etc., and operating a general machine shop, with its principal office at Beaumont, Tex. It began business in the location occupied in 1920 in the year 1919. The property in question consists of a machine2805 shop and other buildings situated on premises leased from the Santa Fe Railroad Co. under a year to year lease containing a clause whereby either party may, on 30 days' notice, terminate the lease. In contemplation of such termination of the lease, the taxpayer in 1922 acquired a tract of land nearby that might be used as a shop site. On this alleged anticipated termination of the lease the taxpayer bases its claim for obsolescence in 1920. The machine shop and blacksmith shop are constructed of steel framing with corrugated iron sides and roofing, as is common in such buildings, the machine shop having a cement floor with a wooden covering. There are other wooden sheds and smaller buildings adjacent. Under the terms of the lease these buildings may be removed by the taxpayer. Because of topographical depression, the premises become flooded during rainy seasons, causing rust and other damage to the machinery and buildings. The taxpayer claims a depreciation of 10 per cent on the machinery and equipment, and 20 per cent on the buildings, whereas the Commissioner allowed 5 per cent on the equipment and 10 per cent on the buildings. The present buildings have been occupied*2806 for seven years and are still in use. Machinery was acquired from time to time, the more expensive items, such as steam hammers, drills, and lathes, being bought second hand. In arriving at valuations for depreciation purposes, the taxpayer has used the book value of the property at the close of the year 1920. The Commissioner proposes in his amended answer a computation based on an average of the values of the property at the beginning and at the end of the year, but no evidence was introduced on which to base the proposed computation. DECISION. The determination of the Commissioner of a deficiency in tax for the year 1920, in the amount of $2,314.18, is approved.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621295/	SHIRAZ NOORMOHAMED LAKHANI, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent;SHIRAZ LAKHANI, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentLakhani v. Comm'rDocket Nos. 21212-10, 24563-11.1United States Tax Court142 T.C. 151; 2014 U.S. Tax Ct. LEXIS 7; 142 T.C. No. 8; March 11, 2014, FiledDecisions will be entered under Rule 155.For 2005-09, P, a professional gambler who bet on horse races, deducted his net wagering losses (either incurred during the year or carried over from prior years) in contravention of I.R.C. sec. 165(d). R disallowed those deductions and imposed an I.R.C. sec. 6662(a) accuracy-related penalty for all years. P argues (1) he is entitled to deductions for pro rata shares of the track's "takeout" from the parimutuel betting pools, which would wholly or partially offset the disallowed net wagering losses for the years at issue and (2) I.R.C. sec. 165(d) unreasonably discriminates against business losses of professional gamblers and constitutes a violation of their constitutional right to the equal protection of the laws. With respect to R's imposition of the I.R.C. sec. 6662(a) penalty, P argues he acted with reasonable cause and in good faith in deducting his net wagering losses for the years at issue.1. Held: Because "takeout" represents the track's share of a parimutuel betting pool and the expenses discharged therefrom are obligations imposed on the track, not the bettors, P is not entitled to deduct a pro rata share of all or any portion thereof.2. Held, further, applying the I.R.C. sec. 165(d) limitation on the deductibility of wagering losses to the wagering losses of a professional gambler is not an unconstitutional violation of the Equal Protection Clause.3. Held, further, the I.R.C. sec. 6662(a) accuracy-related penalty is sustained for all years.7 Shiraz Noormohamed Lakhani, Pro se.Nathan C. Johnston and Linette B. Angelastro, for respondent.HALPERN, Judge.HALPERN152 HALPERN, Judge: By notices of deficiency (notices), respondent determined deficiencies in income tax and penalties for petitioner's 2005-09 calendar taxable years as follows:PenaltyYearDeficiencysec. 66622005$22,571$4,514200618,4623,69220079,9181,98420087,4011,48020095,9651,193 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. All dollar amounts have been rounded to the nearest dollar.153 After concessions, the issues for decision are whether petitioner, a professional gambler, is, for the years at issue, (1) entitled to a deduction for his losses from wagering transactions in excess of his gains from such transactions (whether those net losses were incurred during the taxable year or used by means of a net operating loss carryover) and (2) liable for the section 6662 accuracy-related penalty.28 FINDINGS OF FACT3Some facts are stipulated and are so found. The stipulation of facts, with accompanying exhibits, is incorporated herein by this reference.At the time the petition was filed, petitioner resided in Woodland Hills, California.For each of the years at issue, petitioner, a certified public accountant, maintained an accounting practice, which included the preparation of tax returns for clients. He reported the income and expenses from his accounting practice on a Form 1040, U.S. Individual Income Tax Return, Schedule C, Profit or Loss From Business. During those years, petitioner was also a professional gambler whose gambling activities were limited to parimutuel wagering on horse races. To that end, petitioner placed bets on races occurring9 both at California racetracks and at racetracks in other States. He reported the results from his wagering on a separate Schedule C (gambling Schedule C) for each of the years at issue. On each of the gambling Schedules C, petitioner reported the gross amount he received on (winning) bets as "Gross receipts or sales", and he reported the amounts he had bet as "Cost of goods sold", subtracting the latter from the former, to determine his gross income or his loss from 154 gambling. He also reported and deducted miscellaneous other expenses associated with his gambling activities410 and reported the sum of his gambling winnings, losses, and miscellaneous other expenses as his income or loss (net wagering income or loss, respectively) from gambling for the year. He then combined his net wagering income or loss with his accounting practice income for the year and reported the sum of the two on page 1, line 12 of his Form 1040 as his total net "Business income or (loss)" for the year.For each of 2005, 2006, 2008, and 2009 (gambling loss years), petitioner's net wagering loss exceeded his accounting practice income, so that line 12 of each Form 1040 reported a business loss. For 2007, in which he reported a net wagering gain, and for 2009, petitioner claimed net operating loss carryover deductions all or a portion of which, presumably, arose out of unused net wagering losses incurred in prior years. Among respondent's adjustments for each of the gambling loss years is the disallowance of petitioner's deduction for his net wagering losses on the basis of section 165(d), which provides: "Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions."5 Respondent also disallowed the net operating loss carryovers to 2007 and 2009.155 OPINIONI. Deductibility of Petitioner's Net Wagering LossesA. Parties' Arguments1. Petitioner's ArgumentsPetitioner bases his argument that he is entitled to deduct his wagering losses in excess11 of his wagering gains under sections 162(a) (as ordinary and necessary business expenses), 165(a) (as losses), and/or 212(1) (as expenses for the production of income) on two alternative grounds. One, for each of the parimutuel bets that he made he is entitled to deduct that portion of the bet equal to the takeout percentage that applies to the parimutuel pool formed to receive that bet. Two, section 165(d) is inapplicable to professional gamblers. We will address those arguments in turn.a. Deductibility of TakeoutBefore addressing petitioner's arguments, we will describe the concepts of parimutuel wagering and takeout.612 In parimutuel wagering, applicable to, among other events of chance, betting on horse races, the entire amount wagered is referred to as the betting pool or "handle". The pool can be managed to ensure that the event manager (in horse racing, the track) receives a share of the betting pool regardless of who wins a particular event or race. That share is referred to as the takeout, and the percentage, set by State law, varies from State to State, generally ranging from 15% to 25% and often depending upon the type of bet, e.g., "straight" or "conventional" win, place, or show wagers or "exotic" (multiple horse or multiple race) wagers, the latter 156 usually resulting in higher takeout percentages.7 The takeout is used to defray the track's expenses, including purse money for the horse owners, taxes, license fees, and other State-mandated amounts. What remains from the takeout after those liabilities are provided for constitutes the track's profits. The takeout may also be used to cover any shortfall in the amount available in the parimutuel pool, after reduction for takeout, to pay off the winning bettors. That circumstance, generally referred to as the13 creation of a "minus pool", arises by virtue of the requirement, in many States, that the track provide a minimum profit to winning ticket holders. See, e.g., California Horse Racing Board Rule 1960, which provides, in pertinent part, as follows: "The association must pay to the holder of any * * * [winning ticket or tickets] the amount wagered * * * plus a minimum of 5% thereof. This requirement is unaffected by the existence of a parimutuel pool which does not contain sufficient money to distribute said 5% to all persons holding such tickets." Thus, on those presumably rare occasions when an overwhelming favorite finishes in the money (wins, places, or shows) and, pursuant to the actual odds, pays something less than $2.10 on a $2 bet (say $2.05), the extra nickel due each winning bettor on a $2 bet will constitute an additional amount that must be extracted from the takeout, see, e.g., Cal. Bus. & Prof. Code (Cal. Code) sec. 19613.5 (West 2008), an occurrence that might cause the track to lose money on the race. The balance of the betting pool remaining after reductions for takeout and "breakage" (the odd cents not paid to winning bettors because payoffs are rounded down to the nearest dime), is paid14 out to the winning bettors.Petitioner argues that, in extracting takeout from the betting pools, "[t]he tracks are acting in the capacity of a fiduciary, i.e., collection of taxes and fees which they are remitting to the different state and local tax authorities." He likens the process to that of an "employer collecting payroll taxes from the employees and remitting them to the IRS and the state agencies." He argues that his pro rata share of the 157 takeout constitutes the business expense of a professional gambler and, as such, is not a loss from wagering transactions subject to disallowance under section 165(d). In support of that argument, petitioner relies primarily upon our Opinion in Mayo v. Commissioner, 136 T.C. 81">136 T.C. 81, 97 (2011), in which we held that nonwagering business expenses claimed in connection with carrying on a gambling business are deductible under section 162(a) and not subject to the section 165(d) limitation on the deductibility of wagering losses.At trial, petitioner argued that he is entitled to deductions or losses under section 162,15 165, or 212 on the basis of a blended (average) takeout rate of 19% as applied to his wagers for the years at issue. On brief, he states his willingness to settle for a "minimum 15% take out percentage" as applied to those wagers. In the gambling loss years, he calculates that that would result in expense or loss deductions of $64,235 for 2005, $78,359 for 2006, $66,624 for 2007,8 $46,919 for 2008, and $36,535 for 2009.916 He argues for the deductibility of those amounts on the basis of Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540 (2d Cir. 1930), which holds that, in the absence of adequate substantiation of deductible expenditures, the taxpayer is entitled to a deduction, under section 162, for a reasonable estimate of such expenditures. See id. at 543-544. Only for 2009 does petitioner's estimated takeout deduction exceed his disallowed net wagering loss. In the other three gambling loss years, the alleged takeout deduction covers only a fraction of the net wagering loss disallowance. See supra note 5.158 b. Applicability of Section 165(d)Petitioner argues that section 165(d) does not apply to the expenses, including the net wagering losses, of a professional gambler. Petitioner states his position as follows:Professional gamblers should be allowed the same protection as any other profession when the activity is legal and conducted as a profession. In a lawful and democratic society, Congress enacted this law many decades ago, only because at that time, "gambling was taboo". Now gambling is legal in most States in the Union and this law is unjust, not interpreted correctly. In my opinion the intention of Congress, even then, was not to penalize any profession but to prevent abuse when it was conducted as a recreation. Section 165(d) should be considered unconstitutional and struck down as gambling is part17 of American life and professional gamblers are recognized in society and on television.In support of his view that, today, section 165(d) constitutes a discriminatory, unconstitutional deprivation of professional gamblers' right to the equal protection of the laws, petitioner cites the following paragraph from our Memorandum Opinion in Tschetschot v. Commissioner, T.C. Memo 2007-38">T.C. Memo. 2007-38, 2007 WL 518989">2007 WL 518989, at 5, in which we sustained the disallowance of a professional poker player's net losses from tournament poker against the taxpayer's equal protection argument:The moral climate surrounding gambling has changed since the tax provisions concerning wagering were enacted many years ago. Not only has tournament poker become a nationally televised event, but casinos or lotteries can be found in many States. Further, the ability for the Internal Revenue Service to accurately track money being lost and won has improved, and some of the substantiation concerns, particularly for professionals, no longer exist. That said, the Tax Court is not free to rewrite the Internal Revenue Code and regulations. We are bound by the law as it currently exists, and we are without the ability to speculate on what it should be. * Petitioner responds to the last two sentences of the quoted excerpt18 from Tschetschot with the hope that "the judiciary is at some time [presumably, meaning this Court in this case] going to take a bold stance and help to reverse section 165(d) of the Internal Revenue Code."Lastly, petitioner relies on Cronan v. Commissioner, 33 B.T.A. 668">33 B.T.A. 668, 670 (1935), and Beaumont v. Commissioner, 25 B.T.A. 474">25 B.T.A. 474, 482 (1932), aff'd, 73 F.2d 110">73 F.2d 110 (D.C. Cir. 1934), in which we acknowledged with approval the Commissioner's 159 position that losses incurred in betting on horse races for profit where legal are deductible.2. Respondent's ArgumentsWith respect to petitioner's alleged right to a deduction for his pro rata share of the takeout, respondent argues (1) because takeout is paid from the pool remaining from losing bets,10 it "is inseparable from the wagering transaction and constitutes wagering losses" subject to the section 165(d) limitation and (2) the taxes, license fees, and other expenses discharged from the takeout are expenses owed and paid by the track, not by the individual bettor. Respondent also argues that, even if a deduction for takeout were available to petitioner, his failure to furnish the factual information necessary to make a reasonable determination of the takeout percentage applicable to his losing bets (e.g., the extent to which those bets were attributable to the various parimutuel pools with varying takeout percentages at tracks19 in various States) is sufficient to bar petitioner's right to a passthrough deduction for takeout.With respect to petitioner's equal protection argument, respondent points out that, in Tschetschot, we rejected that argument on the basis of our holding in Valenti v. Commissioner, T.C. Memo. 1994-483, 1994 WL 534499">1994 WL 534499. In Valenti, after noting the historical distinction between gambling and other forms of business activity, we held that "a classification that differentiates the business of gambling from other business has 'a rational basis, and when subjected to judicial scrutiny * * * [it] must be presumed to rest on that basis if there is any conceivable state of facts which would support it'". T.C. Memo. 1994-483, Id., 1994 WL 534499, at 4 (quoting Carmichael v. S. Coal & Coke Co., 301 U.S. 495">301 U.S. 495, 509, 57 S. Ct. 868">57 S. Ct. 868, 81 L. Ed. 1245">81 L. Ed. 1245 (1937)). We concluded: "The argument that section 165(d) violates equal protection as applied to those engaged in the trade or business of gambling borders on the frivolous." Id. Thus, respondent argues that petitioner's equal protection argument is contrary to settled law and, therefore,20 should be rejected.160 B. Analysis1. Petitioner's Right to a Deduction for TakeoutPetitioner makes no argument that a parimutuel betting pool is either a cost-sharing arrangement or a business entity (such as a partnership) in whose profits and losses he is entitled to share. His only argument is that, on his behalf, the track was paying his expenses, of a type, such as taxes and license fees, that he could deduct as, for instance, section 162(a) ordinary and necessary business expenses. We agree with respondent that the taxes, license fees, and other expenses discharged from the takeout are expenses imposed upon the track, not the bettors. That that is so may be illustrated by Cal. Code secs. 19400-19668, addressing horse racing and, in particular, secs. 19610-19619, addressing license fees, commissions, and purses.The term "association" is defined in Cal. Code sec. 19403 to mean "any person engaged in the conduct of a recognized horse race meeting." Cal. Code sec. 19411 defines parimutuel wagering. In pertinent part, that section provides: "The association distributes the total wagers comprising each pool, less the amounts retained for purposes specified in this chapter [i.e., the takeout], to winning bettors based on the official race results." The21 amounts retained represent a percentage of the total amount handled in conventional and exotic parimutuel pools. Cal. Code sec. 19610 (West 2008). The actual percentage retained is 15% for conventional pools, 16.75% for exotic pools; it is 17.75% for harness racing tracks. Id. Cal. Code sec. 19611 sets forth the portions of the takeout that thoroughbred associations must pay as license fees, distribute to the California Thoroughbred Breeders Association (for expenses, educational, and other purposes), or distribute as purses and commissions. Nowhere in the statute is responsibility for any of those payments imposed on persons making bets.1122 161 Petitioner's attempt to analogize the track's retention and disbursement of takeout to an employee's payroll tax obligations with respect to his employees is misguided. First and foremost, none of the payments the track makes from the handle discharge any obligation of any bettor. And while reduction of the parimutuel pool by the amount of the takeout reduces the amount in the pool available to pay winning wagers (i.e., it reduces the bettor's odds should he win12), none of the takeout can be said to come from a winning bettor's wager, which in all events must be returned to him in full and with at least a small profit.13 Nor can the takeout be said to add to the loss of a losing bettor, who loses the same $2 whether the takeout is 15% of the handle, 20% of the handle, or none of it on23 account of a minus pool so deep as to deprive the track of any take after paying all winning wagers.1424 Moreover, not being an obligation or expense of the bettor, takeout cannot qualify as the bettor's deductible 162 nonwagering business expense under Mayo v. Commissioner, 136 T.C. at 97.On the basis of the foregoing, we hold that petitioner is not entitled to a passthrough deduction, under section 162, 165, or 212, for a pro rata share of takeout.2. The Validity of Section 165(d)We agree with respondent that the reasoning in our Opinion inValenti is dispositive of petitioner's equal protection claim. In Valenti, we held that the application of section 165(d) to the net gambling losses of a professional gambler does not violate the gambler's constitutional right to the equal protection of the laws. We would add to Judge Raum's refutation of the taxpayer's argument to the contrary only that the dissipation, in recent times, of the historical moral opposition to gambling does not undercut the "rational basis" for treating professional gambling losses differently from other business-related losses. H.R. Rept. No. 73-704 (1934), 1939-1 C.B. (Part 2) 554, is the report of the Committee on Ways and Means accompanying H.R. 7835, 73d Cong. (1934), which,25 as enacted, became the Revenue Act of 1934, ch. 277, 48 Stat. 680">48 Stat. 680. The Revenue Act of 1934 sec. 23(g), 48 Stat. at 689, is the predecessor to section 165(d), and H.R. Rept. No. 73-704, supra, 1939-1 C.B. (Part 2) at 570, explains that new provision as follows:Section 23(g). Wagering losses: Existing law does not limit the deduction of losses from gambling transactions where such transactions are legal. Under the interpretation of the courts, illegal gambling losses can only be taken to the extent of the gains on such transactions. A similar limitation on losses from legalized gambling is provided for in the bill. Under the present law many taxpayers take deductions for gambling losses but fail to report gambling gains. This limitation will force taxpayers to report their gambling gains if they desire to deduct their gambling losses.The basis for the enactment of section 23(g), as set forth in the last sentence of the foregoing committee report, still pertains to taxpayer reporting of gambling gains and losses. Therefore, it still constitutes a "rational basis" for the continued application of section 165(d) to the losses.15 There being 163 no constitutional impediment to the continued application of section 165(d), we reiterate our admonition in Tschetschot that this Court "is not free to rewrite the Internal26 Revenue Code and regulations * * * [but is] bound by the law as it currently exists". Tschetschot v. Commissioner, T.C. Memo. 2007-38, 2007 WL 518989, at 5. See also Nitzberg v. Commissioner, 580 F.2d 357">580 F.2d 357, 358 (9th Cir. 1978), rev'gT.C. Memo 1975-228">T.C. Memo. 1975-228, and Mayo v. Commissioner, 136 T.C. 81">136 T.C. 81, 90 (2011), both of which hold that a professional gambler's wagering losses in excess of wagering gains are nondeductible under section 165(d).Lastly, we note that petitioner's reliance on our decisions inCronan andBeaumont is misplaced as both those decisions involved tax years before the effective date, and were superseded by the 1934 enactment, of section 23(g).C. ConclusionPetitioner is not entitled to deduct all or any portion of his net gambling losses.II. Imposition of the Section 6662(a) Accuracy-Related PenaltyA. Applicable LawSection 6662(a) and (b)(1)-(3) provides for an accuracy-related penalty (penalty) in the amount of 20% of the portion of any underpayment attributable to, among other things, negligence or intentional disregard of rules or regulations (without distinction, negligence), any substantial understatement of income tax, or any substantial valuation misstatement.27 Although the notices issued to petitioner state that respondent bases his imposition of the penalty upon "one" of the three above-referenced grounds, it is clear that only the first two (negligence and substantial understatement of income tax) are potentially applicable herein.A substantial understatement of income tax exists for an individual if the amount of the understatement exceeds the greater of 10% of the tax required to be shown on the return or $5,000. Seesec. 6662(d)(1)(A). At the conclusion of the trial, the Court asked respondent to provide the Court with computations, incorporating the issues settled before trial, that would show whether there would be a substantial understatement of income tax for each of the years at issue 164 assuming we found for respondent on the section 165(d) issue. In response to that request, on May 16, 2013, respondent filed a status report for each of the consolidated cases establishing that petitioner's understatements of income tax for the years at issue are substantial as they exceed both 10% of the correct tax and $5,000.1628 Therefore, we need not consider the grounds for determining whether petitioner was negligent within the meaning of section 6662(b)(1).Section 6664(c)(1) provides that the penalty shall not be imposed with respect to any portion of an underpayment if a taxpayer shows that there was reasonable cause for, and that the taxpayer acted in good faith with respect to, that portion.The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. * * * Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of * * * law that is reasonable in light of all of the facts and circumstances, including the experience, knowledge, and education of the taxpayer. * * Sec. 1.6664-4(b)(1), Income Tax Regs.B. AnalysisUnder section 7491(c), respondent bears the burden of production, but not the overall burden of proof, with respect to petitioner's liability for the section 6662(a) penalty. See Higbee v. Commissioner, 116 T.C. 438">116 T.C. 438, 446-447 (2001). We have previously stated that the "burden imposed by section 7491(c) is only to come forward with evidence regarding the appropriateness of applying a particular addition to tax29 or penalty to the taxpayer." Weir v. Commissioner, T.C. Memo. 2001-184, 2001 WL 829881">2001 WL 829881, at 5. By demonstrating that petitioner's understatements of income tax exceed the thresholds for a finding of "substantial understatement of income tax" under section 6662, respondent has satisfied his burden of production.On brief, petitioner argues that he "should not be liable for the section 6662 penalty * * because * * * [he] was not aware of section 165(d) * * * [,] there was reasonable cause165 and * * [he] acted in good faith with respect to the understatement * * * [,] [he] did not intentionally ignore the law [, and he] exercised due care in reporting the numbers on his tax returns". We held in Carlebach v. Commissioner, 139 T.C. 1">139 T.C. 1, 16-17 (2012), that a taxpayer cannot avoid the application of the section 6662(a) penalty by pleading that he acted with reasonable cause and good faith on account of his ignorance of the applicable law. As we stated in that case: "A taxpayer's ignorance of the law is no excuse for failure to comply with it."Moreover, petitioner, a certified public accountant with an active tax preparation practice, and admittedly aware of section 165 governing the deductibility of losses, should have been aware of the section 165(d) limitation on net gambling losses. Also, as a professional gambler who regularly bets on horse races and understands parimutuel betting,30 he must have known that takeout represents the track's share of the betting pool and that the expenditures therefrom satisfy obligations of the track, not the bettors. Moreover, as respondent points out, petitioner's argument that he is entitled to deduct a pro rata portion of the takeout was not reflected on his returns for the years at issue and, more than likely, represents an argument developed for trial rather than a good-faith position taken at the time he prepared those returns.C. ConclusionPetitioner is liable for the section 6662(a) accuracy-related penalty for the years at issue.Decisions will be entered under Rule 155.Footnotes1. Petitioner filed a petition with respect to 2005 and 2006 (docket No. 21212-10) in the name of Shiraz Noormohamed Lakhani and a petition with respect to 2007-09 (docket No. 24563-11) in the name of Shiraz Lakhani. The cases were consolidated by order of this Court dated August 17, 2012.↩2. There are also certain computational adjustments that follow from the adjustments at issue, but they are not in controversy, and we need not discuss them.3. Petitioner in his answering brief has not made reference by number to those findings of fact proposed by respondent to which he objects, as required by Rule 151(e)(3). We, therefore, deem petitioner to have conceded the accuracy of respondent's proposed findings of fact with respect to which we discern he raises no objection in his answering brief, except to the extent that his own proposed findings of fact are inconsistent therewith. See Jonson v. Commissioner, 118 T.C. 106">118 T.C. 106, 108 n.4 (2002), aff'd, 353 F.3d 1181">353 F.3d 1181↩ (10th Cir. 2003).4. Although the miscellaneous other expenses petitioner deducted for 2005 and 2006 are treated as nondeductible in the notice covering those years, respondent now concedes their deductibility on the grounds that they constitute deductible nonwagering business expenses of a professional gambler. See Mayo v. Commissioner, 136 T.C. 81">136 T.C. 81, 97↩ (2011).5. Petitioner's disallowed net wagering losses for the gambling loss years were as follows:YearAmount↩2005$81,7932006110,196200860,454200936,2406. It is interesting to note that the nature of parimutuel betting came before our predecessor, the Board of Tax Appeals, in its first year. See McKenna v. Commissioner, 1 B.T.A. 326">1 B.T.A. 326, 332 (1925), in which we stated:The question before us resolves itself to this: What was the actual gain resulting to the taxpayer from his handbook operations? In the pari mutuel system of wagering on horse racing the odds are fixed after the race is won. All the money bet forms a pool out of which payments of a fixed percentage are made to the State and to the licensed commission under whose auspices the races are run, the residue being apportioned to the bettors. Thus the track odds determined. * 7. The various types of straight or conventional wagers (i.e., bets to win, place, or show) and exotic wagers (e.g., exacta, quinella, and trifecta bets) each form separate and distinct parimutuel betting pools. See, e.g., Cal. Bus. & Prof. Code sec. 19412↩ (West 2008).8. The deductibility of petitioner's 2007 wagering losses is not in dispute because they did not exceed his 2007 wagering gains. Therefore, they are fully deductible against those gains under sec. 165(d)↩.9. It is unclear whether petitioner is arguing that he should be able to deduct those amounts in full or only that presumably lesser portion of each amount corresponding to the taxes and license fees paid by the track. On brief, he asks that we uphold his deducting the amounts that "he paid to the race tracks for taxes and licenses which in turn paid the same to the state and local [government]". The distinction is of no matter since we reject his argument that he is entitled to any deduction on account of takeout.10. As noted supra↩, the takeout percentage is applied to the entire betting pool, but, because the winning bettors are entitled to recover the amounts of their bets (i.e., the amounts they contributed to the pool) plus their winnings, the takeout must, of necessity, come from the losing bets.11. Petitioner's testimony at the trial, in which he agreed with respondent's counsel that "all my bets are not on California horse tracks only", indicates that a substantial portion of his bets, probably a majority, were placed at tracks in California, his State of residence. Thus, California law applicable to takeout is particularly relevant to petitioner. Moreover, the various descriptions of parimutuel betting, in general, and takeout, in particular, available on the Internet indicate that California's treatment of takeout is typical of the other States where horse racing and parimutuel betting are permitted. See, e.g↩., Library Index, Sports Gambling, http://www.libraryindex.com/pages/1611/Sports-Gambling-PARI-MUTUEL-GAMBLING: "The management's share [of a betting pool] is called the takeout * * [which is] set by state law and is usually around 20%. * * * This money goes toward track expenses, taxes, and the purse. Most states also require that a portion of the take-out goes into Breeder Funds to encourage horse breeding and health in the state."12. For example, assume 20% of a $100 parimutuel bet-to-win pool (i.e., $20) is wagered on a particular horse, and that horse wins. If the track's takeout with respect to that pool is 20%, so that only $80 is available to pay the winners, the odds on that horse to win will have been 3:1; i.e., the $20 bet on the horse will return to the bettors $80 (the original $20 bet plus a $60 (3 x $20) profit). If the track's takeout is 0% so that the entire $100 pool is available to pay the winners, the odds on that horse to win will have been 4:1; i.e., the $20 bet on the horse will return to the bettors $100 (the original $20 bet plus an $80 (4↩ x $20) profit).13. And since the amount paid out from the pool is net of takeout, no winner needs a deduction to make the amount distributed to him correspond to the sum of (1) his wager and (2) his taxable gain.↩14. Petitioner virtually concedes that point on brief when he emphasizes the function of the takeout, noting that "racetracks do not operate for free, they have to pay to operate the racetrack * * * [p]lusthey↩ have to comply with the regulations promulgated by the Business and Professions Code and the [S]tate and local authorities to pay taxes to operate the racetrack." (Emphasis added.)15. The problem of unreported gambling gains has been mitigated, but not eliminated, by the payor's obligation to report and, in some cases, withhold Federal and State taxes from large winnings. See↩ IRS Form W-2G, Certain Gambling Winnings, and accompanying instructions.16. Although petitioner did not incur (and, therefore, did not report) a net wagering loss for 2007, there was, nonetheless, a substantial understatement of income tax for that year attributable to petitioner's carryover of net wagering losses from prior years.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621296/	The Maltine Company, Petitioner, v. Commissioner of Internal Revenue, RespondentMaltine Co. v. CommissionerDocket No. 6180United States Tax Court5 T.C. 1265; 1945 U.S. Tax Ct. LEXIS 18; December 19, 1945, Promulgated 18 Decision will be entered under Rule 50. Petitioner corporation, capitalized at $ 1,000,000, was organized in 1898, and in that year acquired, in exchange for its capital stock, the assets of a then existing corporation, capitalized at $ 100,000, having substantially the same stockholders, but narrower corporate purposes and powers. Held, (1) petitioner is entitled to include in its equity invested capital the assets so acquired in an amount equal to its unadjusted basis for determining loss upon a sale or exchange, which basis is cost; (2) that, under the facts, the fair market value of the tangible property so acquired in 1898 was $ 134,926.34, and of the intangible property, $ 866,000; (3) that Maltine Co., 6 B. T. A. 153, is not res judicata of the present issues; and (4) that factors entering into the computation of equity invested capital which are not questioned in the deficiency notice or pleadings, but are first suggested on brief, can not be considered at issue. Edward S. Bentley, Esq., for the petitioner.Laurence F. Casey, Esq., for the respondent. Kern, Judge. KERN 1266 The Commissioner determined a deficiency19 in petitioner's excess profits tax for the calendar year 1942 in the amount of $ 49,394.43, resulting from his allowing to petitioner in the computation of this tax an average earning credit rather than the invested capital credit taken by petitioner in its return.It is respondent's position that the only credit on account of invested capital which is available to petitioner is on account of capital invested by a predecessor corporation, and that an average earning credit to petitioner is larger and therefore is the credit properly allowable.The questions presented are whether the issues here are res judicata; and, if not, whether petitioner is entitled to an equity invested capital credit computed on a basis of cost to it of intangible assets acquired from the Maltine Manufacturing Co. in 1898, and, if so, what that cost was.FINDINGS OF FACT.Petitioner, the Maltine Co., is a corporation organized under the laws of New York on December 1, 1897. It filed its income and excess profits tax returns for the calendar year 1942 with the collector for the second district of New York.On February 6, 1878, a corporation known as "The Maltine Manufacturing Company" was organized in 20 New York "for the purpose of carrying on and conducting the manufacture and sale of a medical preparation known as 'Maltine' and its compounds."Its certificate of incorporation further provided that its manufacturing operations were to be carried on in the city and county of New York.It had an authorized capital of 1,000 shares of a par value of $ 100 each. All of these shares were issued and outstanding as of January 8, 1898, in the following names and amounts:Timothy L. Woodruff310 sharesLucius H. Biglow385 sharesRodney A. Ward230 sharesPhineas C. Lounsbury75 shares1267 In December of 1897 petitioner was organized as a business corporation under the laws of New York. Its purposes were stated to be as follows: "The making and selling of medicinal and food products." Its principal office was at Silver Springs, Wyoming County, New York.The authorized capital was 10,000 shares of a par value of $ 100. The incorporators and original subscribers to and holders of the capital stock, which was issued January 8, 1898, were the following:Timothy L. Woodruff3,334 sharesLucius H. Biglow3,333 sharesRodney A. Ward3,333 sharesThereafter, on the21 same date, Timothy L. Woodruff and Rodney A. Ward caused certain of the shares issued to them to be transferred to Lucius H. Biglow and Phineas C. Lounsbury, so that thereafter the stock was held as follows:Timothy L. Woodruff3,100 sharesLucius H. Biglow3,850 sharesRodney A. Ward2,300 sharesPhineas C. Lounsbury750 sharesOn the same day, January 8, 1898, the Maltine Manufacturing Co. and petitioner entered into the following contract:This Agreement, made the 8th day of January, 1898, between The Maltine Manufacturing Company, party of the first part, and The Maltine Company, party of the second part;Whereas, The Maltine Manufacturing Company, party of the first part, is a corporation duly organized under the laws of the State of New York, for the purpose of carrying on the business of the manufacture and sale of a medicinal preparation known as Maltine and its compounds; andWhereas, The Maltine Company, party of the second part, is a corporation duly organized under the laws of the State of New York for the purpose of carrying on the business of making and selling medicinal and food products; andWhereas, the party of the second part is desirous of acquiring22 all of the property, both real and personal, and the assets, business and goodwill of the party of the first part;Now, Therefore, This Indenture Witnesseth: That it is mutually agreed by and between the said party of the first part and the party of the second part, as follows:1. The said party of the first part doth agree to convey, sell, assign, transfer and set over unto the party of the second part all of the property of the party of the first part, both real and personal wheresoever the same may be situate, whether held by or in the name of the said party of the first part, or in trust therefor, and the business and good-will thereof, including all and singular the lands, tenements, hereditaments and appurtenances, goods, chattels, stocks, promissory notes, debts, choses in action, evidence of title, claims, demands and effects of every description belonging to said party of the first part, wheresoever the same may be situate.1268 2. In consideration thereof, the party of the second part agrees to issue all of its capital stock, amounting to one million dollars ($ 1,000,000) to the stockholders of the party of the first part, according to their respective interests in, 23 or holdings of, the capital stock of the party of the first part; that is to say, to Timothy L. Woodruff, thirty-one hundred shares; to Lucius H. Biglow, thirty-eight hundred and fifty shares; to Rodney A. Ward, twenty-three hundred shares, and to Phineas C. Lounsbury, seven hundred and fifty shares; said stock to be issued and delivered, fully paid and nonassessable, to the said stockholders of the party of the first part.3. The party of the second part further agrees to assume all of the debts, liabilities and obligations of the party of the first part.4. It is mutually agreed that the aforementioned delivery of the property, etc., of the party of the first part to the party of the second part, and the issue and delivery of the capital stock of the party of the second part to the stockholders of the party of the first part, shall take place on the 8th day of January, 1898.In Witness Whereof, the parties hereto have hereunto caused their corporate seals to be affixed and these presents to be signed by their respective Presidents and attested by their respective Secretaries the day and year first above written.Pursuant to the contract set out above, the Maltine Manufacturing Co. 24 on January 8, 1898, executed a deed to the real estate on which the factory was located, and on February 9, 1898, assigned to petitioner its interest in the registered trade-mark "Maltine." On December 27, 1901, it assigned to petitioner its interest in the registered trade-mark "Malto." This deed and these assignments were duly recorded.Petitioner took possession of the real estate, equipment, and other assets of the Maltine Manufacturing Co. No steps were taken to dissolve the manufacturing company, and it was not dissolved until March 31, 1924, when its dissolution was effected by proclamation of the Governor of New York.Following petitioner's incorporation it carried on the business and continued to manufacture all Maltine products and marketed them under labels reading "Prepared by the Maltine Manufacturing Company." Maltine is known as an "ethical" product, advertised and sold only to doctors and druggists, not to the general public. It is highly concentrated liquid extract of malt, made by a water extraction of the nutritive principals of natural grains such as barley and wheat. It is in itself highly nutritious, and it is chiefly used as a vehicle for the administration25 of medicines and drugs which are not otherwise in palatable form. It can be used in combination with almost any variety of medicine for which there is current demand, and it has been in wide use for the seventy years since its development. Petitioner has added other products to its line from time to time.The assets of the Maltine Manufacturing Co. as of December 31, 1897, were shown on its books as follows: 1269 AssetsLiabilitiesPatents, trade-marks, goodwill$ 100,000.00Capital stock$ 100,000.00Merchandise inventory53,446.11Book accounts10,389.12Machinery51,910.21Due travellers656.63Construction60,180.76Advertising contracts99.72Furniture and fixtures2,883.00Bills payable83,000.00Real estate61,500.00Mortgages40,000.00Cash4,783.03Amounts with travellers582.39Total234,145.47Accounts receivable31,991.70Profit and loss account134,926.34Record books500.00Insurance paid in advance443.48Total369,071.81Do87.93Bills receivable306.26Suspended accounts456.94Total369,071.81At the time of its incorporation petitioner set up on its books the assets acquired by it in exchange26 for its capital stock as follows:AssetsLiabilitiesPatent trade mark andgood will$ 1,000,000.00Capital stock$ 1,000,000.00Merchandise inventory53,446.11Book accounts dueothers10,389.12Machinery51,910.21Amount due travelers656.63Construction60,180.76Advertising contracts99.20Real estate61,500.00Bills payable83,000.01Office furniture andfixtures2,883.00Mortgages40,000.00Cash on hand and in bank4,783.03Profit and loss account134,926.43Amount in hands oftravelers582.39Book accounts due company31,991.70Total1,269,071.81Physicians record books500.007nsurance paid in advance443.48Do87.93Bills receivable306.26Suspended accounts456.94Total1,269,071.81The good will has been carried at the value of $ 1,000,000 on petitioner's books continuously since that time.One hundred shares of petitioner's stock were sold in 1901 for $ 120 per share. Other sales were made at various times from 1906 to 1927, at prices ranging from $ 100 to $ 148 per share.Respondent refused to allow petitioner to include in its equity invested capital the sum of $ 1,134,926.34 representing the value of the assets27 acquired by petitioner in 1898 in consideration for the issuance of its capital stock, contending that petitioner was limited to the use of the amount of invested capital of the Maltine Manufacturing Co., which was $ 100,000, and computed petitioner's excess profits tax liability by the use of an average earnings credit because it was in excess of the credit which would be available to petitioner after the elimination of the disallowed portion of the claimed equity invested capital.In 1927 the Board of Tax Appeals decided Maltine Co., Docket Nos. 2805 and 3967, reported at 6 B. T. A. 153, which was an appeal from a determination of a deficiency in income and excess profits taxes for 1917, 1918, and 1919 of the same corporation which is the petitioner herein. The petitioner there contended that the transaction of 1898 1270 described hereinabove was an exchange of its stock for stock of the manufacturing company, which entitled it to include the full value of the acquired asset in its invested capital under the statute then in effect. The respondent contended it was an exchange of stock for assets, and that the intangible assets were includible28 in invested capital only in the percentages permitted by the statute. The Board upheld the respondent's contention.The entire record in that case was introduced in evidence at the hearing of this case. In its findings of fact, the following language is found concerning the stock of Maltine Manufacturing Co.: "The value of the stock in January, 1898, was in excess of $ 1,000,000, represented largely by intangible assets."The value of the assets of the Maltine Manufacturing Co. on January 8, 1898, other than its patents, trade-marks, and good will, was $ 134,926.34. The value of the patents, trade-marks and good will of the Maltine Manufacturing Co. on January 8, 1898, was $ 866,000.OPINION.The petitioner urges that the decision of the Board of Tax Appeals in Maltine Co. v. Commissioner, Docket Nos. 2805 and 3967, promulgated February 18, 1927, and reported at 6 B. T. A. 153, makes the issues involved here res judicata.The respondent points out that the issues are different, different revenue acts apply, and, specifically, that the basic questions here, whether the intangible assets were acquired within the meaning of the statute so as 29 to be an allowable component of invested capital, and the value of such intangibles, were not raised, litigated, or determined in the prior decision.We agree with the respondent. The basic issue before the Board in the earlier case was whether the 1898 transaction was a purchase by petitioner of the capital stock of the manufacturing company, or of its assets, a distinction which was important under the then effective statute. No one suggested then that the transaction should be ignored for tax purposes, the question being limited to the construction thereof. The question here is not what the character of the transaction was, but whether it should be entirely disregarded for the purpose of computing invested capital under a statute materially different from the one in effect when the earlier decision was rendered. The issues are different and different tax statutes and years are involved. We must therefore conclude that the doctrine of res judicata is not applicable. See Reynard Corporation, 37 B. T. A. 552; Susanna Bixby Bryant, 2 T.C. 789">2 T. C. 789; Pelham Hall Co. v. Hassett, 147 Fed. (2d) 63.30 1271 The petitioner's contention on the merits here is that it is entitled to include in its computation of its equity invested capital, under the provisions of section 718 (a) (2) of the Internal Revenue Code, the assets of Maltine Manufacturing Co. acquired by it in 1898, in consideration of the issuance of its capital stock, in an amount equal to its unadjusted basis for determining loss upon a sale or exchange; that its basis as to these assets was cost; and that its cost was $ 1,134,926.34, which was the net worth of the property paid in for its stock, under Regulations 112, section 35.718-1.Respondent argues that the formation of a new corporate entity in 1898 by the stockholders of an existing corporation and the acquisition by the new corporation of the assets of the old corporation in exchange for the issuance of the capital stock of the new corporation do not entitle the new corporation to the use for this purpose of the cost to it of the property so acquired in excess of the original investment in the old corporation. Respondent regards such a transaction as no more than a "write up" of good will and the declaration of a stock dividend.There is no dispute about31 the facts of the 1898 transaction. The Maltine Manufacturing Co. had been operating with outstanding success for several years, having paid dividends for six successive years equal to a 100 percent return on the original investment, which was $ 100,000. It operated under a charter which limited its activities to "the manufacture and sale of a medical preparation known as Maltine and its compounds in the City and County of New York."In 1897 petitioner was incorporated with a capital of $ 1,000,000, for the purpose of acquiring the assets and business of the manufacturing company. Its corporate purpose was the making and selling of medicinal and food products and its activities were not confined to any particular locality.The Maltine Manufacturing Co. had four stockholders. Three of them became the incorporators and original stockholders of petitioner, but almost immediately, on the same date, at least, the stockholdings were so adjusted that the four stockholders of the manufacturing company held stock in petitioner in the same proportion, at the ratio of ten for one, of their holdings in the manufacturing company.Petitioner took over the assets and the operation of the business, 32 added new products to its line at various times, and continued its highly successful operation to the present time.There seems to be no serious doubt that if the transaction had occurred in later years it would have qualified as a tax-free reorganization, and in that case petitioner would be required to use its transferor's base for the purpose under discussion. The immediate question here, 1272 then, is whether the fact that the transaction occurred in 1898 leads to a different result.Section 718 (a) (2) of the code provides that property acquired for stock shall be included in the computation of equity invested capital at an amount equal to its basis (unadjusted) for determining loss upon a sale or exchange.Section 113 (a) of the code provides: "Basis (unadjusted) of property. The basis of property shall be the cost of such property; except that * * ."There follow twenty-two exceptions to this basic rule, of which none is claimed by respondent to be applicable to the present situation. Consequently, we conclude that the petitioner's basis of the property involved here for determining loss upon a sale or exchange is cost.One of the exceptions, found at section 113 33 (a) (6), relates to property acquired in a tax-free exchange after February 28, 1913. It does not provide, however, for an exception where property is acquired before that date in an exchange of a character which would have been tax-free had it occurred thereafter.Section 113 (a) (7) provides an exception where property was acquired after December 31, 1917, by a corporation in a reorganization.Section 113 (a) (8) provides an exception where property was acquired after December 31, 1920, by a corporation by the issuance of stock or securities, or as a paid-in surplus, or contribution to capital.Section 113 (a) (14) provides an exception in basis for determining gain on property acquired before March 1, 1913. It is silent as to basis for determining loss and respondent's regulations (Regulations 111, sec. 29.113 (a) (14)-1) explicitly recognize that fact.These exceptions, which do not apply here, are examined because they indicate the degree of precision with which the statute provides for the varying situations for which Congress intended to make special exceptions. The inevitable conclusion is that it meant exactly what it said when it said that the basis, except for the34 several special situations thereafter specifically set forth, should be cost. To hold petitioner's basis for determining loss to be other than cost would be to create another exception, which we conceive to be properly the task of Congress if it is to be done.There now arises the question of the valuation of the assets acquired by petitioner as outlined above. The regulations (sec. 35.718-1 of Regulations 112) provide: * * If the basis to the taxpayer is cost and stock was issued for the property, the cost is the fair market value of such stock at the time of its issuance. If the stock had no established market value at the time of the exchange, the fair market value of the assets of the company at that time should be determined 1273 and the liabilities deducted. The resulting net worth will be deemed to represent the total value of the outstanding stock. In determining net worth for the purpose of fixing the fair market value of the stock at the time of the exchange, the property paid in for such stock shall be included in the assets at its fair market value at that time.If stock having no established market value is issued for intangible property, and it is necessary35 to determine the fair market value of such property, the following factors, among others, may be taken into consideration in determining such value: (a) The earnings attributable to such intangible assets while in the hands of the predecessor owner; and (b) any cash offfers for the purchase of the business, including the intangible property, at or about the time of its acquisition * .There is no dispute concerning the net value of the tangible property, which is $ 134,926.34. Our inquiry is limited to the value of the intangibles, which petitioner contends was $ 1,000,000. The respondent contends they were worth considerably less, although he concedes they were valuable, and that a substantial portion of the earnings was fairly attributable thereto.Of the two factors suggested by the regulations as proper for consideration, among others, there is no evidence here of any cash offers for the business. Respondent offered in evidence the earnings record of the old manufacturing company and computed the value of the intangibles, by the application of the formula proposed by A. R. M. 34, 2 C. B. 31, on the basis of an 8 percent return on tangibles, and36 capitalizing the remainder at 15 percent. The result was $ 506,521.Petitioner objects to the use of A. R. M. 34, on the ground that it has no application here; and it contends that if Docket Nos. 2805 and 3967 are not res judicata, the findings of the Board therein, containing the finding that the value of the manufacturing company's stock was in excess of $ 1,000,000, represented largely by intangibles, are at least prima facie correct, and that there is sufficient evidence in the record here to support petitioner's valuation of $ 1,000,000 for the intangibles.With respect to petitioner's contention that A. R. M. 34 has no application, it is noted that that memorandum provides within itself that, while its suggestions "may be utilized broadly in passing upon questions of valuation," they are "not to be regarded as controlling, however, if better evidence is presented in any specific case." We think there is presently before us sufficient evidence to obviate the necessity of resorting exclusively to A. R. M. 34.There can be no doubt that the intangibles have been shown to have had substantial value. They were set up on petitioner's books at $ 1,000,000 at the time37 of their acquisition. The earnings of the predecessor company averaged $ 110,000 per year for the last five years of its operation, and dividends were declared in each of those years 1274 amounting to 100 percent return on the original capital. The sale of stock nearest in point of time to the critical date was on November 30, 1901, when 100 shares of petitioner's stock were sold for $ 120 per share. No sales have ever occurred for less than par. The president of the company testified that in his opinion the good will of the business was worth at least $ 1,000,000 as of January 8, 1898. The principal product of the company is adaptable for use with almost all medicines and drugs and the demand for it is continuous and stable. It does not depend for its sales on advertising to the public.Considering all the facts, and the pertinent criteria of value, we conclude that the fair market value of the intangible assets acquired by petitioner in 1898 in exchange for its capital stock was $ 866,000.The final contention which we must consider is advanced by respondent in his brief. He suggests that petitioner has not proved that there were not other adjustments in reduction of38 invested capital which might result in an invested capital credit less in amount than the average earnings credit allowed by respondent, and that without proof of all the items making up its invested capital, whether questioned by respondent or not, we can not say he erred in allowing an average earnings credit rather than an invested capital credit.No other factors involved in invested capital were mentioned in connection with this case except those which we have discussed above.The notice of deficiency contained the following explanatory statement:It is held that since you were organized in 1898 to take over the assets and business of The Maltine Manufacturing Company and issued therefor all your stock consisting of $ 1,000,000 par value, which was distributed to the stockholders of the old company in exchange for their stock, the increased value of the assets so acquired does not constitute a part of equity invested capital within the meaning of section 718 of the Internal Revenue Code and the alleged value of $ 1,000,000 claimed for good will at that time has therefore been eliminated from equity invested capital. As the elimination of the write-up in good will from your equity39 invested capital caused the excess profits credit computed on the invested capital basis to be less than the credit computed on the average earnings basis, the latter basis has been used in the computation of your excess profits tax liability.Petitioner assigned as error the respondent's action in:(1) Refusing to include in petitioner's equity invested capital $ 1,134,926.34 representing the value of the assets acquired on January 8, 1898, in consideration of the issuance of its capital stock;(2) In holding the value of such assets to be less than $ 1,134,926.34;(3) In holding the value of the intangible assets so acquired to be less than $ 1,000.000;(4) In refusing to be bound by a prior decision of the Board of Tax Appeals involving the same questions;1275 (5) In refusing petitioner the right to use the value of the assets at the time of acquisition in computing its equity invested capital;(6) In eliminating from its equity invested capital the sum of $ 1,000,000 representing the value of intangibles so acquired;(7) In determining petitioner's excess profits tax credit to be $ 74,488.33 instead of $ 119,037.46 as claimed;(8) In determining petitioner's excess profits40 tax credit on an income basis instead of on an invested capital basis;(9) In holding petitioner subject to an excess profits tax for the year ended December 31, 1942.The respondent's answer admitted the formal allegations of the petition relating to the incorporation of petitioner, the mailing of the notice of deficiency, and the filing of the petitioner's tax returns, and that the tax in controversy is a deficiency of $ 49,394.43 in excess profits tax for 1942; that petitioner acquired the assets in question in consideration of the issuance of its capital stock having an aggregate par value of $ 1,000,000 and that the tangible assets acquired had a value of $ 134,926.34; that respondent refused to be bound by the earlier decision, which petitioner contended was res judicata, and held the petitioner was not entitled to include in its equity invested capital the sum of $ 1,000,000 representing the intangible assets, but could include only the sum of $ 100,000, and inasmuch as a computation of petitioner's excess profits tax computed on such basis was less than when computed on an average earnings basis, the average earnings basis should be adopted. The answer denied all the *41 assignments of error, denied that the determination of the deficiency resulted in the allowance of an overassessment of income tax in the amount of $ 21,779.88 which will be adjusted under Rule 50; denied that the intangible assets were of the value of $ 1,000,000; denied the allegations of fact concerning the prior decision of the Board; and denied generally all allegations not specifically admitted.The only factor entering into petitioner's computation of the invested capital credit claimed by it in its return which the respondent questioned and disallowed and which is in issue here was the inclusion in equity invested capital of the value of the assets acquired in 1898 in exchange for the issuance of its capital stock. There is nothing in the deficiency notice or in the pleadings which would suggest the other questions raised by respondent in his brief, and, therefore, we can not consider them. See Warner G. Baird, 42 B. T. A. 970, and Robert C. Coffey, 21 B. T. A. 1242, 1245.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621300/	GEORGIA CROWN DISTRIBUTING CO., ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Georgia Crown Distributing Co. v. CommissionerDocket Nos. 20890-80, 20891-80, 18405-81.United States Tax CourtT.C. Memo 1983-459; 1983 Tax Ct. Memo LEXIS 327; 46 T.C.M. (CCH) 959; T.C.M. (RIA) 83459; August 8, 1983. Richard Y. Bradley and Albert W. Stubbs, for the petitioners. Larry D. Anderson, for the respondent. FAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: Respondent determined the following deficiencies in petitioners' Federal income tax: PetitionerDocket NoYear 2DeficiencyGeorgia Crown20890-801978$75,432.03Distributing Co.1979123,766.30Donald M. Leebern,20891-80197836,014.00Jr. and Francis18405-81197951,431.00E. LeebernAfter concessions, the only issue is whether amounts paid by petitioner Georgia Crown Distributing Co. to its President, Chairman of the Board, and Chief328 Executive Officer, petitioner Donald M. Leebern, Jr., constituted reasonable compensation. FINDINGS OF FACT Some of the facts are stipulated and are found accordingly. Petitioner, Georgia Crown Distributing Co. (Georgia Crown) is a Georgia corporation having its principal place of business in Columbus, Ga. Petitioners, Donald M. Leebern, Jr. and Francis E. Leebern, resided in Columbus, Ga., when they filed their petitions herein. During the years in issue, Georgia Crown was engaged in the wholesale distribution of alcoholic beveraged in the State of Georgia. It is now a multi-state distributor of these beverages. It was founded and incorporated in 1949 by Donald M. Leebern, Sr., father of petitioner herein. Donald, Sr. died in 1957 as 100 percent shareholder of Georgia Crown. Pursuant to his Last Will and Testament, he devised all the stock of the company to the First National Bank of Columbus, Ga., to hold in trust one-half for the benefit of his surviving spouse and one-half for the benefit of his children in equal shares. At the time of his father's death, petitioner Donald, Jr. was 19 years old (hereafter petitioner Donald Leebern, Jr. will be referred to simply329 as Leebern). Leebern joined Georgia Crown as a salesman upon his graduation from the University of Georgia in 1960. He became general manager in 1961 and president in 1963. At the time Leebern became president, Georgia Crown served a small metropolitan market in the Columbus and Albany, Ga., area. Soon thereafter, Georgia Crown embarked on an ambitious program of expansion. In 1966, Leebern Distributors, Inc., a corporation related to Georgia Crown, was organized to engage in the wholesale distribution of beer in the Columbus area, and in 1968, the Georgia Crown Distributing Company of Atlanta, Inc. (Georgia Crown of Atlanta) was organized to acquire the business of Atlanta Crown Distributing Co., a much larger wholesale distributor in the Atlanta area. The acquisition of the Atlanta company was completed in 1976 with the merger of Georgia Crown, Georgia Crown of Atlanta, and Leebern Distributors, Inc.Georgia Crown is the surviving corporation. Prior to and after the merger, the stock of the three participating corporations was held as follows: Before MergerAfter MergerGC of AtlantaLeebern Dist.GCGCShareholder 3Petitioner Donald75%4.6%25%53.125%M. Leebern, Jr.Fate D. Leebern0%4.6%25%15.625%Robert D. Leebern0%4.6%25%15.625%William D. Leebern25%0%25%15.625%Georgia Crown0%86.2%330 During the relevant period, Georgia Crown enjoyed remarkable success, and during the years in issue, it clearly outperformed the wholesale liquor industry both nationally and in Georgia. The growth of Georgia Crown in sales, net income before taxes, and shareholder's equity is reflected in the following table: TAXABLE YEARS 4NET INCOMESHAREHOLDERSENDED INNET SALESBEFORE TAXESEQUITY1964$3,164,460$122,735$581,51519653,325,00299,197628,45919664,029,85096,104632,58019675,181,397128,146696,78419685,950,05574,078742,809196911,305,748231,836876,327197018,671,874181,681966,029197119,410,271203,5711,071,025197221,151,761202,7571,235,053197324,604,808345,3881,331,982197426,900,408203,0751,340,443197528,157,666482,0881,489,555197629,743,788268,9411,591,583197734,486,677783,7381,707,450197841,877,3132,440,3732,915,045197945,354,8243,152,0874,303,581331 The remarkable performance of Georgia Crown is primarily attributable to the unique capabilities and outstanding performance of Leebern. He was in total control of all company operations. He decided all policy matters, made all purchasing and marketing decisions, developed the sales organizations, hired and fired all employees, set employee salaries, and dealt with Federal and state regulatory people. At the time Leebern first became president in 1963, Georgia Crown's annual sales were in the range of 3 million dollars. By 1979 annual sales exceeded 45 million dollars. Leebern was also very active in civic and trade associations. He served on various committees and was director of the Wine and Spirits Wholesalers of America, Inc., (WSWA), the national association of beverage alcohol wholesalers. He has also been treasurer, secretary, and vice-president of that organization. Twice he served as president of that organization's chapter in the State of Georgia. He was a winner of the Time Magazine Distinguished Wholesaler Award. He was also a member of the First Council of Seagram's Distributors, an advisory group of approximately 10 of Seagram's distributors, and a past president332 of the Seagram's Family Association, the national association of Seagram's distributors. From 1966 through and including the years in issue, Georgia Crown adopted a policy of compensating Leebern with an annual salary plus a bonus equal to a percentage of the company's net profits before taxes. 5 The bonus was set shortly after commencement of each fiscal year by the Board of Directors, and the amount was computed shortly before the end of each fiscal year by multiplying the estimated net profits by the applicable percentage. When the plan was adopted in 1966, the bonus was set at 20 percent. In 1976, the year of the merger, the bonus was reduced to 10 percent and remained at 10 percent through the years in issue. The reason for the reduction was that the company had been making big profits so they "brought it back down." In 1971, 1972, and 1973, the Board of Directors declared the 20 percent bonus for Leebern; however, no such bonus was paid for those years. In 1974 no bonus was paid or declared. The company made personal loans to Leebern during these years. For all other years, Leebern was paid his bonus. 333 During the years in issue, Leebern owned 53 percent of the stock of Georgia Crown. He was also the President, Chairman of the Board of Directors, and Chief Executive Officer. The remaining stock was held by Leebern's three younger brothers. One brother, Robert D. Leebern, was employed by Georgia Crown as Vice President and Secretary and received a salary of $60,660.60 and $63,736.46 in 1978 and 1979, respectively. The Board of Directors consisted of 8 people three of whom were Leebern and two of his brothers, Fate D. and Robert D. Leebern. For many years, Leebern personally guaranteed the long-term debt of Georgia Crown. That debt reached a high of $3,114,000 during the years in issue. Under a loan agreement with the bank, Georgia Crown was prohibited from paying dividends unless the bank waived the restriction. Since 1964 Georgia Crown has paid no dividends with the exception of 1979 when $87,615 in dividends was paid with the consent of the bank. From 1976 through 1978, Georgia Crown had over $750,000 in outstanding advances to its officer-shareholders of which a substantial amount was attributable to Leebern. In 1979 this outstanding balance was reduced to just below334 $575,000. During 1978 and 1979, Georgia Crown employed over 200 people. The total compensation paid by Georgia Crown to its employees, including Leebern, remained a constant 7 percent of its net sales. Georgia Crown did not provide its employees with any type of deferred compensation plan such as stock options, profits sharing plans, or pension plans. Leebern was the only employee compensated with a net profits bonus. Georgia Crown compensated Leebern as follows: 197719781979Base Salary 6$160,103.00$160,104.32$160,104.32Bonus (10% of80,000.00300,000.00350,000.00estimated net profitbefore tax)Total$240,103.00$460,104.32$510,104.32Petitioner Georgia Crown deducted as compensation the amounts paid to Leebern. In his notices of deficiency, respondent determined any amount in excess of $260,820 for the taxable years 1978 and 1979 constituted unreasonable compensation. 7335 OPINION Under section 162(a)(1), a deduction is allowable to a corporation for "a reasonable allowance for salaries or other compensation for personal services actually rendered." As President, Chief Executive Officer, and Chairman of the Board, Leebern received total compensation of $460,104.32 and $510,104.32 in 1978 and 1979, respectively. The issue is whether these amounts constituted reasonable compensation. In order to be deductible, compensation must be both reasonable in amount and in fact paid purely for services. Sec. 1.162-7(a), Income Tax Regs. The question is one of fact to be determined by the particular facts and circumstances of each case, Pepsi-Cola Bottling Co. of Salina, Inc. v. Commissioner,61 T.C. 564">61 T.C. 564, 567 (1974), affd. 528 F. 2d 176 (10th Cir. 1975), and the burden of proof is on the taxpayer. Botany Mills v. United States,278 U.S. 282">278 U.S. 282, 292 (1929). A rather comprehensive list of factors to336 be considered is found in Mayson Mfg. Co. v. Commissioner,178 F.2d 115">178 F.2d 115, 119 (6th Cir. 1949), revg. a Memorandum Opinion of this Court. Although we discuss only those factors upon which we place the greatest reliance, our conclusion is the result of evaluating the entire situation in light of all the above factors.In cases like this which involve a closely held corporation where the taxpayer is in control and where there is a history of nonpayment of dividends despite considerable earnings, careful scrutiny must be given to ensure that the corporation is not distributing dividends disguised as compensation. See Kennedy v. Commissioner,72 T.C. 793">72 T.C. 793 (1979), revd. 671 F.2d 167">671 F.2d 167 (6th Cir. 1982); Charles Schneider & Co. v. Commissioner,500 F.2d 148">500 F.2d 148, 151 (8th Cir. 1974), affg. a Memorandum Opinion of this Court; Logan Lumber Co. v. Commissioner,365 F.2d 846">365 F.2d 846, 851 (5th Cir. 1966), affg. on this issue a Memorandum Opinion of this Court; Capitol-Barg Dry Clean. Co. v. Commissioner,131 F.2d 712">131 F.2d 712 (6th Cir. 1942).337 However, when other evidence persuasively establishes the reasonableness of compensation on the basis of employment related criteria, a deduction will not be denied notwithstanding the presence of these factors. See Commercial Iron Works v. Commissioner,166 F.2d 221">166 F.2d 221 (5th Cir. 1948), affg. a Memorandum Opinion of this Court, and United States v. Safety Engineering & Supply Co.,374 F.2d 885">374 F.2d 885 (5th Cir. 1967). A critical factor to be considered is an employee's skill and qualifications, and where an employee's contribution is particularly impressive, compensation commensurate with such contribution is in order. See Kennedy v. Commissioner,671 F.2d 167">671 F.2d 167 (6th Cir. 1982), revg. 72 T.C. 793">72 T.C. 793 (1979); Home Interiors & Gifts, Inc. v. Commissioner,73 T.C. 1142">73 T.C. 1142 (1980); Boyd Construction Company v. United States,339 F.2d 620">339 F.2d 620 (Ct. Cl. 1964); Roth Office Equipment Co. v. Gallagher,172 F.2d 452">172 F.2d 452 (6th Cir. 1949); Ziegler Steel Service Corp. v. Commissioner.T.C. Memo 1962-57">T.C. Memo. 1962-57. There is no question Georgia Crown demonstrated remarkable success, and there is likewise338 no question that Leebern's contribution to that success was instrumental. Under his direction and leadership, Georgia Crown expanded and consistently increased its sales and profits. When Leebern first became president in 1963, Georgia Crown distributed a limited line of whiskeys and wines to a small metropolitan area in and around Columbus, Ga., and by 1978 and 1979, it distributed a full line of alcohol products throughout the State of Georgia. In 1963, Georgia Crown's annual sales were in the range of 3 million dollars and by 1979 its annual sales exceeded 45 million dollars. At all relevant times, Leebern was the active head of all company operations. He maintained offices in both Atlanta and Columbus and generally split the work week, often consisting of 7 days, between the two offices. He decided all corporate policy matters and provided the overall guidance for a highly profitable distributorship. He made all purchasing, pricing, and marketing decisions. He developed the sales organizations, hired and fired all employees, and set their salaries. He dealt with all Federal and state regulatory authorities. Needless to say, he worked very long hours. Leebern is also339 recognized as a leader and an innovator in the industry. Georgia Crown was one of the first "red whiskey houses" to become a full-line distributor of not only whiskey but also domestic and imported beer, wine, mixes, cups, Perrier water, etc. 8 Leebern is also very active in civic and trade associations. He is a 21-year member of the Board of Directors of the WSWA, the national trade association of alcohol wholesalers, and has served on various committees and has held several offices of that organization. He received national recognition as the winner of the Time Magazine Distinguished Wholesaler Award. Perhaps Leebern's single most outstanding contribution is that, through his leadership for nearly two decades, Georgia Crown has established one of the finest reputations in the industry. Thus, Georgia Crown has developed and maintained strong relationships will both its suppliers and its retailers. It was Leebern's connections with Seagram's Distillers, for340 instance, that first led to Georgia Crown's penetration of the Atlanta market and which eventually resulted in the acquisition of the much larger Atlanta distributorship.Other facts indicate the amounts at issue herein were paid purely for compensation and without an eye to the distribution of earnings. The payments were made by Georgia Crown pursuant to its long standing policy of compensating its chief executive officer with a net profits bonus. The policy was instituted in 1966 and, with the exception of the period 1971-1974, was followed each year thereafter. Nothing changed with that policy in the years in issue, and Leebern's activities or responsibilities during these years did not change.The only difference was that the company made more money in these years and, under the bonus plan, Leebern's compensation increased accordingly. We note that prior to 1978 and 1979, respondent never challenged the amount of compensation paid Leebern. Moreover, reflecting a conscious effort to keep a limit on his compensation, in 1976 Georgia Crown reduced Leebern's bonus from 20 percent to 10 percent since Georgia Crown had been making big profits. 9341 One factor which is indicative of a dividend distribution is if payments are made in proportion to stockholdings. Trinity Quarries, Inc. v. United States,679 F.2d 205">679 F.2d 205 (11th Cir. 1982); Nor-Cal Adjusters, Inc. v. Commissioner,503 F.2d 359">503 F.2d 359 (9th Cir. 1974), affg. a Memorandum Opinion of this Court. However, the payments herein were not pro-rata; Leebern was the only employee who received a net profits bonus. This supports petitioners' position the amounts were intended to be compensation for services rendered. Kennedy v. Commissioner,671 F.2d 167">671 F.2d 167 (6th Cir. 1982), revg. 72 T.C. 793">72 T.C. 793 (1979); Berkshire Oil Co. v. Commissioner,9 T.C. 903">9 T.C. 903 (1947); Soabar v. Commissioner,7 T.C. 89">7 T.C. 89 (1946). Respondent relies to a great extent on the opinion of his expert witness, Dr. David Bowering (Bowering), a former assistant professor at the University of Maryland and a consultant for the past five years. In a nutshell, Bowering allegedly compared Leebern's compensation as a chief executive officer of342 Georgia Crown with the compensation of chief executive officers of companies in the same size category in terms of net sales. He used data from both the wholesale liquor industry and from the broad range of wholesale industries (since certain relevant data was not available from the wholesale liquor industry). Based on his analysis, Bowering, at the conclusion of his written report, estimated a "high end" reasonable compensation for the chief executive officer of Georgia Crown to be $269,020 and $363,109 in 1978 and 1979, respectively. 10Bowering's report is based on his view of what "comparable businesses are paying employees performing comparable services." Yet, he acknowledges the difficulty in obtaining reliable data concerning closely held corporations. Moreover, as pointed out by the Court during trial, there are serious defects in Bowering's methodology. First, the data used is based solely on unknown companies that343 compare to Georgia Crown and only as to volume of net sales. Bowering flatly rejected profitability as a standard of comprison, yet it is not uncommon to compensate chief executive officers with a bonus based on the company's net profits. 11 Thus, the report fails to take into account one of the principal points upon which petitioners' case is based, namely, that Leebern's compensation was, in part, a function of the unparalleled growth in profits experienced by Georgia Crown during the years in issue. Second, the report was prepared before the trial in this case and before Bowering had a chance to hear the evidence. He based his opinion on "a laundry list of services that * * * are typically performed by a chief executive officer." Yet, after hearing the testimony, he agreed on cross-examination that the scope of Leebern's duties and activities are broader than the services performed by the typical chief executive officer. Thus, it is apparent that, in developing his opinion, Bowering did not have a true picture of Leebern's value, another crucial part of petitioner's case. 12344 Respondent has no quarrel when the compensation figure remains in the $250,000 range, but he challenges it when, due solely to unusually profitable years, it rises to the $500,000 range. Essentially respondent's position is that despite the performance of Georgia Crown and despite any contribution Leebern may have made toward the improvement of that performance, the compensation figures at issues are too high. We cannot agree. Based on his nearly 20 years as the active head of Georgia Crown, his demonstrated ability to generate profits and, in general, his value to the company, we find the amounts paid Leebern, a high level executive, constituted reasonable compensation. Ascertainment of an executive's true worth to his company is difficult. Each company is unique in its own way, and there are generally no reliable comparables. A firm that is different or unusually managed must be examined on its own merits and by its own results before executive pay can be fairly determined. We do not herein purport to possess any rare insight into these matters, but we feel that what was paid under these circumstances was reasonable for the services rendered. For over 20 years, Leebern has345 been the figurehead of Georgia Crown. He has turned a small local concern into a highly profitable regional distributor of assorted alcohol products. Leebern has never reduced his workload or his involvement in company affairs. In fact, he has consistently assumed an ever increasing load of responsibilities. Leebern's contribution to Georgia Crown's success is beyond question, and his compensation which is based in part on the company's net profits reflects that success. Section 162(a)(1) is not intended to be a substitute for what otherwise constitutes sound business judgment by denying a deduction for compensation which may be in excess of the norm, see Home Interiors & Gifts, Inc. v. Commissioner,73 T.C. 1142">73 T.C. 1142, 1162 (1980), and in our opinion, the amounts paid Leebern reflect a reasonable value for his services. 13To reflect concessions and the foregoing, Decision will be entered under Rule 155 in docket*346 No. 20890-80, andDecision will be entered for petitioners in docket No. 20891-80 and docket No. 18405-81.Footnotes1. Cases of the following petitioners are consolidated herewith: Donald M. Leebern, Jr. and Francis E. Leebern, docket No. 20891-80, and Donald M. Leebern, Jr. and Francis E. Leebern, docket No. 18405-81.↩2. Petitioner Georgia Crown Distributing Co. computed its income on the basis of its fiscal year ending June 30.↩3. Fate D. Leebern, Robert D. Leebern, and William D. Leebern are the younger brothers of petitioner Donald M. Leebern, Jr.↩4. Prior to March 31, 1976, the taxable year of Georgia Crown of Atlanta ended on March 31, the taxable year of Leebern Distributors, Inc., ended on July 31, and the taxable year of Georgia Crown ended June 30. For purposes of this table, the taxable years ending in each calendar year have been consolidated.↩5. At the time the bonus plan was adopted, 73 percent of the stock of Georgia Crown was held by the trust department of the First National Bank of Columbus, Ga., as trustee under the various trusts created by the Will of Donald M. Leebern, Sr., and 13 percent was held by Leebern.↩6. The base salary consists of $150,000 annual salary plus $10,104.32 annual insurance premium paid by the company. The premium for 1977 was $10,103.00.↩7. In addition respondent determined the unreasonable amounts represent unearned income in the form of dividends to petitioner Donald M. Leebern, Jr. Thus, he determined such amounts were not subject to the 50 percent maximum tax rate provided by sec. 1348. This related issue depends on the resolution of the reasonable compensation issue.↩8. A "red whiskey house" refers to a distributor of whiskey who is generally limited to bourbons and blends. Until recent times, wine, beer, and accessories were not carried by distributors of distilled whiskey.↩9. See Denison Poultry & Egg Co. v. United States,52 AFTR 2d 83↩-5148 (N.D. Tex. 1982), a recent case where the taxpayer, the president and controlling shareholder of a wholesale distributor of Coors beer, received compensation of $162,448 in 1977 based in part on a 20 percent net profits before taxes bonus.In finding the company's success was due to the taxpayer, the District Court held the entire amount constituted reasonable compensation.10. Respondent does not concede any amounts greater than $260,820, the amounts determined in his notices of deficiency for 1978 and 1979, constituted reasonable compensation notwithstanding the "high end" reasonable amounts determined by his expert.↩11. Indeed, numerous cases have found compensation figures of high executives reasonable when based on a percentage of the company's net profits. See e.g., Kennedy v. Commissioner,671 F.2d 167">671 F.2d 167 (6th Cir. 1982), revg. 72 T.C. 793">72 T.C. 793 (1979) (34 percent net profits bonus); Lewisville Investment Co. v. Commissioner,56 T.C. 770">56 T.C. 770 (1971); Ziegler Steel Service Corp. v. Commissioner,T.C. Memo. 1962-57 (20 percent net profits bonus). See also Harolds Club v. Commissioner,340 F.2d 861">340 F.2d 861 (9th Cir. 1965), affg. T.C. Memo. 1963-198↩ (where the Ninth Circuit Court of Appeals upheld this Court's determination that reasonable compensation could be based on 15 percent of the company's net income). 12. While we point out these defects in the report of respondent's expert, we do not imply any agreement with other points in the report or with his use of the data therein.↩13. Our decision is not based on the fact that pursuant to its loan agreement with the bank, Georgia Crown was prohibited from distributing dividends.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621301/	Forster Mfg. Co., Inc. v. Commissioner.Forster Mfg. Co. v. CommissionerDocket No. 5021-69.United States Tax CourtT.C. Memo 1972-138; 1972 Tax Ct. Memo LEXIS 119; 31 T.C.M. (CCH) 647; T.C.M. (RIA) 72138; June 27, 1972Carl F. Bauersfeld, for the petitioner. Alan I. Weinberg, for the respondent. STERRETTMemorandum Findings of Fact and Opinion STERRETT, Judge: The Commissioner determined deficiencies in petitioner's Federal income tax as follows: Taxable YearAmountAugust 31, 1965$5,144.02August 31, 19663,888.05120 Due to concessions, the only issue remaining for adjudication is whether petitioner, Forster Mfg. Co., Inc., is entitled to deduct as an ordinary and necessary business expense the net expenses 1 incurred in operating and maintaining two homes, one of which was rented to its president, general manager and majority shareholder, and the other which was rented to the president's son, a director and district sales manager of petitioner. 2Findings of Fact Some of the facts have been stipulated. The stipulation, together121 with the exhibits attached thereto, are incorporated herein by this reference. Forster Mfg. Co., Inc. (hereinafter referred to as petitioner) is a corporation organized under the laws of the State of Maine with its principal office in Wilton, Maine. It filed United States corporate 648 income tax returns for the taxable years ended August 31, 1965, and August 31, 1966, with the district director of internal revenue at Augusta, Maine. Petitioner is in the business of manufacturing and selling woodenware and plasticware products. Woodenware products consist primarily of toothpicks, clothespins, ice cream sticks, wooden spoons and forks, cocktail stirrers, tongue depressors, and similar flat items. It also manufacturers a line of larger woodenware products including croquet sets, rolling pins, furniture legs, etc. The line of plasticware products consists of plastic cutlery. Petitioner is the largest producer of woodenware products. Petitioner's principal manufacturing plant is located at Wilton, Maine, which since 1961 has been the site of its general administrative offices. Prior to that time, specifically 1951 to 1961, petitioner's principal location was Farmington, Maine. 122 Petitioner operates additional plants in East Wilton, Strong, Stratton and Mattawamkeag, Maine. The Wilton office is 80 miles from Portland and 180 miles from Boston, Massachusetts. Wilton's population totals approximately 3,800. Petitioner sells its products throughout the United States and in foreign countries as well. Its distribution system consists of a central warehousing operation in Wilton, and 20 additional warehouse locations throughout the country. It has approximately 100 sales representatives situated in various parts of the country. These representatives are independent contractors who solicit orders for petitioner on a commission basis. Petitioner also sells its products directly to large users such as D.C.A. Food Industries, Eskimo Pie Corp., etc. During the years in issue petitioner employed between 900 and 1,000 people. In 1951 petitioner purchased certain real estate, referred to as the Leavitt property, located on Bass Hill in Wilton, for $41,000. It was acquired to provide housing for petitioner's president and general manager. The Leavitt property consisted of a 25,000 square foot lot. Located thereon was a frame single family dwelling (hereinafter sometimes123 referred to as the Leavitt house or main house) and a guest house. The main house contained a basement, and a living room, dining room, den and a bedroom on the main floor, five bedrooms on the second floor and an attached garage. The guest house included a living roomdining room combination, two bedrooms, kitchenette, and an unattached two-car garage with a utility room or tool shed. 3From its initial acquisition in 1951 through 1953 the Leavitt house remained unoccupied. In 1952 petitioner offered to rent it to William F. Woodside (hereinafter referred to as Woodside), petitioner's assistant treasurer. Woodside declined the offer as he was living in a company house in Farmington, where petitioner's general offices were then located, and he did not wish to incur the additional expense in living in Wilton, some 10 miles away. Since 1953 petitioner has rented the Leavitt house to Theodore R. Hodgkins 4 (hereinafter referred to as T. R. Hodgkins) president, general manager124 and majority shareholder of petitioner from at least 1951 through the years in issue. 5 During 1965 and 1966, T. R. Hodgkins paid a monthly rental of $195, totaling $2,340 per year. The annual fair rental value of said property during such period was $2,400 per annum. Hodgkins was also liable for the payment of the various utility costs incurred. Petitioner paid all other expenses in caring for the property including insurance, taxes, repairs and caretaker labor costs. It also purchased numerous capital items used within the house including the following: DateItem AcquiredAcquiredCostHeating equipment1955$ 87.50Parking area1956250.00Heater1957322.14Refrigerator1959554.00Dishwasher1959274.922 chaise lounges and chairs195991.40Kitchen improvements19603,499.41Table1960262.85Ceiling fan196038.06Aluminum door196052.11Washer-dryer1961223.00Hot water heater1962225.00Rugs19622,775.00Tea service196275.00Stove1962225.00Oriental rug19622,000.00Bed1964148.50Dishwasher1964321.17Washer1964442.00Air conditioner19661,645.00Sprinkler system1966 1,965.53Total $15,477.59125 649 The property was used at least primarily to provide housing for T. R. Hodkins. Charles H. Burton (hereinafter referred to as Burton) in 1953 and 1955, was offered a position with petitioner as president and general manager. The employment offer included Burton's right to rent the Leavitt house. Petitioner and Burton could not agree to terms and therefore Burton declined the offers. In 1960 the Leavitt house was offered to William Howard (hereinafter referred to as Howard), who had become petitioner's general manager. Howard wished eventually to purchase the residence with which he was provided and the company did not want to sell the main house. Therefore petitioner purchased a residence known as the Goodspeed property126 which it rented to Howard with an option to buy. In 1970 the Leavitt property was offered to William H. Hushing, who had become petitioner's president. 6The Goodspeed property was purchased by petitioner for $40,000. It too was situated on Bass Hill in Wilton. It consisted of a 10-acre tract of land including an orchard and wooded area. Located thereon was a two-story single family frame dwelling (hereinafter sometimes referred to as the Goodspeed house), attached garage, a tennis court, a four-car unattached garage and a barn. The Goodspeed house contained 17 rooms, seven on the first floor; eight on the second and two on the third. 7The Goodspeed house was rented to Howard from September 1960 until termination of his employment in December of 1963, at a monthly rental of $150. During this period Howard paid the utility bills and petitioner incurred the expense for care and maintenance of the property, including taxes, 127 insurance and caretaker's services. Since 1963 the Goodspeed house has been rented to David L. Hodgkins (hereinafter referred to as David), son of T. R. Hodgkins, at a monthly rental of $150, totaling $1,800 per year. He was also responsible for utility costs incurred and the caretaker's salary. Petitioner paid the remaining expenses. During the years in issue David was petitioner's district sales manager and a director of the company. The fair rental value of the Goodspeed house in 1965 and 1966 was $1,800 per annum. The property, during the years before us, was used at least primarily to provide housing for David Hodgkins. Petitioner encountered difficulty in attracting qualified personnel because of its rural location and the scarcity of suitable housing in the area. For this reason petitioner acquired residential properties which it generally sold but on occasion rented to prospective executives. The following shows all homes acquired by petitioner since 1945: Year ofPurchasePlant LocationPurchase Price1945Strong Maine- Day$ 2,450.001945Strong Maine- Lake4,000.001946Strong Maine- Kirchner6,000.00Sold 19641946Strong Maine- Merchant4,500.00Sold 19531946Strong Maine- Davis6,500.00Sold 19631946Farmington- Herman6,000.00Sold 19541948Mattawamkeag- Mill3,782.151951Wilton- Leavitt41,000.001952Mattawamkeag- Schedd4,300.00Sold 19571952Mattawamkeag- McGinley2,800.00Sold 19561952Mattawamkeag- Burr6,000.00Sold 19561952Mattawamkeag- Calden3,000.00Sold 19541952Mattawamkeag- Wyman6,698.56Destroyed by fire in 19661953Mattawamkeag- Severance4,700.00Sold 19561955Mattawamkeag- Dyer3,800.00Sold 19701956Mattawamkeag- Green3,500.00Sold 19611958Mattawamkeag- Stratton5,000.00Sold 19601959Mattawamkeag- Archer4,500.00Sold 19631960Wilton- Goodspeed40,000.001964Wilton- Butler (Gould cottage)35,000.001964Wilton- North15,000.001970Mattawamkeag- Nicholson18,000.00128 650 Petitioner, during the period here involved, conducted a guest program whereby its customers and sales representatives were invited to Wilton for the purpose of touring and inspecting the company's facilities, manufacturing operations and attending sales meetings. In connection with this program petitioner provided its visitors with lodging, meals, entertainment and recreational activities. Due to the inadequate accommodations in the Wilton area guests were housed at various cottages owned by petitioner, including the Wilson Lake cottage, 8 Gould cottage (also known as Butler house) and Leavitt guest cottage. However, he Gould and Leavitt cottages were used primarily as temporary homes for new executives that were coming into the firm; petitioner would rent them for periods of 3 to 6 months. When not so rented the available rooms would house company guests. In addition to the Leavitt and129 Goodspeed homes petitioner, during the years in issue, owned six other houses all of which produced losses except one; the Wyman house. 9 Four of these homes, the Day, Lake, Wyman and Company houses were apparently rented year-round to company executives. The Butler and North houses were either rented for short periods to new executives or were used in the guest program. The North house was rented for only a short period as it was completely renovated during the years before us. A summary of the figures may be reflected as follows: Day HouseLake HouseWyman HouseCompany HouseButler HouseNorth House1965:Expense$ 762.03$ 639.72$ 730.00$ 611.77$3,619.78$1,844.49Income 705.00636.00513.90540.00900.000Profit or (Loss)$ (57.03)$ (3.72)$ (216.10)$ (71.77)[2,719.78)[1,844.49)1966:Expense$ 901.91$ 602.79$ 371.09$ 639.93$3,571.53$2,857.21Income 720.00576.00530.84540.001,800.00350.00Profit or (Loss)$ (181.91)$ (26.79)$ 159.75$ (99.93)[1,771.53)[2,507.21)130 During the years in issue T. R. Hodgkins owned a residence in Wilton which he rented to his sister. His wife owned the Wilson Lake cottage which she rented to petitioner. David Hodgkins owned a cottage on Clearwater Lake, approximately 15 miles from Wilton. He also owned some unimproved lots in Wilton. The notice of deficiency, prior to adjustment, reflects the following: 651 Leavitt House:August 31, 1965August 31, 1966Expenditures claimedLabor$5,474.8$ 3,144.26Insurance250.27250.27Taxes594.57572.33Repairs1,462.781,020.42Depreciation 2,163.402,341.28$9,945.90$7,328.56Less Rent$2,340.00$2,340.00Taxes 454.68389.59 2,794.682,729.59Expenses Disallowed $7,151.22$4,598.97Goodspeed House:August 31, 1965August 31, 1966Expenditures claimedLabor$2,149.78$ 2,394.45Insurance153.00153.00Taxes1,162.811,119.32Repairs1,999.88666.04Depreciation 1,155.141,164.14$6,620.61$5,496.95Less Rent$1,800.00$1,800.00Taxes 846.01752.122,646.012,552.12Expenses Disallowed $3,974.60$2,944.83131 Ultimate Findings of Fact The Leavitt house and Goodspeed house, during the years in issue, were assets held for the personal benefit of petitioner's principal shareholder and his son. Opinion In 1951 petitioner purchased the Leavitt house. From 1953 through the years in issue the house was rented to T. R. Hodgkins, petitioner's president, general manager and majority shareholder. The rent paid approximated the fair rental value of the property. In 1960, petitioner, in compliance with an employment agreement, purchased the Goodspeed house and rented it to Howard, an executive of the company. Following Howard's disengagement from petitioner in 1963, David L. Hodgkins, son of T. R. Hodgkins and a director and sales manager of the company, moved into the house. The rent paid by David was equivalent to the fair rental value. The expenditures incurred by petitioner in caring for and maintaining the two homes exceeded the rent received. The issue presented for adjudication relates to whether petitioner is entitled to deductions for depreciation and upkeep, within the provisions of section 167 and 162, I.R.C. 1954, 10 to the extent that they exceed the rent received. Petitioner132 does not argue that the excess expenses are deductible as additional compensation to the occupants of two houses, and hence we are precluded from an analysis of the deductibility issue on that ground. The sole question to be considered in deciding the issue at hand is whether ownership and maintenance of the realty related primarily to personal or to business purposes. Such an issue requires a determination of fact and the burden of proof rests on the petitioner. Louis Greenspon, 23 T.C. 138">23 T.C. 138 (1954),133 aff'd on this issue 229 F. 2d 947 (C.A. 8, 1956); Louis Boehm, 35 B.T.A. 1106">35 B.T.A. 1106 (1937). Of further 1 significance is the fact that here we have 652 a corporation taking deductions for expenditures on the private home of its dominant shareholder and chief executive, as well as on the home of the majority stockholder's son. "In such circumstances the proof should be very clear and very certain that the expenses charged to the corporation were legitimate business expenses of the corporation. Otherwise, the opportunity for abuse would be great." Louis Greenspon, supra, at 151. We have considered the facts presented and conclude that during the years in issue the two houses in question were not employed primarily for business purposes, but rather were assets used predominantly for the personal benefit of petitioner's principal shareholder. In support of this conclusion we note initially that during the years before us both the Leavitt and Goodspeed homes were used generally, if not exclusively, as the personal residences of T. R. Hodgkins and David L. Hodgkins, petitioner's controlling stockholder and his son. See Transport Mfg. & Equipment Co. v. Commissioner, 434 F. 2d 373134 (C.A. 8, 1970), affirming a Memorandum Opinion of this Court; International Trading Co. v. Commissioner, 275 F. 2d 578 (C.A. 7, 1960), affirming a Memorandum Opinion of this Court; Reynard Corporation, 30 B.T.A. 451">30 B.T.A. 451 (1934). Petitioner contends however that the structures in issue qualify as business property because (1) they were acquired to attract prospective executives to accept employment with petitioner; (2) both homes were employed to entertain and house company guests; (3) the Leavitt house was a showplace used to impress customers and promote business; and (4) the rent paid was equivalent to the properties' fair rental value. In regard to petitioner's first assertion, we can appreciate the necessity in certain instances to purchase housing to attract qualified executives. Cf. section 119 and the cases cited thereunder. See also United States Junior Chamber of Commerce v. United States, 334 F. 2d 660 (Ct. Cl., 1964). In such a situation the expenditures incurred may very well qualify as a business expense. 11 However, in the instant case the property in issue, during the years before us, was occupied by petitioner's principal shareholder135 and his son, both of whom owned other homes in the area and did not have to be persuaded or lured to Maine to accept positions of employment. We further note that the nonbusiness character of the use of the Goodspeed house during the years in issue is not altered by the circumstances which led to its acquisition. Rather, to the extent the prior occupancy possibly gave the house the color of business use, the hue clearly faded upon the executive's severance from the company, and the building assumed a new tone on David's occupancy; that of an asset held for the personal benefit of its tenant. Cf. Gevirtz v. Commissioner, 123 F. 2d 707 (C.A. 2, 1941); Gilbert Wilkes, 17 T.C. 865">17 T.C. 865 (1951); R. C. Bayliss, 35 B.T.A. 1128">35 B.T.A. 1128 (1937). Compare Andrew F. McBride, Jr., 50 T.C. 1">50 T.C. 1, 10 (1968). 12136 The Leavitt house, on the other hand, involved no such alteration; from 1963 through the years in issue T. R. Hodgkins was the property's only tenant. 13As to petitioner's second contention, we can find little, if any, substantive evidence 653 in the record which would demonstrate the properties' use in entertaining or housing company guests.14 However, even if we were to concede such implementation 15 it would at best be only incidental to the properties' principal use, the housing of two corporate executives. Such an insignificant business application does not qualify the expenditures incurred therein as ordinary and necessary business expenses. We find support for this position in Commissioner v. Doyle, 231 F. 2d 635 (C.A. 7, 1956), affrming a Memorandum Opinion137 of this Court, wherein the Court commenting upon the latitude to be given to the phrase "ordinary and necessary expense" albeit in another context, stated: We construe the statutory words "ordinary and necessary expenses" to mean those expenses which economically are an integral part of a business * * . Integrality is the test. Disbursements which fail to meet this test, although they may be concomitants to the business as operated by some persons, are not ordinary and necessary expenses thereof within the meaning of * . [Emphasis supplied.] Additionally, in Greenspon, supra, this Court stated: However, even if there were proof in the record of the extent to which the farm was used to entertain business guests, we could not allow deduction of the particular expenses which have been charged to the corporations here. We think that it is too remote138 and too extraordinary to classify expenditures for farm tools, fertilizers, shrubbery, etc. as promotional expenses or as entertainment expenses. See also International Artists, Ltd., 55 T.C. 94">55 T.C. 94, 104 (1970). In Greenspon, supra, the Tax Court, faced with the precise issue raised by petitioner's third assertion, stated: Nor are we able to accept the contention that these expenses are justified because the farm was developed as a sort of horticultural showplace to impress potential customers. The relationship between the aesthetic stimulation of a potential customer from the view of an unusual array of shrubbery and flowers and his order for pipe is much too oblique. 16Relying on the above quoted language it is apparent that even if we were to determine that the Leavitt house was in fact a "showplace" this would not permit the characterization of expenses incurred therein as business139 deductions, but rather would necessitate a further demonstration of a connection between such property and petitioner's business. We find no such connection between the care of a home and the production of woodenware products. Petitioner's final argument is also not well founded. The payment of the fair rental value by the tenants does not convert the properties' character from personal to business use. 17 See International Trading Co. v. Commissioner, supra, wherein the Court stated: True, the Tax Court found that under the circumstances the fair rental values of the premises for the time the families made use of the property were not in excess of the rentals they paid. Still this does not overcome the court's finding that the property had little or no business use and was maintained primarily for the personal use of the stockholders, and thus, implicity, any expenses incurred in its maintenance were not in connection with its trade or business. 140 At best its only result is to prevent constructive dividend treatment to such tenants. Compare United Aniline Co. v. Commissioner, 316 F. 2d 701, 705 (C.A. 1, 1963), affirming a Memorandum Opinion of this Court; Nicholls, North, Buse Co., 56 T.C. 1225">56 T.C. 1225, 1240 (1971); International Artists, Ltd., supra, at 108 with International Trading Co., supra, T.C. Memo 1958-104">T.C. Memo. 1958-104. Lastly we note that petitioner has failed to assert that the property in issue was held for the production of income. In light of the facts presented we find its decision 654 to exclude such contention a reasonable one. See Samuel Yanow, 44 T.C. 444">44 T.C. 444, 452-3 (1965), affd. per curiam 358 F. 2d 743 (C.A. 3, 1966). Upon an examination of the entire record we conclude that the expenditures incurred and depreciation deductions claimed to the extent they exceed rent received on the property in issue are disallowed. Decision will be entered under Rule 50. Footnotes1. Respondent concedes that petitioner is entitled to deduct expenses and depreciation to the extent of rental income produced plus property taxes. ↩2. The notice of deficiency disallowed expenses incurred in maintaining the two homes, and thereby increased taxable income in the following amounts: Leavitt HouseGoodspeed House8/31/658/31/668/31/658/31/66$7,151.22$4,598.97$3,974.60$2,944.83Expenses disallowed per notice of deficiency. Through amendment of the notice of deficiency such amounts have been reduced and may be presently reflected as follows: ↩$6,864.92$4,592.08$4,002.25$3,000.133. The record presented indicates that respondent is only contesting the business character of the main house; he concedes the deductibility of expenditures incurred in the guest house and unattached garage.↩4. From 1943 to 1953, Theodore R. Hodgkins lived with his former wife at 21 Court St., Farmington, Maine. In May of 1953 he was divorced. As part of the property settlement he transferred the Farmington home to his former spouse and moved into the Leavitt house. ↩5. William Howard became general manager in 1960. However he retained such position only until February 1962 at which time he became sales manager. He left the company in December of 1963.↩6. Whether Hushing has in fact rented the Leavitt house cannot be ascertained from the record.↩7. It seems we are herein concerned only with the main house and the immediate surrounding area. The character of the additional property is not in issue.↩8. Petitioner did not hold title to the Wilson Lake cottage. It was owned during the years in issue by Virginia G. Hodgkins, T. R. Hodgkins' spouse. However, petitioner paid substantially all expenses incurred therein and in addition paid Virginia Hodgkins $3,600 per year in rent.↩9. The Wyman house produced a gain in 1966, prior to its destruction by fire; 1965 was a loss year.↩10. All section references are to the Internal Revenue Code of 1954 unless otherwise indicated. The above noted sections state in part as follows: 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 * * . SEC. 167. DEPRECIATION. (a) General Rule. - There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) - (1) of property used in the trade or business, or (2) of property held for the production of income.↩11. Respondent, in the instant case, does not contest the expenditures incurred in maintaining the other homes owned by petitioner, which were in fact acquired to attract executives or house guests.↩12. The cases cited above deal with an individual taxpayer's conversion of property held for the production of income to property held solely for personal reasons. This same theory of conversion has however been applied to corporations. See Richard R. Riss, Sr., 56 T.C. 388">56 T.C. 388, 415 (1971), on appeal (C.A. 8, May 26, 1972) wherein this Court stated: Generally speaking, where property has been held for the personal use of a taxpayer, a deduction under * * section 167(a)(2) * * * will be denied unless it can be shown that a conversion of the property occurred * * . Usually, this question arises in the context of an individual taxpayer who has abandoned his place of residence, and who is seeking a deduction for the cost of maintaining that property prior to sale * *. Hence, the case law that has developed in this area has centered around the activities of individual taxpayers. Whether these rules should be extended to a corporate taxpayer in a case such as the one now before us is a question which we believe must be answered in the affirmative.↩13. We point out that petitioner's offering of the Leavitt house to various prospective executives does not, in this Court's opinion, alter the character of the property wherein the president, general manager and dominant shareholder remains the sole tenant of such property. Compare United States Junior Chamber of Commerce v. United States, 334 F.2d 660">334 F. 2d 660, 662↩ (Ct. Cl., 1964).14. We are herein referring only to the Leavitt main house. Respondent on brief apparently concedes the business character of the Leavitt guest house. ↩15. In such event petitioner is still confronted with section 274 in regard to the properties' use as an entertainment facility, which burden has not been met.↩16. The Eighth Circuit, in affirming this decision, stated: We find no cases authorizing the deduction of promotional expense which resulted in enhancing the value of the taxpayer's home. An allowance of this type would open the door to many questionable deductions.↩17. The payment of fair rental value could indicate a profit motive on the part of the corporation in renting the property. However, as will be seen infra, petitioner raises no such contention and we find no such motive from the record presented.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621303/	ESTATE OF JOHN E. GILSON, DECEASED, GEORGE I. GILSON, JESSIE F. GILSON, AND FIRST WISCONSIN TRUST COMPANY, TRUSTEES, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Gilson v. CommissionerDocket No. 105366.United States Board of Tax Appeals47 B.T.A. 529; 1942 BTA LEXIS 678; August 13, 1942, Promulgated 678 In 1932 petitioner had a serious and extensive operation for cancer. Thereafter he went about his business without apparent inconvenience except that resulting from a colostomy. In April 1937 he submitted to another operation, presumably for gall stones, but which revealed a cancerous condition of the liver beyond relief. On December 31, 1936, he transferred without consideration certain stock in a corporation controlled by him to his wife, two sons, and his secretary. On August 4, 1937, he transferred to his wife, two sons, two daughters, and his secretary other shares at less than their fair market value, receiving as down payment dividends declared on August 14 and taking notes for the balance. He died September 29, 1937. Held, under all the facts and circumstances, the transfers of December 31, 1936, and the transfers of August 4, 1937, to the extent of the difference between the selling price and the fair market value of the stock, were gifts in contemplation of death and properly includable in decedent's gross estate. Kneeland A. Godfrey, Esq., for the petitioners. Jonas M. Smith, Esq., for the respondent. ARNOLD 529 This proceeding679 involves a deficiency of $8,455.76 in estate taxes. The issue is whether certain gifts of shares of stock on December 31, 1936, and certain sales of similar stock on August 4, 1937, constituted gifts made in contemplation of death, the extent of the alleged gifts as to the sales being the difference between the selling price and the fair market value of the stock. FINDINGS OF FACT. The petitioners are the trustees and former executors of the last will and testament of John E. Gilson, who died a resident of Port Washington, Wisconsin, on September 29, 1937, at the age of 59. The estate tax return was filed with the collector of internal revenue for the district of Wisconsin. For more than 20 years prior to his death decedent conducted a foundry business in Port Washington. Prior to January 1, 1937, this business was operated as a sole proprietorship under the firm name of "J. E. Gilson Company." In 1928 his elder son, George I. Gilson, became active in the business and in 1934 his other son, John B. Gilson, entered the business. During 1932, which was the low ebb of the depression as far as employment and sales by the J. E. Gilson Co. were concerned, the company employed680 approximately 45 persons. From 1933 to 1936 its business grew continually until it employed 97 530 persons at the time of decedent's death and its sales were three to four times its 1932 sales. Except for certain periods during 1932 and 1937, hereinafter more fully discussed, the decedent was actively engaged in conducting the foundry business until shortly before his death. Prior to March 16, 1932, decedent was suffering severely from what he thought was hemorrhoids. At or about this time he complained of his condition to his wife for the first time. She suggested that he see a doctor in Milwaukee that they had met on a vacation trip. The doctor's examination convinced him that decedent's condition was more serious than hemorrhoids. This diagnosis was supported by a second physician, who took the decedent to the Chicago Memorial Hospital for further examination. The decedent's condition was diagnosed as carcinoma or cancer of the rectum. Decedent, upon being informed of this condition, "thought everything was over." The surgeon explained the very extensive and serious nature of the operation that would have to be performed and decedent agreed to submit thereto. 681 He was admitted to the hospital on March 16, 1932, and approximately 18 inches of the lower intestine were removed. An artificial opening was made in decedent's side through which waste from the body was eliminated by drainage into a pad or apron receptacle. It required daily cleansing and changing. Decedent was discharged from the hospital on April 29, 1932, and returned to his home in Port Washington to convalesce. As his strength increased he gradually increased the time devoted to his business affairs until he resumed full control. During the years subsequent to the operation his condition was apparently good, he was free from the terrible distress he had had prior thereto, and he picked up in spirits and weight. He had been told by the surgeon that there might be a recurrence of the cancer, but that "if he could go four or five years he could be pretty safe." His local physician told him that after three years he was reasonably safe. On occasions he expressed the conviction that his operation had been as successful as similar operations on several other people in the community, and he expressed the belief that with the passage of time a recurrence of cancer became increasingly682 remote. In or about September 1936 decedent discussed the incorporation of his foundry business with his accountants and his attorney. Pursuant to decedent's request, his accountants prepared an analysis and report on the relative advantages and disadvantages of sole proprietorship and incorporation as applied to his business. This report was submitted to decedent under date of November 13, 1936. It made no specific recommendation as to what the decedent should do about incorporating but stated that the accountants would be pleased to discuss the matter further upon notification. 531 On or about December 15, 1936, decedent visited his doctor in Chicago. He complained at that time of some digestive disturbance and of a little distress in the upper right abdomen in the region of the gall bladder. His doctor hospitalized him from the 15th to the 18th, as he suspected the decedent might have gall stones or metastasis of the liver. X-rays were taken, which indicated the trouble might be gall stones. He was advised that another operation would be necessary. At that time decedent was planning his annual winter vacation and the doctor told him to go ahead with his plans683 and see how he made out. Shortly after returning from the hospital and on or about December 31, 1936, decedent incorporated his business as the "J. E. Gilson Company", with a capital stock of $100,000, par value $100 per share. On December 31, 1936, he transferred by gift 152 shares of the capital stock of said corporation as follows: Jessie F. Gilson, wife50 sharesGeorge I. Gilson, son50 sharesJohn B. Gilson, son30 sharesClementine Kraus, secretary20 sharesWalter H. Bender, attorney2 sharesIn making these gifts decedent stated that the members of his family and Miss Kraus, who had worked with him for many years, were deserving of some interest in the business. He further expressed the hope that a financial interest in the business would result in a greater personal interest on the part of the donees. At the time these gifts were made decedent gave no indication that he was concerned with the thoughts of death. On or about January 15, 1937, decedent, his wife, and their son, George, left home on a motor trip to Florida. The son remained in Florida with his parents for a week, during which time they visited various points of interest in684 Florida and many of the orchards. On these trips decedent purchased canned jellies and things of that type to send to some of his good customers. In the evenings they always dined out, then took in the movies, went for a walk, or went down to the yacht club to see the boats. Decedent's weight while in Florida was fairly normal. Decedent returned home shortly before April 7, 1937. On or about April 7, 1937, decedent reentered the hospital and on April 10 an operation was performed. Upon opening up the abdomen to explore the gall bladder the doctor discovered that decedent had carcinoma of the liver, evidenced by a growth on top of the liver nearly as large as a good big chestnut. This was a condition about which nothing could be done and no further operation was attempted. Instead, the doctor had a gall stone given to decedent, who was told that it was his gall stone. The members of decedent's family were 532 advised as to his true condition and cautioned against revealing it to him. The surgeon advised decedent's physician in Port Washington as to the facts and prescribed an intravenous injection of colloidal gold to be administered by the local physician for the685 purpose of retarding the cancerous growth but informed decedent that the injections were to make the gall ducts and bladder work. Decedent was discharged from the hospital on April 23, and after a few days at home he returned to the plant for a few hours a day. As his strength increased he became increasingly active in the business. In or about June 1937 he moved out to his summer home, which was four miles from Port Washington, and remained there until Labor Day. He drove his car back and forth from the foundry plant to the summer home. During the summer of 1937 decedent made plans for enlarging the floor space of the factory by approximately 50 percent because of greatly increased business. In or about June 1937 he drew up the preliminary sketches and engaged the services of an architect to draw the permanent plans. He held frequent consultations with the architect and with the contractor who was to do the building in connection with the proposed expansion of the foundry plant. Decedent's activities outside his business up to the middle of August 1937 included supervising the construction of a very extensive rose bed at his summer home, the drafting of plans and supervision686 of the construction of a sunhouse at the summer home, and consideration of the purchase of a sailboat. In addition he was active with the school board, being nominated and reelected in July 1937. He conducted several meetings at his summer home in the evenings, to which he invited a great many of the townspeople and at which various school policies and plans were discussed. Decedent had served as chairman of the school board for twelve years and had been very active in educational work for years. On August 4, 1937, decedent sold certain shares of stock of the J. E. Gilson Co. at $100 per share to the following persons: NameSharesConsiderationJessie F. Gilson, wife50$5,000George I. Gilson, son505,000Retta Gilson, daughter505,000Marion Gilson, daughter505,000John B. Gilson, son505,000Clementine Kraus, employee303,000Total28028,000The shares of stock were transferred on the books of the corporation to the purchasers. Just prior to these transfers and on July 31, 1937, the books of the corporation showed a surplus of $43,700, or a 533 book value of approximately $143 per share. On August 14, 1937, the corporation687 declared a dividend on its stock, which dividend was used as a down payment on the purchase price of the stock and 5 percent notes due in five years were given by the parties named for the balance. The whole initiative with respect to the sales aforementioned was taken by the decedent, and the wife, at least, was not consulted as to whether she would buy the additional stock. Decedent's normal activities continued until about the middle of August. During the second or third week of August it became apparent that he was losing weight, although his appearance outwardly was good. During the summer he gave no indication to his local physician that he was suffering any pains or that he knew the purpose of the colloidal gold injections. In administering the colloidal gold the local physician removed the label and told the decedent the injection was for the purpose of increasing the ability of his liver to function. Decedent received about twelve injections of colloidal gold, but they upset his stomach so much that the injections were discontinued. On August 28 the decedent was visited by his attorney and the latter's wife. At that time decedent mentioned that he had some discomfort688 and some little pain of a neurotic character, which he presumed was recovery pains, as he had similar pains from his first operation. He stated that he had been operated on for gall stones and that he had the stone. Decedent gave no indication that he believed or thought he was suffering from an incurable ailment, but he did discuss making a last will and testament with his attorney. On September 11, 1937, decedent executed his will and on September 15, 1937, he executed a codicil thereto. Under the terms of the will his real estate, together with $5,000 in cash, was given to his widow, 400 shares of stock in J. E. Gilson Co., and cash of $3,000 and $5,000 were given to his two sons, 168 shares of said stock were placed in trust for them, and, except for certain specific bequests, the residue of his estate was placed in trust for his two daughters. The codicil provided for placing the share of John B. Gilson in a trust which could be terminated upon certain conditions. On September 19, 1937, decedent developed a bowel disorder that caused him severe pain, which was relieved by the use of morphine. This was the first use of morphine after the 1937 operation. The death certificate689 gave the principal causes of death in order of date of onset as: chronic myocarditis, September 1937; chronic nephritis, August 1937; and contributory causes of importance as, carcinomatosis of interestines. The estate tax return reported decedent's gross estate as $274,971.60, exclusive of the transfers involved herein. In determining the deficiency respondent increased the gross estate by $27,750 representing 534 the 150 shares of stock 1 transferred on December 31, 1936, and by $23,800 representing the excess of the aggregate value of 280 shares on August 4, 1937, over the selling price thereof. Respondent valued the stock transferred on each occasion at $185 per share, and it is stipulated that, if the transfers constituted gifts in contemplation of death, the value determined by respondent is correct. Decedent was an active and intelligent leader in his community. He was one of the organizers of the local Building & Loan Association and its president when690 he died. He founded the Port Washington Rotary Club and was its first president. He was a director in several corporations, was active in Masonic circles, was chairman of the Ozaukee County Republican Committee for many years, and was interested in various civic endeavors. He was normally of a cheerful disposition and seldom complained of his personal ills. The dominant motive and impelling cause for the gifts and transfers made by decedent on December 31, 1936, and August 4, 1937, were contemplation of death. OPINION. ARNOLD: Section 302(c) of the Revenue Act of 1926 as amended 2 provides, so far as pertinent hereto, that the value of a decedent's gross estate: * * shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated, except real property situated outside of the United States - (c) To the extent of any interest therein of which decedent has at any time made a transfer, by trust or otherwise, in contemplation of * * * death; except in case of a bona fide sale for an adequate and full consideration in money or money's worth. Any transfer of a material part of his property in691 the nature of a final disposition or distribution thereof, made by decedent within two years prior to his death * , without such consideration, shall, unless shown to the contrary, be deemed to have been made in contemplation of death within the meaning of this title. If the transfers made by decedent on December 31, 1936, and on August 4, 1937, were gifts in whole or in part, then the statute sets up a presumption that these gifts were made in contemplation of death, as decedent died within nine months of the first gifts. The burden rests upon the petitioners to rebut the statutory presumption and to overcome respondent's determination. No question is presented as to the values included in the gross estate as a result of the transfers. The only question is whether such transfers were made in contemplation of death. 535 Whether gifts are made in contemplation of death is primarily a question of fact. In determining the ultimate fact it is necessary to carefully scrutinize the circumstances of each case in order to detect692 decedent's dominant motive, as is always to be found in motive. U.S. 102. In the course of the cited opinion the Supreme Court defined the statutory words thought of death is the impelling cause of the transfer that rule of construction which in place of contemplation of death makes the final criterion to be an apprehension that death 'is near at hand'." The Supreme Court reversed the rule laid down by the Court of Claims that there be a condition creating a reasonable fear that death was near at hand, and that such reasonable fear or apprehension must be the only cause of transfer, by stating that of death be the inducing cause of the transfer whether or not death is believed to be near. By their evidence petitioners have attempted to rebut the presumption of the statute and overcome respondent's determination by establishing that the gifts were motivated by thoughts of continued life and that the transfers were not testamentary dispositions influenced by the thought or fear that was near at hand, but were transfers to aid and assist his family, to give them a present income, and to more closely align the donees with the business. Finally, it is urged that the sales of August 4, 1937, were693 for an adequate and full consideration and no gifts resulted. After carefully weighing and scrutinizing the facts adduced, we are convinced that neither the statutory presumption nor the burden of proof as to respondent's determination has been overcome. All the witnesses agreed that decedent was a highly intelligent man. The surgeon testified that decedent knew he was suffering from cancer in 1932, that he was desperate, and that he over. and that the operation then to be performed was serious and extensive, with the chances of recovery against him. It does not appear whether he knew the percentages against the success of the operation or not, but the surgeon testified that one operation in five was successful if the case was obtained early enough to effect a cure. The testimony shows that the cancer an operation, the chance of success of which was wholly problematical. He knew the operation offered no guarantee against a recurrence of the cancer cells elsewhere in his body, but he took this chance to prolong his life. The testimony of the witnesses establishes that decedent had the possibilities of a recurrence of his condition on his mind. Had he 536 sought to694 forget his cancerous condition, no chance was afforded him, as the aftereffects of the colostomy constituted a daily reminder. That the possibility of a recurrence was ever before him is shown by the testimony of the two doctors, the son, the widow, and the attorney, with each of whom he discussed the matter. Neither doctor assured decedent that the passage of three or five years without a recurrence would constitute a guarantee against cancer, but only that he would be that most patients who know they are operated on for cancer feel that there will be a recurrence, and in his opinion decedent thought the same thing. Decedent, as an intelligent man, must have known that a malignant affliction, such as he knew he had when first operated on and of which the colostomy was thereafter a daily reminder, would inevitably prove fatal unless completely eradicated. We must, therefore, examine his actions under these circumstances for a clue to his predominant motive in making the gifts. It is significant that decedent made the first transfers only after ascertaining that another operation was necessary. Informed on or about December 18, 1936, of the impending operation, he immediately695 incorporated his business for the purpose, inter alia, of making the gifts of December 31, 1936, since it would be impracticable to give undivided interests in a sole proprietorship. Such hasty action becomes doubly significant in view of decedent's complete despair at the time of the first operation, his obvious concern about his condition thereafter, and the possibility of a recurrence. While it may be true that the transfers were partly motivated by a desire to aid and assist his family and to more closely align the donees with the business, the question is not whether decedent had these motives as well, but what his predominant motive was. His continued interest in local affairs and in his business after he learned he was afflicted with cancer was but natural to anyone who had led an active life such as decedent had led. It tended to distract his mind from his physical condition. The respondent has determined that decedent's predominant motive in making the gifts was contemplation of death. The evidence does not overcome this determination. It is of interest that the gifts made on December 31, 1936, were substantially696 in accord with the testamentary dispositions made by his last will and testament, namely, the sons to acquire the business and the wife and daughters to be otherwise provided for. It is established that the decedent was not given to complaining, as his widow testified that she didn't know of his pain and suffering in 1932 until a few days before he went to the doctor. If the pain he suffered prior to March 16, 1932, brought no words of complaint from him until shortly before the operation, it is quite unlikely that carcinoma of the liver, which is 537 much less painful, according to the testimony of the surgeon, would bring forth any complaints, particularly in view of his knowledge that he had cancer in 1932. Obviously decedent was cognizant that his condition was growing more precarious at and prior to the transfers of August 4, 1937, as his physical condition was such that the colloidal gold treatment had to be discontinued. Considering all of the circumstances, we believe that decedent was motivated by thoughts of death and the necessity of putting his house in order before the moment of inevitable surrender. We, therefore, hold that the gifts here involved were made697 in contemplation of death within the meaning of section 302:c) of the Revenue Act of 1926, as amended. ; affd., . There remains the question of whether the transfers of August 4, 1937, were bona fide sales for an adequate and full consideration in money or money's worth. Petitioners defend the sales upon the ground that the books indicated a book value of $143 per share on July 31, 1937, before taxes, and, being stock in a closed corporation that was engaged in a hazardous business, decedent could not have realized more than $100 per share in the open market. While agreeing that for tax purposes the stock had a value of $185 per share, petitioners deny that this establishes the selling price thereof, citing , and contend that $100 a share was an adequate consideration for the stock. A major difficulty with petitioners' argument is that decedent acted for both vendor and vendee in arranging for the sales to vendees who were the natural objects of his bounty. The widow testified that decedent took the entire initiative in selling and698 transferring the stock and all she had to do was sign the notes. She stated she wasn't even consulted about the sale, but merely acquiesced in the purchase. Certainly, there was no bona fide sale for an adequate and full consideration within the meaning of the statute under these circumstances. We are, therefore, of the opinion that the excess of the agreed value over the selling price constituted a gift presumably made in contemplation of death, and that the evidence adduced supports the statutory presumption. The Schwing case, supra, was decided upon its own peculiar facts and is not controlling herein. Reviewed by the Board. Decision will be entered for the respondent.BLACK BLACK, dissenting: I dissent from that part of the majority opinion which holds that the gifts of 150 shares of stock in the J. E. Gilson Co. which decedent made on December 31, 1936, to his wife and two 538 sons and his secretary were made in contemplation of death. The Board's findings of fact as to these gifts state, among other things, as follows: In making these gifts decedent stated that the members of his family and Miss Kraus, who had worked with him*699 for many years, were deserving of some interest in the business. He further expressed the hope that a financial interest in the business would result in a greater personal interest on the part of the donees. At the time these gifts were made decedent gave no indication that he was concerned with the thoughts of death. It seems to me that the above findings of fact show that the transfers in question were related to purposes associated with life, rather than with the distribution of property in contemplation of death. Cf. . I think the decision as to these particular gifts should be that they were not made in contemplation of death and that so much of the deficiency in estate tax as is due to the inclusion of their value in decedent's estate should be expunged. VAN FOSSAN, LEECH, MELLOTT, and TYSON agree with this dissent. Footnotes1. Transfers of December 31, 1936, totaled 152 shares, but the two shares that decedent transferred to his attorney were apparently considered compensation and not a gift made in contemplation of death. ↩2. Amended by Joint Resolution of March 3, 1931, Public No. 131, 71st Cong., and as further amended by section 803(c), Revenue Act of 1932. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621304/	George Winchester Stone, Jr., and Hellen Dean Stone, Petitioners, v. Commissioner of Internal Revenue, RespondentStone v. CommissionerDocket No. 42788United States Tax Court23 T.C. 254; 1954 U.S. Tax Ct. LEXIS 44; November 17, 1954, Filed 44 Decision will be entered for the petitioners. Petitioner, a professor of English literature, was granted a fellowship by the John Simon Guggenheim Foundation to enable him to devote his full time for a year to a research project on which he had worked in his spare time for several years. Held, the grant constitutes a gift and not taxable income. Roswell Magill, Esq., and Albert Rosenblum, Esq., for the petitioners.George E. Grimball, Jr., Esq., for the respondent. Tietjens, Judge. Turner, J., dissenting. Murdock, Opper, LeMire, and Fisher, JJ., agree with this dissent. TIETJENS254 This proceeding involves a deficiency of $ 178.04 in income tax for the calendar year 1950. The sole issue is whether the amount of $ 1,000 received by the petitioner George Winchester Stone, Jr., from the John Simon Guggenheim Foundation is taxable income or a gift. The petitioners filed a joint return for 1950 with the collector of internal revenue at Baltimore, Maryland.255 FINDINGS OF FACT.The petitioners reside in McLean, Virginia. George Winchester Stone, Jr., hereinafter referred to as the petitioner, 46 is, and for several years has been, a professor of English literature at George Washington University. He holds the degrees of A. B., A. M., and Ph. D. which were conferred prior to 1950. He is especially interested in 18th century drama. In addition to teaching, he has worked in his spare time for many years upon a study of dramatic performances given in London in the period 1660 to 1800.The John Simon Guggenheim Foundation was incorporated by special act of the New York State Legislature on March 16, 1925 (Laws 1925, ch. 133). The act provides in part:Section 1. Simon Guggenheim, Olga Hirsh Guggenheim, Francis H. Brownell, Carroll A. Wilson, Charles D. Hilles, Roger W. Straus and Charles Earl, together with such other persons as they may associate with themselves, and their successors, are hereby constituted a body corporate by the name of John Simon Guggenheim Memorial Foundation, for the purpose of receiving and maintaining a fund or funds and applying the same or the income thereof to promote the advancement and diffusion of knowledge and understanding and the appreciation of beauty, by aiding without distinction on account of race, color or creed, scholars, scientists47 and artists of either sex in the prosecution of their labors and by such other lawful means as the trustees shall from time to time deem appropriate.§ 2. The corporation hereby formed shall have power to * * deal with and expend the income or principal of the corporation in such manner as in the judgment of the trustees will best promote its objects. * * The foundation was established in 1925 by the late Senator Simon Guggenheim and his wife. The foundation's original capital fund of $ 3,000,000 came from Senator Guggenheim. By gifts inter vivos and by will, the original capital fund has been increased, so that the foundation's balance sheet as of the beginning of 1953 showed assets in excess of $ 31,700,000.In his March 26, 1925, Letter of Gift to the trustees of the foundation and their successors, the late Senator Guggenheim stated in part as follows:The name John Simon Guggenheim embodied in the title is that of a dearly loved son who was cut off by death on April 26, 1922, just as he had completed his preparation for college. In this great sorrow, there came to Mrs. Guggenheim and myself a desire in some sense to continue the influence of the young life of eager aspiration48 by establishing a foundation which in his name should, in the words of the charter, "promote the advancement and diffusion of knowledge and understanding, and the appreciation of beauty, by aiding without distinction on account of race, color or creed, scholars, scientists and artists of either sex in the prosecution of their labors."* * * It is Mrs. Guggenheim's and my desire, in memory of our son, through the agency of this Foundation, to add to the educational, literary, artistic and scientific 256 power of this country, and also to provide for the cause of better international understanding. Our thought was that the income of the fund devoted to these purposes should be used to provide opportunities for both men and women to carry on advanced study in any field of knowledge, or in any of the fine arts, including music; and that systematic arrangements should be made to assure these opportunities under the freest possible conditions, and to make available for the public benefit the results of such studies. Believing as we do that such opportunities may be found in every country of the world, we purposely make no specification of locality, domestic or foreign, for the49 pursuit of these aims. * ** * * We strongly hope that this Foundation will advance human achievement by aiding students to push forward the boundaries of understanding, and will enrich human life by aiding them in the cultivation of beauty and taste. If, at the close of our lives, looking both backward and forward, we can envision an endless succession of scholars, scientists, and artists aided by the John Simon Guggenheim Memorial Foundation, devoting themselves to these purposes, we shall feel that, with the help of our associates, we shall have accomplished the aim which we had set before us, in memory of our son.The foundation is exempt, under section 101 (6) of the Internal Revenue Code of 1939, from income tax.The foundation is directed by a board of 9 trustees. The trustees appoint an educational board of 24 members. A committee of 5 of these members, appointed annually by such board, selects the persons to be awarded fellowships in each year.In furtherance of the purposes of the founders the Educational Advisory Board recommended the establishment of a system of fellowships offering to promising scholars opportunities under freest possible conditions to carry on50 advanced study and research in any field of knowledge, or opportunities for the development of unusual talent in any of the fine arts.The bylaws of the foundation provide in part:The Corporation will provide a number of Fellowships for advanced study or research, abroad or in the United States, in various fields of knowledge or in the fine arts, including music.The granting and holding of these Fellowships shall be governed by Rules which shall be promulgated from time to time by the Board of Trustees.The foundation has granted fellowship awards in some 60 fields, or groups of fields. Among these are painting, sculpture, music, creative writing, and research in medicine, chemistry, physics, history, anthropology, and literature. The individual to whom a fellowship is awarded works upon a project of his own selection and by methods of his own devising. The grants are made primarily to assist scholars and creative artists to carry on their own works of research and artistic creation. Occasionally, where commercial publication of the fruits of the work is not feasible, grants will be made to assist in publication, in order that the public benefit of the work is not lost 257 51 and that the fellow may have the educational benefit of criticism from other persons. The foundation derives no economic benefits from any publication of the results of work by fellows.Each year the foundation receives more applications than it awards fellowships. In 1950 the foundation received 1192 applications and awarded 156 fellowships. In 1952 about 1600 applications were received and 224 fellowships were awarded.The committee of selection chooses among the applicants for fellowships seeking to assist the ablest people who apply in any year. Awards are based upon the applicants' present abilities to do creative work or advanced research in the fields of their particular interests as revealed by their past achievements.The petitioner applied to the foundation for a fellowship for the year 1947-48. The application was not granted. In 1949 the petitioner made another application for the year 1950-51.The application form for a Guggenheim fellowship makes the following request of an applicant:PLANS FOR WORK:Submit a statement giving detailed plans for the work you would pursue during your tenure of a Fellowship. This statement should include, inter alia: a description52 of the project, including its character and scope, and the significance of its presumable contribution to knowledge, or to art; the present state of the project, time of commencement, progress to date, and expectation as to completion; the place or places where the work would be carried on, and the authorities, if any, with whom it would be done; your expectation as to publication of the results of your work; and your ultimate purpose as a scholar or artist. * The application also asks information as to the applicant's abilities and prospects for educational development. Inquiry is made as to personal history, education, accomplishments, and references concerning the applicant's abilities.The petitioner stated in the application as to his project:Volumes V-VIII of an eight-volume History of Dramatic Performances in London, 1660-1800. A chronological presentation of what went on each evening at each London theatre, with casts, incidental entertainments of singing and dancing, box receipts, and significant contemporary comment, properly annotated and indexed. Each volume to be introduced by a comprehensive essay synthesizing the findings for the period covered by the volume. 53 In his application the petitioner stated:In 1933, shortly after the Folger Shakespeare Library opened, I was invited by the Director to catalogue the Garrick Collection, as the 2,000 items of manuscript and printed material were unpacked. There I found for Dr. D. M. Little, editor of the monumental edition of Garrick Letters just now in the press, 300 unpublished Garrick Letters. I also discovered Garrick's long lost alteration of Hamlet, his Journal of a trip to France and Italy, 1763, and the Cross-Hopkins Diaries. I have published information on the first two items. 258 The last one will supply much unpublished contemporary comment on stage performances at Drury Lane (1747-1776). It forms the core of one volume in my present research.He also stated that he had received a Summer Fellowship from the Folger Library in 1948 in the amount of $ 500 for work at Folger on the History of London Dramatic Performances.The petitioner made the following detailed statement as to his project:Problem: For the past 117 years John Genest's Some Account of the English Stage (Bath, 1832) has had to serve as the register of dramatic performances in London from54 1660 to 1830. But his Account is inadequate for modern scholars. A ten-volume monument of industry in its time, it is not only poorly indexed, but fails to record 40 per cent of the performances each year for each theatre. It is incomplete in listing casts, and records little contemporary comment about the reception of the plays. Although three scholars in recent years have provided fuller information for three specific areas within the age, the task of recording all performances of the period still needs to be done.Proposed Solution: For a dozen years Dr. W. B. Van Lennep (Curator of the Harvard Theatre Collection) and I have been working at the task of preparing the full account needed -- an account which will supersede Genest's work. We plan to publish a History of London Dramatic Performances, 1660-1800, in eight volumes, (I, II, 1660-1700; III, IV, 1700-1740; V, VI, 1740-1776; VII, VIII, 1776-1800). We have invited Professor A. H. Scouten (University of Pennsylvania) and Dr. Emmett L. Avery (Washington State) to join us. In the division of labor Dr. Van Lennep will undertake the first period, Drs. Scouten and Avery the second, plus performances in the minor55 theatres to the end of the century, and I am undertaking the records of Drury Lane and Covent Garden during the last two periods (1740-1800).Content: The publication will be so arranged that the reader may see in chronological order what went on each evening at all the London theatres. Every recorded performance of a play in London is being noted, together with the afterpieces, the casts, the incidental entertainments of singing and dancing, and, where available, the box receipts. See attached data card.The notes include a brief resume of the plot and main ideas of any available manuscript or contemporary account of an unpublished play. Contemporary comment, now for the first time available, in diaries, letters, journals and periodicals, is also being included. Each volume is being equipped with an index of the plays, playwrights and characters.Each volume will be published separately when the material is in hand. Each will be introduced by a comprehensive essay synthesizing the findings in the period and relating them to the wider aspects of the intellectual milieu.Value: I believe this study is significant because, over and above the conclusions presented in the56 introductory essays, future scholars will be able by use of it to project any play, author, or type of play against the whole background of the 18th-century drama. Through it isolated treatments of narrow specialities will receive a total context in which their actual importance may be readily judged. What, for example, was Dryden's reputation on the 18th-century stage? I have discovered for the editors of the new W. A. Clark Memorial Edition (U. C. L. A.) of Dryden 307 performances of seven Dryden plays from 1740-1800. Dr. Avery will doubtless turn up 300 more for the preceding period, 1700-1740. Six hundred performances massed together argue 259 considerable popularity, but when projected against the total offerings for any single year, not to mention the whole century, or when projected against the 5,278 performances of 34 Shakespearean plays for the period, they appear to be less significant. Critics must be able to make this evaluation.This study will provide the basic means for scholarship in 18th-century drama to be as broad as possible in scope.The study will do more. It will give facts for the social historian, for the historian of taste, and for the historian57 of ideas in this stimulating period. It will indicate in its introductory essays and appendices the significance of the theatre (1) in the economics of small business in London (the number of trades that supported the theatre and were supported by it -- chandlers, carpenters, glovers, tailors, wine-merchants, painters, porters, oil-sellers, and numerous concessionairres), (2) in the municipal taxation program, (3) in the social and religious obligations of the theatrical group (benefit performances for public hospitals and charitable societies, and religious oratorios for the Lenten season), (4) in the book trade, author-contract and copywright field, and (5) in theatrical biography.These ramifications, in carefully indexed volumes, indicate the added usefulness of the work as a general reference for readers other than the scholar of 18th-century drama.* * * By June 1950 I expect to have completed the data for Drury Lane for the first of my volumes (1740-1776). I need a year's uninterrupted time to work up the parallel information for Covent Garden. By the time I have finished that, Drs. Scouten and Avery will have the pertinent facts on the minor theatres during that period; 58 so, if I can concentrate for a year we should have a publication, and a significant one I hope, in hand.One has to live with this sort of task twenty-four hours a day if the result is to be accurate and exhaustive. I need that uninterrupted time. All the information I require is available in this country (in the Folger Library, Harvard Library, Yale Library, Huntington Library) or can be obtained from England by microfilm. But I cannot take the time to do the task without fellowship aid.I could conveniently take off the academic year 1950-1951, so I am particularly desirous of a Guggenheim Fellowship for that year.In a "Suggested Form of Estimated Budget for Period of Fellowship" the petitioner submitted the following:Estimated Expenditures:Traveling expenses for yourself (and family if any)$ 75.00Living expenses6,350.00Supplies necessary to work75.00All other expenses100.00Total$ 6,600.00Estimated Resources:Sabbatical, or other leave, salary$ 2,550.00Other income1,050.00Fellowship stipend applied for3,000.00Total$ 6,600.00In March 1950 the petitioner received a letter from the Guggenheim Foundation informing him that59 his appointment to a fellowship had 260 been approved for 12 months from September 1, 1950, at a stipend of $ 3,000, for the purpose of the preparation of a calendar of dramatic performances in London, 1660-1800, upon certain conditions stated in an attached document.The document attached to the letter informing the petitioner of his fellowship award stated in part as follows:IT shall be a condition of every Fellowship that the holder agrees to retain his Fellowship throughout the period for which he is appointed, unless compelled to withdraw for urgent reasons, and to engage in no other occupation during this period than the scholarly or creative activities specified in the statement of project, except with the special permission of the Board of Trustees. Fellows are expected to use their Fellowships in the years for which they are appointed. If any Fellow resigns or withdraws from his Fellowship during the period for which he was appointed, for urgent reasons satisfactory to the Trustees of the Foundation, the Trustees reserve the right in every such case to adjust the stipend to any amount which in their judgment is equitable in the circumstances. Fellows shall receive60 letters of appointment, bearing the seal of the Foundation, specifying the terms for which they are appointed, stating the fields of study in which they are to occupy themselves, and recommending them as distinguished students to the esteem, confidence, and friendly consideration of all persons to whom they may present their letters.Every holder of a Fellowship, from the date upon which he accepts his appointment, until its termination, must at all times have on file at the office of the Foundation an address at which he can be reached promptly.The term of the fellowship applied for by the petitioner was from September 1950 to August 1951. During that college year he was on sabbatical leave from the university and received half salary. He requested that the fellowship awarded be paid him at the rate of $ 250 per month beginning with September 1950. He received $ 1,000 of this during 1950. In the summer of 1951 he taught classes during the summer school session. Otherwise he devoted his full time to the project. The work he undertook was not completed during the year of the fellowship and he has continued it subsequently in his spare time.As a consequence of this research 61 the petitioner is qualified to give various graduate seminars in 18th century drama for which he was not qualified before he embarked upon the fellowship.The petitioner carried out his work according to his own plan. The foundation exercised no supervision over his work, made no suggestions concerning it, and did not request or receive any report upon its progress or completion. No accounting was made of the fellowship funds received. The amount of time spent upon the project was determined by the petitioner. He performed no services for the foundation and was not in its employ. The foundation intended the fellowship award as a gift.The amount of $ 1,000 received by the petitioner in 1950 from the foundation was a gift.261 OPINION.The issue is whether the amount received by the petitioner from the John Simon Guggenheim Foundation is taxable income under section 22 (a) or a gift excludible under section 22 (b) (3), Internal Revenue Code of 1939.We have found that the fellowship payment to the petitioner was a gift. On this issue the controlling factor is the intent of the payor. Bogardus v. Commissioner, 302 U.S. 34">302 U.S. 34 (1937). It is 62 obvious that the foundation intended it as a gift. The object of the foundation is to aid scholars, scientists, and artists in the prosecution of their labors. The donor of the capital fund stated that the income was to be used to provide opportunities for men and women to carry on advanced study. The secretary of the foundation testified that the fellowship awards were intended as gifts.The respondent argues that the award was paid as compensation for services to be rendered by the petitioner, saying that it was granted on the basis of the petitioner's qualifications to do the work required by his project, which project was approved by the foundation with the expectation of results consistent with the petitioner's qualifications, and that to the extent there is any donative intent in making the award the beneficiary is society at large and not the petitioner whose services were expected in return for the grant. It is pointed out that the application showed the potential value of the results of the project to future scholars and historians, and that the amount of the award was in approximately the amount of the salary loss to the petitioner in taking sabbatical leave. 63 It is argued that the purpose of the foundation is to promote the advancement of knowledge and to add to the literary and scientific power of the country and that the fulfilment of this purpose depends upon the selection of projects from which results can be expected, and hence it is not unreasonable to conclude that the foundation adopts as its own the projects proposed by the fellows it selects.This argument misconceives the motives of both the petitioner and the foundation. The foundation does not accomplish its purposes by employing scholars or scientists to carry out projects. Its method is to make gifts to persons whose past achievements and present abilities, as shown by the foundation's investigation, merit financial assistance to enable them to carry out their own projects of creative work or self-improvement.The foundation has no program of projects, and does not select fellows entirely on the basis of their proposed projects. Since the foundation is a corporation exempt from income tax, it cannot give away money indiscriminately, but must exercise some selectivity in 262 choosing the recipients of its aid. Accordingly, it asks for a statement of the work64 proposed to be done by each applicant and it investigates his qualifications and capabilities. The secretary of the foundation testified that the objective is to choose the most meritorious individuals, those who can best advance their training or creative achievements, rather than the projects considered most beneficial to the public. The emphasis, he said, was upon individuals, not projects. In providing funds to qualified persons to carry out their own projects of creative work or self-advancement the foundation is carrying out the desires of its founders to give others educational opportunities such as their son would have had if he had lived. Here it made a gift to aid a worthy scholar that he might accomplish more readily a self-imposed task which would add to his professional standing. As an incidental result of the research the petitioner has since been able to give graduate seminars in 18th century English drama.The petitioner, on his part, did not offer his services to the foundation to do research under its direction upon a subject selected by it, nor was he seeking to sell or realize upon the prospective result of his labors. What he sought was a gift for the65 support of his family while he devoted his time to this project of his own intense interest. While benefit to future scholars and historians might result from the work his primary motive was to fulfill the task that had aroused his enthusiasm and commanded his attention since 1933.The award in this case bears no resemblance to the payments for a research fellowship in Ephraim Banks, 17 T. C. 1386. Banks was appointed a research fellow by the Polytechnic Institute of Brooklyn. The institute was carrying out a research project under a contract with the Navy and appointed fellows to do certain work in the Department of Chemistry under directions of Professor Ward. Banks' work included making stereoscopic measurements of the light output and light absorption of various materials and studying the structure of materials by X-ray techniques. He described his work in a paper which was accepted in partial satisfaction of the requirements for a doctor's degree which he subsequently received. In the cited case the work was performed to carry out a contract between the institute and the Government. It was assigned by and done under orders of supervisors, 66 reports were required, and the relation between the fellow and the institute was that of employee and employer. The same situation existed in Ti Li Loo, 220">22 T. C. 220. In the present case no such relationship existed. The grant was in the nature of a scholarship to facilitate the further education or training of the recipient even though in this case he held several degrees. His research was in a field of his own selection. He was under no obligation to perform services for the foundation or any other person. The arrangement 263 between the foundation and the fellow is not an employment contract. The foundation does not assume or stipulate for authority to direct and control the fellow as to the details and means by which the project is carried out, to require conformity with a schedule of working hours, to supervise the work to see that it is satisfactorily done, or to require reports on the progress of or the completion of the task. The payments are not for services.The respondent also urges that the case is controlled by Robertson v. United States, 343 U.S. 711">343 U.S. 711 (1952). In that case the taxpayer submitted67 a symphony and won an award which had been offered for the best symphonic work written by a composer native to the Americas. The award was offered in 1945 by Henry H. Reichhold, who was president of the Detroit Orchestra, Inc. The terms of the offer provided that none of the compositions could be published or publicly performed prior to entry, that each composition receiving an award would remain the property of the composer, and that the composer would grant the Detroit Orchestra, Inc., all synchronization rights as applied to motion pictures, all mechanical rights as applied to recordings, the exclusive right to authorize the first performance in each of certain countries, and the right to designate the publisher. The taxpayer had in the years 1936 to 1939 composed a symphony which had not been performed. He submitted it and won the principal award in 1947. He contended that the amount received was a gift and not taxable income. The Court stated (p. 713):In the legal sense payment of a prize to a winner of a contest is the discharge of a contractual obligation. The acceptance by the contestants of the offer tendered by the sponsor of the contest creates an enforceable contract. 68 See 6 Corbin on Contracts Section 1489; Restatement, Contracts, Section 521. The discharge of legal obligations -- the payment for services rendered or consideration paid pursuant to a contract -- is in no sense a gift. The case would be different if an award were made in recognition of past achievements or present abilities, or if payment was given not for services, see Old Colony Trust Co. v. Commissioner, 279 U.S. 716">279 U.S. 716, 730, 49 S. Ct. 499">49 S. Ct. 499, 504, 73 L. Ed. 918">73 L. Ed. 918, but out of affection, respect, admiration, charity or like impulses. Where the payment is in return for services rendered, it is irrelevant that the donor derives no economic benefit from it.The respondent contends that the payment to the petitioner was similarly in discharge of a contractual obligation, that the foundation's offer for applications for fellowships was open to anyone, and that the petitioner's acceptance of the offer created an enforceable contract under which the foundation was obligated under its charter and the laws of the State wherein it was chartered. The contention is made that the application asked for an award to permit the applicant to69 work on this project and the letter of notification contained a statement that it was awarded on condition that the petitioner do no other work during the period of the fellowship.264 The holding in the Robertson case has no application here. In that case there were certain terms in the offer which the composer accepted in submitting his composition. He agreed to grant to the Detroit Orchestra, Inc., rights as to motion pictures and recordings, the right to authorize the first performance in each of certain countries, and the right to designate the publisher. These were valuable rights. While the donor of the prize did not himself receive these rights, he caused them to be given to the Detroit Orchestra of which he was the president and which he desired to benefit. In the present case the foundation received no rights of value for itself and bargained for no rights for any other person.Nor did the foundation enter into a contract with the petitioner within the intent of the Robertson case. The offered prize in that case was of a fixed amount payable in any event and was held to be accepted by the contestants when they submitted compositions. In the present case70 there is no such offer. The foundation made no promise to pay a fixed number of awards or a specified sum of money and might have refused all applications in any year. Although it stood ready to assist worthy applicants who might be chosen by its board of selection, this is no commitment sufficient to create an enforceable contract by the filing of an application proposing a project. Even if an offer can be said to exist, the applications do not amount to acceptances. The application here was for funds to enable the petitioner to do something he wanted to do at the time and in the manner of his own choosing. This is not a sufficient consideration to create an enforceable contract.The respondent refers to the "conditions" stated in the document sent the petitioner with the notification of the award as constituting conditions of the "contract," particularly the satement that he should engage in no other occupation during the period of the fellowship than the activities specified in his statement of the project. Conditions such as these do not necessarily convert what is intended as a gift into a contract for services. A gift may be made subject to certain conditions. A payment71 made subject to a condition is or is not a gift depending upon whether the parties intended compliance with the condition as consideration for the payment. Restatement, Contracts, p. 82; 1 Williston, Contracts (rev. ed. 1936), sec. 112; Stelmack v. Glen Alden Coal Co., 14 A. 2d 127, 128, 129, (Pa., 1940). Compliance with the conditions stated by the foundation was clearly not intended as consideration for the award.The petitioner was not "offering the results of his professional skill to win prize money," as in the Robertson case. (See the opinion of the Court of Appeals for the Tenth Circuit, 190 F.2d 680">190 F. 2d 680, at p. 683.) Nor was the foundation offering a prize in the sense of other prize 265 cases such as Herbert Stein, 14 T. C. 494 (1950), and Amirikian v. United States, (C. A. 4, 1952) 197 F.2d 442">197 F. 2d 442.The fellowship award was not paid pursuant to a contract and was not a payment for services. It was a gift excludible under section 22 (b) (3) of the 1939 Code.Decision will be entered for the petitioners. TURNER Turner, J., dissenting: 72 The facts being as they are, I find myself unable to see in the payments made by the foundation to the petitioner the transfer and receipt of a gift, excludible from gross income under section 22 (b) (3) of the Internal Revenue Code of 1939, and not the receipt of compensation for services rendered, which is gross income under section 22 (a).In making his proposal to the foundation, petitioner made the claim that he had to earn a living for himself and family, and could take time to do the work outlined only if the foundation would agree to make specified payments therefor to supplement his sabbatical salary and other income, and by the terms of the agreement reached, and under which the payments here in question were made, the foundation became obligated to make the payments only when and as the services were performed. Furthermore, the agreement was to run for a period of 12 months from September 1, 1950, at a "stipend" 1 of $ 3,000. Petitioner could engage in no other occupation during that time, and only the foundation had the right to waive the conditions specified. In short, the performance of the services or the doing of the work agreed upon was a prerequisite, or the 73 quid pro quo, for the money received. It falls squarely within the provisions of section 22 (a), wherein it is provided that "gross income" includes "income derived from salaries, wages, or compensation for personal service * * * of whatever kind and in whatever form paid, or from professions, vocations," etc.Seemingly, there is a natural urge to say that payments which serve to promote the development of literature and art are free of tax burdens. But whether or not they are so free, is a matter which Congress alone has the rightful power and authority to determine, and in keeping therewith, Congress has made provision in the Internal Revenue Code for the exemption of corporations, funds, and foundations which are engaged exclusively, and not for profit, in educational and literary work. It has74 also seen fit to allow to taxpayers, subject to certain limitations, deductions for contributions made to such 266 corporations, funds, or foundations, but at no place has it exempted compensation, salaries, or stipends paid to individuals who are working for or under the foundations in carrying on such educational or literary work. To the contrary, the stipend or compensation of such individuals is included in the broad definition of gross income under section 22 (a). 2 That the net result in a case such as this might be beneficial to the public as a whole is no more ground for exemption of the stipend or compensation from income tax, than in the case of the recompense of a social worker, community chest employee, or teaching fellow at a university, or other paid workers in or under the Guggenheim Foundation itself. It would be quite difficult to imagine any case where the advancement of public interest only was more wholly the sole objective of the work to be done, than in the case of the composer whose compensation as taxable income was in question in Robertson v. United States, 343 U.S. 711">343 U.S. 711. In that case, nevertheless, the Supreme Court*75 held, in language even more forcibly applicable here, that the payment was made under a contract for services rendered and, as such, was taxable income. However strong the feeling or desire may be that the doing of such work as that herein be fostered and promoted, we must leave to Congress the prerogative of saying that compensation for services rendered in the doing of such work is to be free from taxation. In my opinion, Congress has not so provided.Footnotes1. In Webster's New International Dictionary, the word "stipend" is defined as "Settled pay or compensation for services, whether paid daily, monthly, or annually," and under synonyms, the only reference is "See Wages."↩2. See, however, section 117 of the Internal Revenue Code of 1954↩, wherein for taxable years beginning after December 31, 1953, Congress has, subject to certain conditions and limitations, specifically excluded from gross income in the case of an individual any amount received as a scholarship at an educational institution, or as a fellowship grant.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621305/	William Mattinson and Hazel R. Mattinson v. Commissioner.Mattinson v. CommissionerDocket No. 88205.United States Tax CourtT.C. Memo 1962-167; 1962 Tax Ct. Memo LEXIS 142; 21 T.C.M. (CCH) 932; T.C.M. (RIA) 62167; July 13, 1962William Mattinson, 2037 Crestmont Dr., Birmingham, Ala., for the petitioners. Glen W. Gilson II, Esq., for the respondent. TURNER Memorandum Findings of Fact and Opinion TURNER, Judge: The respondent determined a deficiency in income tax against the petitioners for the year 1958 in the amount of $120. By amended answer, respondent claimed an increased deficiency in the amount of $61.46, or a total deficiency of $181.46. The questions presented are (1) whether petitioners are entitled to a dependency exemption for the father of petitioner William Mattinson, and (2) if the father is not a dependent, whether petitioners are entitled to a medical expense deduction in the amount of $307.33, which is included in payments made in behalf143 of the father. Findings of Fact Some of the facts have been stipulated and are found as stipulated. Petitioners are husband and wife, and residents of Birmingham, Alabama. They filed their joint income tax return for the taxable year 1958 with the district director of internal revenue for Alabama. William Mattinson, hereafter referred to as petitioner, was employed as a salesman by the Transmission Supply Company of Birmingham. The joint return showed that he received compensation in the amount of $6,600 in 1958, and that income tax of $594 had been withheld. Besides their own exemptions and a depedency exemption for their son, petitioners claimed dependency exemptions for petitioner's father and mother, George and Elizabeth Mattinson. On two schedules attached to the return petitioners itemized their deductions. "Contributions" totaled $40; "Interest" in the amount of $858.21 was shown to have been paid to a savings and loan concern; "Taxes" were shown in the total amount of $368.48, which included "Ad valorem" tax of $119.60 and such other taxes as state income tax, sales tax, alcoholic beverage tax, unemployment tax and automobile tag. Except for state income tax, all144 of the taxes were also shown as deductions for state income tax purposes, with an additional amount of $94.50 for social security tax. Medical and drug expenses were itemized in the aggregate amount of $571.33, of which $116.93 represented drugs and $454.40 represented medical expense. On the return, the cost of drugs in excess of one percent of $6,600 was shown as $50.93 and with medical expense of $454.40 totaled $505.33, which less $198, 3 percent of $6,600, amounted to $307.33, the amount claimed as a deduction for medical expense. A deduction of $9.35 for the cost of a "safe deposit box" was claimed under the heading Other Deductions. During the year 1958 petitioner's parents lived in their own home in Wylam, Alabama, which was free of any debt. Rental value of their home was not less than $35 per month. During the year George Mattinson received monthly a social security check in the amount of $74.30, or a total of $891.60 for the year. Elizabeth Mattinson also received a social security check each month. It was in the amount of $37.20, or a total of $446.40 for the year. The aggregate amount both received from the checks during the year was $1,338. In November 1958, George145 Mattinson fell and broke his hip. Petitioner paid all of the medical expenses pertaining thereto. Of the medical expenses itemized on the return, $18.37 was for Elizabeth Mattinson and $391.77 was for George Mattinson. Petitioner usually bought groceries for his parents once a week. The parents sometimes purchased a few items from a small grocery that was within a block of their home. Petitioner also gave his mother some money with which to buy clothing. At no time did he use any of his parents' money in shopping for them. During 1958 petitioners made monthly payments of between $119 and $120 on their home. The payments covered principal, interest and taxes, but not insurance. In 1957, petitioner started a power transmission equipment business, in connection with which he operated an automobile. Petitioners also owned another automobile which during 1958 was operated by petitioner's wife. Opinion Petitioner contends that he is entitled to a credit against net income of $600 for his father as a dependent. No question is raised with respect to credit for the mother. In order to be entitled to the dependency credit claimed, petitioner has the burden of establishing that he146 furnished more than one-half of his father's support for the taxable year 1958. Petitioner's parents lived in their own debt-free home, which had a rental value of at least $35 a month, or a total value of $420 a year. They received social security checks monthly which amounted to an aggregate total of $1,338 for the year. Petitioner estimated that during the year he spent approximately $1,500 "for groceries, cash, clothing, et cetera" for the support of his parents. He was unable to show that he spent such an amount or how it was spent. It is not shown that the $1,500 was in addition to or included the amount expended for his father's medical expenses, an amount that appears to have definitely been expended by petitioner on his father. If petitioner is correct in his estimate of his support, it appears that his father and mother had more income on which to live than the three of petitioner's family. On petitioner's vague and uncorroborated testimony, we are unable to accept that as a fact. Petitioner has failed to prove that the respondent erred in disallowing the dependency credit claimed for his father. Since it is not proven that the father was a dependent, it is a matter*147 of law that petitioners are not entitled to a deduction for medical expense made on behalf of him. Section 213(a), Internal Revenue Code of 1954. While the amount expended was $391.77, their net medical deduction was only $307.33. As they are not entitled to that benefit, the deduction is disallowed. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621307/	ARLAN L. ROBINSON AND SANDRA ROBINSON GUNTER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentRobinson v. CommissionerDocket No. 20588-82United States Tax CourtT.C. Memo 1990-235; 1990 Tax Ct. Memo LEXIS 242; 59 T.C.M. (CCH) 561; T.C.M. (RIA) 90235; May 14, 1990, Filed 242 Decision will be entered under Rule 155. Paul M. Newton and Fredrick T. Hoff, Jr., for the petitioners. Robert W. West and John B. Harper, for the respondent. SCOTT, Judge. SCOTT 795 MEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined deficiencies in petitioners' income tax and additions to tax for Arlan L. Robinson under section 6653(b) 1 for the years and in the amounts as follows: Additions to TaxYearDeficiencySection 6653(b)1971$ 30,198.05$ 15,099.03197232,137.1916,068.60197352,045.1426,022.57197476,456.6938,228.35197591,725.2545,862.63197647,856.3523,928.18197742,012.8721,006.44197861,215.8530,607.92197930,208.4315,104.22244 The issues for decision are: 1) whether there was an understatement of income by petitioners in any or all of the calendar years 1971 through 1979 resulting in a deficiency in petitioners' income tax for that year; 2) if there was a deficiency in petitioners' income tax in any of the years 1971 through 1979, whether any part of such deficiency was due to fraud on the part of petitioner, Arlan L. Robinson, with intent to evade tax so as to make him liable for the addition to tax for fraud under section 6653(b); 796 3) whether the statute of limitations bars the assessment of any deficiency in income tax for any of the calendar years 1971 through 1978; 4) if there is a deficiency in income tax for any of the calendar years 1971 through 1979, whether petitioner Sandra Robinson Gunter, who signed joint returns for each of the years with her then husband, Arlan L. Robinson, is entitled to be relieved of liability for such deficiency (including interest, penalties, and other amounts) under the provisions of section 6103(e). FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioners, who were husband and wife during the years here in issue, each resided245 in Biloxi, Mississippi, at the time of the filing of their petition in this case. Petitioners were divorced in 1980. Petitioners filed joint Federal income tax returns for each of the calendar years 1971 through 1979 with the Director, Internal Revenue Service Center, Chamblee, Georgia, on or before April 15 of the year following the year for which the return was filed. For some years prior to 1971 and during 1971 and part of 1972 Arlan L. Robinson (petitioner) owned and operated Robinson Mercury, Inc., a Mississippi corporation, the principal business of which was the retail sale of automobiles in Gulfport, Mississippi. The automobile dealership was sold in 1972. In 1967 petitioner was elected for a 4-year term as a supervisor of Harrison County, Mississippi, and was reelected in 1971 and 1975 for successive 4-year terms. Petitioner served as a supervisor of Harrison County from January 1968 until January 1980. Petitioner did not seek reelection in 1979. There were five elected supervisors of Harrison County. The county was divided into five divisions called beats. Each beat elected a supervisor. The supervisor of each beat administered county operations within that beat246 and the supervisors jointly administered operations as the legislative body of the county. Petitioner represented Beat 5 of Harrison County. The supervisor of each beat was authorized to hire the employees for his beat. These employees were hired either by the Beat supervisor or the superintendent for the beat who was hired by the supervisor. Prior to the middle of 1974 the supervisor of each beat had the authority to engage contractors to do work in the beat and to purchase the materials needed by the beat for that work. Starting in about the middle of 1974 the county put in a system that required suppliers of materials and persons doing work for the county to submit bids to the county usually on a 6-month basis. The lowest and best bid would generally be accepted by a vote of the five supervisors requiring a vote of three to accept a bid. The supervisor of each beat was still authorized to order the supplies for that beat from the lowest bidder and at times the supervisors, when a bid of one individual was about to expire, would order a stockpile of material from that individual which would be sufficient for the use of his beat for several months or perhaps the entire six months247 until another invitation to bid was issued. At times a supervisor of a particular beat would put something up for bid and describe it in such a detailed way that only one person, or a very limited number of persons, could bid on it. Also, county supervisors, at times, would order one item and instead of receiving the item ordered, would accept another item from a different individual. The county supervisors retained authority to order, without bids, materials below a certain cost. Petitioner received a salary as supervisor of Beat 5 during each of the years 1971 through 1979 in the amounts shown: 1971$ 8,799.9619729,353.95197312,399.96197413,458.22197515,000.00197615,000.00197715,500.00197817,400.00197917,400.00Petitioner also received a salary from Robinson Mercury, Inc., in 1971 of $ 8,482.20 and 1972 of $ 4,000. 797 During the taxable years 1971 through 1979 petitioner derived taxable income from various sources. The following sources of income were reported on petitioner's income tax returns for these years: 1) salary and dividends from Robinson Mercury, Inc.; 2) salary from his position as supervisor of Beat 5 of Harrison248 County, Mississippi; 3) dividend income from corporate stocks he owned; 4) interest income from savings accounts and other interest-bearing securities he owned; 5) commission income; 6) gains from the sales of corporate stocks, land, and other assets; 7) rental income from the lease of real estate; 8) income from the sale of timber; and 9) income from the operation of a farm, including the sale of cattle. When respondent investigated petitioners' income tax returns for the years 1971 through 1979, he determined that the records to the extent they were available to the revenue agent were not sufficient to determine petitioners' taxable income for those years and computed petitioners' income using the net worth plus cash expenditures method of reconstructing income. The following schedule shows various assets and liabilities of petitioners, petitioners' living expenses, and certain adjustments to petitioners' income for the years indicated: 1/1/7112/31/7112/31/7212/31/73Cash in banks:First Miss. Nat. Bank2,89012,313 2,313 912 Gulf National Bank00 5,199 57,709 First Nat. Bk. of Wiggins00 0 0 Coast Federal S & L00 101,301 17,008 Stocks:Robinson Auto54,87254,872 0 0 Merchants Bank2,7000 0 0 Great Southern Bus. Corp.5,0005,000 5,000 5,000 Coast Cattle Co.00 0 1,000 Autos-Personal00 0 0 Real Estate:1956-Acreage11,00011,000 11,000 0 1969-Acreage6,0676,067 6,067 0 1958-Biloxi residence25,00025,000 25,000 25,000 1969-40 acres-Salida Breland5,0005,000 5,000 5,000 1971-50 acres-Dedeaux Rd.090,000 90,000 90,000 1971-40 acres-Lee05,000 3,000 3,000 1972-73-Stone Co. residence, etc.010,000 20,797 20,797 1973-40 acres-LeBlanc00 0 7,000 1973-160 acres-Crawford00 0 20,661 1974 Batson Property00 0 0 1975-40 acres00 0 0 1977-Barn-2,000 sq. ft.00 0 0 1977-Sheds-2,000 sq. ft.00 0 0 1977-Barn & Sheds00 0 0 Life Insurance Value00 0 0 Farm Assets:1972-79-Per Schedule F00 7,272 29,155 1973-Tractor00 0 0 1973-74-Fence00 0 3,150 Loan Receivable00 0 9,445 Note Receivable-Jess Parker00 0 0 Liabilities:Notes Payable080,000 72,000 81,000 Accounts Payable00 0 0 Life Insurance Loan Payable00 0 0 S.B.A. Loan Payable00 0 0 Bank Loans Payable00 0 0 Adjustments: Personal Living Expense13,123 12,173 14,501 Income Tax Paid3,958 4,872 15,116 Fair Rental Value-Auto0 0 2,100 Non-taxable Portion of Capital Gains0 (39,488)(19,996)Life Insurance Premiums Paid877 877 877 Deductions: Standard Deduction(1,500)0 0 Medical0 0 (109)Taxes0 (2,163)(4,561)Contributions0 (10)(6)Interest0 (4,000)(3,600)Miscellaneous0 0 (225)Personal Exemptions (3,375)(3,750)(3,750)Taxable Income, per Return23,804 53,249 22,734 249 12/31/7412/31/7512/31/7612/31/77Cash in banks:First Miss. Nat. Bank962 512 2,279 846 Gulf National Bank5,902 4,174 1,448 13,314 First Nat. Bk. of Wiggins0 0 0 0 Coast Federal S & L16,090 1,418 47,457 1,026 Stocks:Robinson Auto0 0 0 0 Merchants Bank0 0 0 0 Great Southern Bus. Corp.5,000 5,000 0 0 Coast Cattle Co.0 0 0 0 Autos-Personal0 0 0 0 Real Estate:1956-Acreage0 0 0 0 1969-Acreage0 0 0 0 1958-Biloxi residence25,000 25,000 25,000 25,000 1969-40 acres-Salida Breland5,000 5,000 5,000 5,000 1971-50 acres-Dedeaux Rd.90,000 90,000 90,000 90,000 1971-40 acres-Lee3,000 3,000 3,000 3,000 1972-73-Stone Co. residence, etc.20,797 20,797 20,797 20,797 1973-40 acres-LeBlanc7,000 7,000 7,000 7,000 1973-160 acres-Crawford20,661 20,661 20,661 20,661 1974 Batson Property170,503 170,503 170,503 170,503 1975-40 acres0 0 0 0 1977-Barn-2,000 sq. ft.0 0 0 0 1977-Sheds-2,000 sq. ft.0 0 0 0 1977-Barn & Sheds0 0 0 6,000 Life Insurance Value0 0 0 0 Farm Assets:1972-79-Per Schedule F33,592 33,592 23,320 23,320 1973-Tractor0 0 0 0 1973-74-Fence6,300 6,300 6,300 6,300 Loan Receivable0 0 0 0 Note Receivable-Jess Parker0 0 0 0 Liabilities:Notes Payable186,000 145,500 105,000 64,500 Accounts Payable0 0 1,079 1,833 Life Insurance Loan Payable0 0 0 0 S.B.A. Loan Payable0 0 0 0 Bank Loans Payable0 0 65,000 65,000 Adjustments: Personal Living Expense11,049 16,522 20,544 18,575 Income Tax Paid1,431 4,517 (1,736)4,648 Fair Rental Value-Auto2,300 2,500 2,700 2,900 Non-taxable Portion of Capital Gains(1,799)(650)0 (101)Life Insurance Premiums Paid877 877 877 877 Deductions: Standard Deduction0 0 0 0 Medical(109)(109)(150)(150)Taxes(2,600)(1,149)(1,263)(2,140)Contributions(33)0 (10)0 Interest(3,200)(8,231)(10,577)(9,890)Miscellaneous(385)(275)(125)(1,082)Personal Exemptions (3,750)(3,750)(3,750)(3,750)Taxable Income, per Return1,069 8,676 18,256 18,769 250 12/31/7812/31/79Cash in banks:First Miss. Nat. Bank1,310 972 Gulf National Bank0 0 First Nat. Bk. of Wiggins166 16,735 Coast Federal S & L3,061 3,053 Stocks:Robinson Auto0 0 Merchants Bank0 0 Great Southern Bus. Corp.0 0 Coast Cattle Co.0 0 Autos-Personal11,865 19,115 Real Estate:1956-Acreage0 0 1969-Acreage0 0 1958-Biloxi residence25,000 25,000 1969-40 acres-Salida Breland5,000 5,000 1971-50 acres-Dedeaux Rd.90,000 90,000 1971-40 acres-Lee3,000 3,000 1972-73-Stone Co. residence, etc.20,797 20,797 1973-40 acres-LeBlanc7,000 7,000 1973-160 acres-Crawford20,661 20,661 1974 Batson Property152,890 152,890 1975-40 acres0 0 1977-Barn-2,000 sq. ft.0 0 1977-Sheds-2,000 sq. ft.0 0 1977-Barn & Sheds6,000 6,000 Life Insurance Value0 0 Farm Assets:1972-79-Per Schedule F21,707 26,417 1973-Tractor0 0 1973-74-Fence6,300 6,300 Loan Receivable0 0 Note Receivable-Jess Parker40,000 0 Liabilities:Notes Payable24,000 16,000 Accounts Payable1,766 868 Life Insurance Loan Payable10,325 10,325 S.B.A. Loan Payable37,000 34,797 Bank Loans Payable18,500 0 Adjustments: Personal Living Expense21,297 14,083 Income Tax Paid3,398 6,775 Fair Rental Value-Auto0 0 Non-taxable Portion of Capital Gains(6,181)(18,011)Life Insurance Premiums Paid877 220 Deductions: Standard Deduction0 0 Medical(150)(150)Taxes(1,764)(3,263)Contributions0 0 Interest(12,171)0 Miscellaneous(2,259)0 Personal Exemptions (3,750)(5,000)Taxable Income, per Return33,211 55,419 251 800 The land shown on the schedule as acquired by petitioner during the years here in issue was purchased by him. In addition to the land he owned, petitioner leased approximately 1,200 acres of adjoining land. Except for 40 acres of the land purchased by petitioner on January 10, 1969, referred to by the parties as the Saleta Breland land, most of the land petitioner owned and that he rented was used for raising cattle. At the time petitioner purchased the Saleta Breland land, which is located in Stone County, Mississippi, which county is immediately north of Harrison County, Mississippi, it was unimproved. Petitioner improved the property with a lake and dam and with a house built in 1971 and 1972. The improvements to this land also included stables for horses, a wooden bridge across the lake, and a barn. The land purchased by petitioner from Ferris S. Batson for $ 180,543252 in 1974 (sometimes referred to by the parties as the Ferris Batson land and sometimes as the Big Level land) is also in Stone County and between two and four miles north of land previously purchased by petitioner referred to as the Red Creek Land. The Ferris Batson land and the Red Creek land are separated by Red Creek and, there is no direct access across the creek between the Red Creek land and the Ferris Batson land. Petitioner used a portion of the Ferris Batson land for raising cattle and leased a portion of it to others for various agricultural purposes. In 1974 petitioner sold approximately 22.89 acres of the Ferris Batson land and in 1978 he sold 40 acres of that land. Otherwise, petitioner owned all the land purchased from 1969 through 1974 throughout the years here in issue. Sometime in 1979 the Federal Bureau of Investigation commenced an investigation of petitioners's activities as supervisor of Beat 5 of Harrison County, Mississippi, and as a result of this investigation, a 5-count indictment was returned against petitioner on January 7, 1981. Count one of the indictment alleged a violation by petitioner of 18 U.S.C. 1951 (1976) (Hobbs Act), 253 charging him in 1978 with knowingly and willfully obtaining a water well drilled at his residence in Stone County, Mississipp, from Braden Pump and Well Service Inc., induced by the wrongful use of fear of economic loss and under color of official right, which property he was not entitled to obtain. Count two charged petitioner with violation of 18 U.S.C. 1951 (1976) (Hobbs Act), by the extortion of cash from Larry Breland Trucking Company during the period November 1977 through January 1979. Count three charged petitioner with obtaining cash from Mid-South Gulf Products Company, Inc., from March 1976 through September 1978, through wrongful use of fear of economic loss and under color of official right. Count four charged petitioner with violation of section 42 U.S.C. 6721 et seq., for diverting and converting a portion of the funds to pay the salary of Robert Marion Daniels (Bobby Daniels) to his personal use by having Daniels perform private work on his property while being paid by funds of Harrison County, Mississippi, a part of which were provided through Federal funds during the period February 1977 through August 1978. Count254 five charged petitioner with violation of section 42 U.S.C. 6721 et seq., by diversion and conversion of a portion of the funds of Harrison County used to pay the salary of Lennis Hudson by having Lennis Hudson do private work on his property during the period August 1977 through August 1978 while being paid as an employee of Harrison County with funds partially furnished by the Federal government. A jury trial was held in the United States District Court for the Southern District of Mississippi. Petitioner was convicted on counts one, four, and five, and acquitted on counts two and three. Petitioner appealed his conviction to the Court of appeals for the Fifth Circuit where his conviction was affirmed. Petitioners had owned a house in Biloxi, Mississippi, which was their home since sometime in 1958. This home was occupied by petitioners as their home from the time of its purchase throughout the years involved in this case. Beginning in 1971 and continuing through 1972, petitioners built a house on the Saleta Breland land in Stone County. This house contained three bedrooms, two baths, a large room which contained the kitchen, dining space, and a den255 or living room. The house also had an open downstairs recreation room. After completion of the house, petitioners furnished it. Petitioners had the house carpeted and they bought two bedroom suites, one single bed, a couch and a loveseat, new appliances consisting of a stove, refrigerator, trash compactor, dishwasher, washing machine and dryer, and a pool table for the recreation room and some bar stools. The house also contained a dinette set and a lazy boy recliner and a deep freeze. Petitioners moved one bedroom suite from their residence in Biloxi to the Stone County house and in 1972 purchased a new bedroom suite for the Biloxi house to replace the one moved to the Stone County house. At times during the period 1971 through 1979 petitioner owned a diamond ring, a wedding band, three watches, and a gold chain in the center of which was a gold coin. Mrs. Robinson owned a watch, a diamond ring, and a wedding band during this period of time. At the beginning and end of 1971 petitioners had furniture, fixtures, and jewelry which had cost them $ 5,000. During each of the years 1972 and 1973 petitioners spent an additional $ 5,000 for such items. In each of the years 1974256 and 1975 petitioners spent an additional $ 10,000 for such items, and in each of the years 1976, 1977, 801 1978, and 1979 an additional $ 1,000, $ 1,500, $ 1,000, and $ 1,500, respectively. Some time after petitioner purchased the Saleta Breland land in Stone County on January 10, 1969, clearing was done to permit the building of a dam and a lake on the land. The dam built by petitioner on the Breland land was approximately 344 feet long and 16 feet wide across the top. It was constructed by Gulf Paving, Inc. of Biloxi, Mississippi. The lake covered approximately 17 to 18 acres and was spring-fed. It was equipped with a gravity-operated discharge to insure that the lake water remained fresh. The dam contained 12,350 cubic yards of dirt and the clay core for the dam contained 1,572 cubic yards, for a total of 13,922 cubic yards for the dam and core combined. In order to be effective, an earthen dam must have a clay core in the center of the dam. The clay core prevents the dam from leaking by making the dam impervious to water seepage. A dam without a clay core will seep water and not be effective. The equipment used by Gulf Paving, Inc. in building the dam included a bulldozer, 257 a scraper, and a sheep's foot roller. The cost of construction of the dam including materials was approximately $ 18,000. It took Gulf Paving, Inc. approximately 2 to 3 months to build the dam working on it on a less than full time basis. The dam could have been constructed in approximately 3 to 4 weeks if Gulf Paving, Inc. had worked 7 days a week, 12 hours a day. Gulf Paving, Inc. always had at least two people working on the dam whenever any work was done and sometimes more than two people. At least two people were needed at all times for safety reasons because of the danger involved if only one person was working. Gulf Paving, Inc. did not do any of the clearing of the land for the lake, but only built the dam. The primary business of Gulf Paving, Inc. was road and highway construction, subdivision construction, and asphalt paving. Gulf Paving, Inc. did a substantial amount of work for Beat 5 of Harrison County throughout petitioner's three terms as supervisor of Beat 5. Gulf Paving, Inc. was not in the business of building dams and would not have built a dam on the property of a person who had no relationship with the officers of the company. Gulf Paving, Inc. built the258 dam on petitioner's property because of petitioner's friendship with officers of the corporation, his position, and in the expectation of doing future business with Harrison County.After his purchase of 368 acres of land in Stone County on January 9, 1974, petitioner owned over 700 acres of land in Stone County or its surrounding counties. Very little of the land petitioner purchased was cleared and in condition to use for pasture for cattle raising or for farming at the time he acquired it. The leased land also was mostly uncleared. By December 31, 1979, substantially all of the lands petitioner owned were cleared and planted in pasture and substantially all of the leased lands were in timber. Donald and Rose Breland were the owners and operators of Breland Trucking and Construction Company prior to and during 1973 and 1974. The company was located in Picayune, Mississippi prior to 1973. It was engaged in the business of road construction, road and site preparation, hauling dirt, gravel and other materials, and laying asphalt. Breland Trucking and Construction Company owned and used in its business heavy equipment, such as trucks, bulldozers, front-end loaders, backhoes, 259 asphalt spreaders, draglines, motor graters, welding machines, and tractors. In January 1973 Breland Trucking and Construction Company moved its operation and asphalt plant to Harrison County, Mississippi. It operated in Harrison County, Mississippi from January 1973 until approximately September 1, 1974, when the company filed for bankruptcyh and went out of business. In 1973 and 1974 Breland Trucking and Construction Company did business for Harrison County. It was customary in Harrison County for businesses awarded contracts to do favors for or make payoffs or kickbacks to the beat supervisors and sometimes the beat superintendent. During the period from early 1974 until Breland Trucking and Construction Company went into bankruptcy in 1974, Rose Breland on behalf of Breland Trucking and Construction Company made certain cash payments to petitioner and from mid-1973 furnished labor and materials to petitioner in the form of work performed by employees of Breland Trucking and Construction Company with materials furnished by that company on petitioner's farm in Stone County, Mississippi. Breland Trucking and Construction Company received no compensation from petitioner for the260 work its employees did on petitioner's farm in 1973 and 1974 and no payment from petitioner for the materials used in that work. In the opinion of Rose Breland, as an officer of Breland Trucking andtion of the house, petitioners furnished it. Petitionersis are reductions which decrease net worth.upon the Wisconsin Tax Appeals Commission within 30 days of service of this decision if there has been no petition for rehearing, or within 30 days of service of the order finally disposing of the petition for rehearing, or within 30 days after the final disposition by operation of law of any petition for rehearing. The 30 days period commences the day after personal service or mailing of the decision to order, or the day after the final disposition by operation of law of any petition for rehearing. (DecTrucking and Construction Company, the cash payments to petitioner and the work done on petitioners' land were necessary in order for the company to continue to perform work for Beat 5 of Harrison County. The following types of work were done by employees of Breland Trucking and Construction Company on261 petitioner's Stone County farm: (a) Farm roads were built from petitioner's residence to other properties he owned; (b) land was cleared of trees and other foliage, leveled and prepared to be converted to pasture; (c) asphalt was placed on the main entrance road to and the driveway of petitioner's house and around the base of the house and on the 802 spillway of the dam; (d) cattle ponds were built or improved on the farm; (e) fences were put up around the farm; (f) fertilizer was hauled for use on the pastures; (g) gravel, clay gravel, sand, fill dirt, and other materials needed for construction of the roads and improvement of the land were furnished; and (h) farm work such as feeding and branding cattle and hauling hay was done. All equipment needed to perform the work performed by employees of 803 Breland Trucking and Construction Company including draglines, motor graders, bulldozers, trucks, tractors, asphalt spreaders, front-end loaders, and welding machines were supplied from the equipment owned by Breland Trucking and Construction Company for the work it did on petitioner's farm. Breland Trucking and Construction Company paid its employees for the hours they worked on petitioner's262 farm and paid the operating expenses of its machinery which was used on petitioner's farm. The only payment Breland Trucking and Construction Company received with respect to work done on petitioner's farm during 1973 and 1974 was $ 12,000 received from Harrison County which was placed on a Harrison County invoice, but actually represented payment for work done on the farm. Petitioner made the arrangements for Breland Trucking and Construction Company to receive the $ 12,000 payment from Harrison County by use of a fictitious delivery ticket in favor of Breland Trucking and Construction Company. Breland Trucking and Construction Company employees worked on petitioner's farm on an on-and-off basis, but not on a consistent basis, from the summer of 1973 until toward the end of August 1974. On January 8, 1974, Rose Breland made a $ 5,000 cash payment to petitioner which amount came from the $ 12,000 check of Harrison County given to her purportedly for Harrison County work, but actually for work done on petitioner's farm. Thereafter, Rose Breland made other cash payments to petitioner. At the end of August 1974, Breland Trucking and Construction Company ceased operations when it263 filed a liquidating bankruptcy proceeding. In April 1976, Donald and Rose Breland began doing business in their individual capacity under the name of Breland Trucking Company. The new individual business did approximately the same type of work that had been done by Breland Trucking and Construction Company, except that this business did not sell or lay asphalt. After Don and Rose Breland started in business as the Breland Trucking Company, they again began doing work for Beat 5 of Harrison County. At this time they had to put in bids for the work they wanted and they obtained hauling work by having a low bid to haul sand, gravel, shale, and other items. Petitioner or the superintendent for Beat 5 would come by and tell Rose Breland what the prior low bid had been and would suggest that the bid of Breland Trucking Company be substantially lower with the understanding that extra tickets for hauling that was not done would be written to make up for the low price. In return for arranging for Breland Trucking Company to get business on low bids and for the work it was given in Beat 5, starting in 1977, Rose Breland again periodically made cash payments or kickbacks in amounts ranging264 from $ 1,500 to $ 6,000 to petitioner. Also starting in 1977, employees of Breland Trucking Company began to do work on petitioner's farm. Work was done by employees of Breland Trucking Company on petitioner's farm from 1977 to sometime in 1979. The nature of this work was somewhat different from most of the work done by employees of Breland Trucking and Construction Company in 1973 and 1974. During 1977 through 1979 employees of Breland Trucking Company hauled fertilizer for petitioner's farm and worked in connection with cutting hay and baling hay and, in addition, the employees of Breland Trucking Company dug a pond on petitioner's farm in the area referred to as Big Level. In addition to cutting and baling hay employees of Breland Trucking Company picked up hay behind tractors and stacked it in petitioner's barn. Rose Breland owned a small International cub tractor which she used for yard work around her house. Petitioner had expressed an interest in the tractor and said he wanted it. Petitioner mentioned that fact to her several times. Rose Breland had bought this tractor sometime around 1973 and she kept it at her house. Tractors like the cub tractor she had were hard265 to find. At the insistence of petitioner, Rose Breland in 1978 took the cub tractor up to his Stone County farm and let him have it. The reason she took the tractor up to petitioner's farm was at his insistence and because she felt it was necessary to do this to keep doing business with Beat 5 of Harrison County. Rose Breland was not paid either for the work her employees did on petitioner's farm during 1977 through 1979 or for the tractor, except by being given work for Beat 5 of Harrison County. During 1973 and 1974 when Breland Trucking and Construction Company was doing work for petitioner on his farms, the company at times left various pieces of its own equipment on his farms. This equipment included draglines, motor graders, bulldozers, trucks, tractors, asphalt spreaders, front-end loaders, and welding machines. In September 1974 when Breland Trucking and Construction Company filed for bankruptcy and ceased doing business, some of the company's equipment was on petitioner's farm. Some of the equipment was returned to Breland Trucking and Construction Company but a motor grader of Breland Trucking and Construction Company was kept by petitioner, even though he was requested266 to return it. Also a tractor was kept and a welding machine and a bucket for a dragline. The equipment that stayed on petitioner's farm was reported as a part of the bankruptcy estate in the bankruptcy proceedings, but neither Rose Breland nor the trustee in bankruptcy ever obtained the motor grader, the tractor, the welding machine, or the bucket which petitioner kept on his farm at the time of the bankruptcy. Neither Breland Trucking and Construction Company nor the bankruptcy estate was ever paid for these items. The labor done on petitioner's farms by equipment and employees of Breland Trucking and Construction Company and the materials furnished by that company without compensation from petitioner in 1973 and 1974 would have cost petitioner approximately $ 62,500 in each of the years 1973 and 1974 had petitioner paid for the work. Of the work done by employees and equipment of Breland Trucking and Construction Company for petitioner in 1973 and 1974, approximately 80 percent was for capital improvements that increased the value of petitioner's property. Petitioner's net worth increased by $ 50,000 in 1973 and $ 50,000 (cumulatively $ 100,000) in 1974 by what would have267 been the cost to petitioner for the labor, equipment rental, and materials furnished by Breland Trucking and Construction Company for capital improvements to petitioner's farms. The only work done by employees of Breland Trucking Company during the period 1977 through 1979 which resulted in capital improvements to petitioner's farm was the digging of the pond on the Big Level tract. The motor grader belonging to Breland Trucking and Construction Company which petitioner kept in 1974 had a value of approximately $ 12,500, the tractor a value of approximately $ 600, and the welding machine a value of approximately $ 1000. The value of the cub tractor which petitioner obtained from Rose Breland personally in late 1977 had a value of approximately $ 1000. During the time petitioner was supervisor of Beat 5 of Harrison County the number of employees working for the county ranged from a low of 20 to a high of 40 employees. Either petitioner or Joe Shelton, the superintendent of Beat 5, hired those employees. Petitioner, starting sometime in 1976, instructed Joe Shelton to send certain county employees to do work on petitioner's farm. These employees were full time employees of Harrison268 County and were being paid by Harrison County. These employees were at petitioner's instruction sent to work on his farm during the regular working hours of employees for Harrison County. Some of the employees sent to work on petitioner's farm would spend as little as one day at a time working there and others would spend over a year or a year and one-half working there. When the employees working on petitioner's farm needed any type of equipment, Joe Shelton usually sent county equipment up to be used and sent at least two employees with the equipment. Rex Bosarge was one of the county employees who was sent to petitioner's farm by Joe Shelton. Rex Bosarge began work on petitioner's farm in July 1977 and continued until the FBI began investigating petitioner's activities in February 1979. Rex Bosarge spent at least one-half of his working time during the period July 1977 to February 1979 doing work on petitioner's farm. When Rex Bosarge first started working for the county he worked every day on petitioner's farm, the same hours as Lennis Hudson worked on petitioner's farm, and he rode to and from the farm with Lennis Hudson. Rex Bosarge also worked every day for approximately269 three weeks with J. D. Ladner on petitioner's farm. J. D. Ladner operated a motor grader and a D-5 Caterpillar tractor owned by Harrison County on the farm. While Rex Bosarge worked on petitioner's farm he was supervised by another county employee by the name of Bobby Daniels. Rex Bosarge worked both on the Big Level farm and the Red Creek farm. Rex Bosarge helped build and maintain fences on the farm and he planted grass in pastures and with a disc prepared pastures for planting by using a D-3 Caterpillar bulldozer. Rex Bosarge also used a D-3 bulldozer on the roads on petitioner's farm and to build ditches on the side of the road. Rex Bosarge pulled stumps out of the land using the D-3 bulldozer. In addition Rex Bosarge did work on the farm feeding and branding cattle and planting corn and other crops. On one occasion Rex Bosarge and J. D. Ladner loaded a truck with some pipe belonging to Harrison County that was on the beach in Biloxi and took the pipe to petitioner's farm and unloaded it. L. C. Holsi, another county employee employed by Beat 5, was assigned to work on petitioner's farm by Joe Shelton. On two separate occasions Holsi was employed by Harrison County during270 the time that petitioner was supervisor. L. C. Holsi's first employment with Harrison County was from 1974 to January 1977. Holsi spent at least 13 months out of the time of this employment working regularly on petitioner's farm. L. C. Holsi returned to employment with Harrison county in September 1977 and was immediately assigned to work on petitioner's farm. L. C. Holsi spent the next 20 months working from time to time on petitioner's farm until the FBI investigation began in February 1979. At times while L. C. Holsi was working on petitioner's farm he saw petitioner and received occasional instructions from him. L. C. Holsi was a heavy equipment operator and ran a D-4 and D-5 Caterpillar bulldozer 804 clearing land on petitioner's farm and working on roads. L. C. Holsi also helped build and repair fences and helped cut and bale hay on petitioner's farm. L. C. Holsi also worked on clearing the westmost 80 acres of the land known as the Crawford land. L. C. Holsi was not paid by petitioner for any of the work he did on his farm, but he did continue to receive his salary as an employee of Harrison County during all the time that he worked on petitioner's farm. L. C. Holsi was busy271 during all of the time he worked on petitioner's farm. At one time L. C. Holsi complained to Joe Shelton that he was overworked and wished to stop working on the farm. Lennis Hudson was employed by Beat 5 of Harrison County at two different times while petitioner was supervisor of Beat 5. Hudson was employed by Harrison County during 1976 until January 1977 when he quit his employment. At that time Lennis Hudson had worked nine months on petitioner's farm on a daily basis. Lennis Hudson was reemployed by Harrison County in July or August of 1977. At that time Lennis Hudson worked approximately one month on county projects and then was sent back to petitioner's farm to work. Lennis Hudson stayed on the farm working on a regular basis for approximately one and one-half years, until February 1979. During the period from approximately May 1976 through January 1977, and the period from July 1977 through February 1979, Lennis Hudson helped to build a barn on petitioner's farm, helped L. C. Holsi build a fence, used a tractor to remove underbrush, used a disc, planted crop land, cut and baled hay, planted grass seed, patched fences, and fed cattle. During the period in 1976 to January272 1977 when Lennis Hudson worked on petitioner's farm, he worked with L. C. Holsi for part of the time; and when he worked on petitioner's farm from July 1977 through February 1979, he worked most of the time with Rex Bosarge. Lennis Hudson sometimes saw petitioner on the farm, and on some occasions received directions from him. However, most of his directions came from another county employee, Bobby Daniels. During all of the time that Lennis Hudson worked on petitioner's farm, he was employed by Harrison County and paid by Harrison County for the work he did, except for one weekend when petitioner paid him $ 70 for some work he did over the weekend. Other than the $ 70, Lennis Hudson received no payment for any of his work from petitioner. During all of the days Lennis Hudson was working on petitioner's farm, he stayed busy with farm work for petitioner. Hudson complained at one time to Joe Shelton that the work was too hard and he wished to be transferred back to Harrison County work. Robert Marion Daniels (Bobby Daniels) was another Harrison County employee who was told to work on petitioner's farm in Stone County, Mississippi. Bobby Daniels originally went to work for Beat273 5 of Harrison County in January 1977. Daniels was hired by petitioner to work for Harrison County as a heavy equipment operator. Although Bobby Daniels was hired as a Harrison County employee, he worked only three months out of the three years of his employment by Harrison County on Harrison County projects. The remainder of the three-year period Bobby Daniels worked on petitioner's farm doing farm work for petitioner. Daniels' only county work during the remainder of the period involved occasionally loading and hauling some gravel from a gravel pit near petitioner's farm. The work Bobby Daniels did on petitioner's farm included working with cattle, such as penning cattle, dehorning cattle, giving shots to cattle, spraying cattle, feeding cattle, cutting and baling hay, building and maintaining roads on the farm, building and repairing ponds, preparing fields for planting and planting fields in corn, wheat, and rye grass, cutting and clearing timber and logs, and working on drainage ditches and culverts. While Bobby Daniels was working on petitioner's farm he would begin work at approximately 7 a.m. in the morning and would quit somewhere between 3:00 p.m. and 6:00 p.m. Daniels274 would work either five or six days and sometimes seven days a week, depending upon the work to be done. While Bobby Daniels worked on petitioner's farm he was paid by Harrison County and not by petitioner. Petitioner would bring Bobby Daniels his Harrison County payroll check and deliver it to him personally at the farm. Bobby Daniels was directed in his work on the farm by petitioner. Petitioner would tell him what work he wanted accomplished during a particular period of time and Bobby Daniels worked on this work and directed other county employees in their work. Bobby Daniels directed among other employees Lennis Hudson, J. D. Ladner, Bobby Ladner, and Rex Bosarge. Bobby Daniels was never hired as a night watchman for county equipment. County equipment that was on petitioner's farm was there for use for petitioner's benefit in the work on the farm. On one occasion Bobby Daniels went to the Harrison County barn and picked up some tile and culvert, and brought the tile and culvert to petitioner's farm, and installed the tile and culvert on petitioner's farm. Petitioner did not pay Bobby Daniels any cash compensation for work on his farm. Petitioner did permit Bobby Daniels and275 his family to live rent free in a mobile home on the Saleta Breland property owned by petitioner. Petitioner furnished the utilities for the mobile home. Bobby Daniels was the son of Curtis Daniels, who was employed by petitioner as a manager 805 on the farm on the Ferris Batson land. At some time during the period that petitioner was supervisor of Beat 5 of Harrison County, a Harrison County employee named Bobby Ladner, while being paid by the county, worked on petitioner's farm as did a Harrison County employee named Arthur Adams and another named Walter Robinson. During the calendar year 1976, the total amount paid by Harrison County to its employees while those employees were working on petitioner's farm was $ 15,500. Of this amount 70 percent was with respect to work done which created capital improvements to the property, thus increasing its value, and the remainder was for general farm work. For the calendar year 1977, the total amount paid by Harrison County to its employees while those employees were working on petitioner's farm was $ 17,475, 70 percent of which related to items that constituted capital improvements to the lands or buildings and caused a corresponding276 increase in their value. The remainder related to general farm work. During 1978 the total amount paid by Harrison County to its employees while those employees were working on petitioner's farm was $ 24,475. Of this amount, 70 percent related to work done by those employees creating capital improvements which increased the value of petitioner's property. The remainder was for general farm work. In 1979, the total amount paid by Harrison County to its employees while those employees were working on petitioner's farm was $ 10,550 and of this amount, 70 percent related to work done that constituted capital improvements to the farm, increasing its value, and the other 30 percent related to general farm work. During the years 1975, 1976, 1977, 1978, and through February 1979, various pieces of county equipment were used on petitioner's farm in connection with building capital improvements and doing farm work. This equipment was not in use at all times when it was on petitioner's farm, but was used on behalf of petitioner when needed in connection with farm work. The value of the county equipment used by petitioner on his farm for the time it was used in connection with his farm277 work and improving petitioner's farm was $ 8,850 in each of the years 1975 and 1976, and was $ 11,000 in each of the years 1977, 1978, and 1979. The equipment was used primarily for work which constituted capital improvements to the farm, so that the amounts of the value of the equipment's use resulted in an increase in the value of petitioner's property. In 1975 a wooden bridge approximately 298 feet long and 12 feet wide was built across the lake on the Saleta Breland land. The bridge was built by H. E. Wilson Construction Company, which was not paid for its work in building the bridge although H. E. Wilson, Sr., received two bull calves and some hay from petitioner after the bridge was completed. The bridge was built in the fall of 1975 using wood that had been pressure treated with preservatives so that it would withstand the destructive effects of the water. H. E. Wilson Construction Company used a crew of three to four laborers and one equipment operator operating a dragline to build the bridge. The laborers and the equipment operator were all experienced personnel employed by the company for many years. The supervision of building the bridge was done by H. E. Wilson, 278 Sr. who, at the time he did this work, was partially retired from work with H. E. Wilson Construction Company. In 1975 the primary operation of the company was handled by H. E. Wilson, Jr., the son of H. E. Wilson, Sr. The materials used to build the bridge were provided by Treated Materials, Inc. at a cost to petitioner of $ 12,500. H. E. Wilson Construction Company had done business for many years with Beat 5 of Harrison County. It was the business relationship between Beat 5 of Harrison County of which petitioner was supervisor and the H. E. Wilson Construction Company that caused H. E. Wilson Construction Company to build the bridge for petitioner without compensation. The cost of the work done by H. E. Wilson Construction Company in building the bridge was approximately $ 13,250. Treated Materials, Inc. had done business with petitioner personally and with petitioner as supervisor of Beat 5 of Harrison County for many years. Petitioner was considered by Treated Materials, Inc. as a good customer. The total cost for labor and materials in building the bridge was $ 25,750. In 1977 petitioner built stables for his horses on the Breland land near the lake. The stables279 were approximately 35 feet long and 16 feet wide. Along the front and rear was a framework of treated pilings driven into the ground at each corner and at approximately 4-foot intervals. There were nine such piling to form the front of the stables and nine to form the rear. Running through the middle of the stables lengthwise was another row of treated pilings to support the roof. Lumber 2 inches by 6 inches was used to form the perimeter of the stables and form the framework for the roof running from the front to the rear of the stables over the intermediate pilings in the middle. Stripping lumber, 1 inch by 4 inches, was placed lengthwise running from the side to each 2 by 6 rafter, continuing to the opposite end of the stables. Tin roofing material was nailed to the stripping and to the rafters. The sides of the stables were completed with 1-inch by 4-inch lumber nailed to the pilings to form walls on two sides and the rear of the stables. Gates were added to the front of the stables to form eight individual stalls. Dion Robinson, petitioner's son, and Mickey Stanley, 806 petitioner's brother-in-law, built the roof for the stables. They put on the rafters, stripping, and tin280 roofing material. The cost of the stables was $ 3,800. The cost of a fence built on petitioner's farm in 1973 and 1974 was $ 6,300, one-half of such amount being spent in each year. During 1978 and 1979, John Braden was the owner of Braden Pump and Well Service Company, which had done work for Beat 5 of Harrison County, both in drilling and servicing wells. In the spring of 1978 petitioner called Mr. Braden and asked him to repair a well on his farm. Lightning had struck the well and the water supply from the well had been greatly decreased. Mr. Braden was able to get the well operating, but it only pumped four to five gallons of water per minute rather than the 50 to 60 gallons per minute that a well of that type should pump. Sometime around November 10, 1978, Mr. Braden was called to the Beat 5 barn to service the well at that barn. The well had lost its prime and would not pump water. He succeeded in getting the well to work on this service trip, but approximately one week later received another call that the well at the Beat 5 barn was not working again. When he went again to service the well, Mr. Braden tested it and determined that there was a hole in the casing of the281 well, which meant that the well could not be repaired but a new well had to be drilled in order to get water for the Beat 5 barn. After Mr. Braden determined that the well could not be repaired, petitioner called him and asked Mr. Braden to meet him at the Beat 5 barn to discuss the drilling of a new well. Petitioner told Mr. Braden that he could have the contract to drill the well at the Beat 5 barn if he would also drill a new well at petitioner's farm in Stone County to replace the lightning-damaged well. Mr. Braden was told by petitioner to include in his bid for the county well enough money to drill the well at the farm and the bid would be approved. Mr. Braden submitted a bid for the Beat 5 well to be drilled to a depth of approximately 800 feet and the bid was approved. The bid was for a total of $ 5,144 with $ 2.50 to be added or subtracted for each foot that the well was drilled plus or minus 800 feet. The well at the Beat 5 barn was drilled only to 340 feet and, at this level, pure water was obtained. After the well at the Beat 5 barn was drilled, Mr. Braden drilled a well at petitioner's Stone County farm to a depth of between 450 and 500 feet. He submitted an invoice282 for approximately $ 5,400 to Harrison County for drilling a well at the Beat 5 barn. Harrison County paid the invoice for the $ 5,400. Part of the invoice that Mr. Braden submitted to Harrison County was to cover the cost of drilling the well at petitioner's farm in Stone County. The value of Mr. Braden's services in drilling a new well on petitioner's farm in Stone County was approximately $ 2,400. Petitioner instructed Mr. Braden to take the old pump and tank from the Beat 5 barn and to repair them. Sometime later petitioner instructed Mr. Braden to take the repaired pump and tank and install them on his farm in Stone County. Mr. Braden, thereafter, installed the repaired pump and tank on petitioner's Big Level farm. The repaired pump and tank together were worth approximately $ 300 and the service work to install the pump was worth approximately $ 100. Prior to 1973 petitioner had only a small number of cattle and most of them were kept by petitioner on his father's farm. In 1973 petitioner began to greatly increase his cattle business and operate the business on his own farms. The expansion of petitioner's cattle business continued in 1974 with the acquisition of the Big283 Level farm and continued to expand from that time through the end of 1979. During the years 1973 to 1979 petitioner had some Beefmaster cattle, some Brahma cattle, some Hereford cattle, and some range or woods cattle on his farm. Petitioner sold most of the registered purebred calves that were produced on his farm, although at times these calves were kept until they were 10 to 15 months old to determine their quality for breeding purposes. Petitioner continuously culled the older nonproductive cattle from his herd and replaced them with young heifer calves born to his herd. Of all of the registered purebred calves born on petitioner's farm during a year, he kept no more than 25 percent of the heifers to replace aging and nonproductive cows that were sold. Almost all purebred bull calves produced on petitioner's farm were sold. Any of petitioner's cattle that were not range or wood cattle, and were not registered purebreds, were referred to by petitioner as crossbred. Generally, petitioner did not keep any of the bull calves born to his crossbred herd each year, but would occasionally keep a bull calf that seemed promising as a herd bull. Petitioner only kept a few of the best284 heifer crossbred calves born each year. Petitioner increased his cattle herd in size from 1973 to 1979 by both raised cattle and purchased cattle. Petitioner purchased cattle each year starting in 1973. During the later part of 1979 and the early part of 1980 petitioner and Sandra Robinson Gunter were in the process of obtaining a divorce. Mrs. Gunter engaged Walter E. Ross and Don W. King as her attorneys in the divorce proceeding. In preparing for the divorce proceeding, Mrs. Gunter, Mr. Ross, and Mr. King visited petitioner's farms in early 1980 for the purpose of estimating the numbers and types of cattle that petitioner owned and the value of those cattle. The count of cattle obtained by Mr. Ross and Mr. King with Mrs. Gunter's assistance on this visit to petitioner's farm showed 807 90 to 100 Beefmaster cattle, 60 Beefmaster-Brahma-Hereford crossbred cattle, and 400 range or woods cattle. Based on information as to the value of cattle furnished to them by Mrs. Gunter, Mr. Ross and Mr. King estimated the value of petitioner's cattle herd at December 31, 1979, to be $ 390,000, consisting of $ 250,000 for Beefmaster cattle, $ 60,000 for Beefmaster-Brahma-Hereford crossbred cattle,285 and $ 80,000 for range or woods cattle. The general price range of Beefmaster cattle sold by petitioner in early 1980 was $ 1,500 to $ 3,000 although there were some few sales at less and some few sales at more. Based on the available evidence in this case, we find that the value of the cattle in petitioner's herd based on a cost price to petitioner was $ 190,000 for the Beefmaster cattle, $ 60,000 for Brahma-Hereford crossbred cattle and $ 80,000 for range or woods cattle at December 31, 1979, making a total of $ 330,000 as a cost price for all cattle in the herd, of which one-third were raised by petitioner, leaving a cost of all purchased cattle as of December 31, 1979, of $ 220,000. Since purchased cattle were acquired over the period 1973 through 1979, we hold that the cost of purchased cattle in petitioner's herd at December 31, 1973, 1974, 1975, 1976, 1977, and 1978 was $ 15,000, $ 43,800, $ 73,332, $ 109,998, $ 146,664, and $ 183,330, respectively. When Rose Breland visited petitioner at his farm on one occasion in 1979, he showed her a large quantity of cash which he told her he kept hidden at the farm. He told her he kept large quantities of cash at the farm. The cash286 petitioner had on hand at the beginning of 1971 was 0 and the cash petitioner had on hand at the end of 1971, 1972, 1973, 1974, 1975, 1976, 1977, 1978, and 1979, was $ 300, $ 300, $ 300, $ 2,500, $ 5,000, $ 7,500, $ 10,600, $ 10,600, and $ 10,600, respectively. On October 5, 1981, respondent issued a summons under section 7602 to Walter E. Ross, Jr., a third-party recordkeeper within the meaning of section 7609(a)(3). On October 11, 1981, petitioner stayed compliance with the summons pursuant to section 7609(b) by giving notice to Mr. Ross not to comply. On January 15, 1982, a petition to enforce the summons was filed in the United States District Court for the Southern District of Mississippi. On February 22, 1982, the court ordered the documents turned over to respondent's agents and then obtained the documents on February 23, 1982. The summons enforcement proceeding was pending for 39 days from January 15, 1982, to February 23, 1982. Therefore, any period of limitations under section 6501 is suspended for 39 days. The period for making an assessment under section 6501(a) for 1978 was extended to May 24, 1982. Prior to 1968 petitioner's assets consisted mostly of his house287 in Biloxi, his automobile dealership, and some few financial investments. After petitioner was elected the supervisor of Beat 5 of Harrison County, he began to acquire land and other assets. Petitioner Sandra Robinson Gunter was aware of the land that petitioner had acquired and knew about petitioner's purchase of cattle. In her divorce proceeding, Mrs. Gunter obtained the house in Biloxi, the real estate on Dedeaux Road, and $ 10,000 cash. The Dedeaux Road real estate was ceased for $ 1,000 per month at the time Mrs. Gunter received it. Petitioners' Federal income tax returns for each of the years here in issue were prepared by an accountant from information furnished by petitioner. After the returns were prepared, petitioner would bring the returns to Mrs. Gunter who would glance over them and sign them. On their tax returns for the years here in issue, petitioners reported the following amounts and sources of income: Items Included in Adjusted Gross IncomeAdjusted GrossWages andOtherYearIncomeSalaryDividendsInterestIncome 1971$ 28,679.27$ 17,282.16$ 9,812.50$ 151.56$ 1,433.05197255,672.8013,353.951,379.9940,938.86197329,121.2112,399.964,293.3912,427.86197411,236.1313,458.22733.15(2,955.24)197522,280.2715,000.0066.117,214.16197635,495.0915,000.00395.5720,099.52197734,072.2515,500.00174.5718,397.68197850,736.0017,400.00148.0033,188.00197960,432.0017,400.005,030.0038,002.00288 The first year that petitioner reported gain or loss from operation of the farm was 1973. Thereafter, for each of the years 1974 through 1979, petitioner reported farm gain or loss. For 1973 petitioner reported sales of purchased livestock (cattle) of $ 3,888.48 with a reported gain on the sales of $ 381.08. Petitioner reported sales of market livestock and produce raised and held primarily for sale and other farm income of $ 2,856.63. Under expenses, petitioner deducted 808 labor hired of $ 2,100 and various other expenses including repairs and maintenance, interest, feed purchased, and similar items, making a total of expenses of $ 10,732.68. Petitioner reported depreciation of $ 3,267.62, making total deductions of $ 14,000.30. For 1974 petitioner reported sales of purchased livestock289 of $ 40,330.61 which he stated had a cost basis of $ 36,604.27 with a profit from the sales of $ 3,726.34. Petitioner reported sales of market livestock and produce raised of $ 6,753.02 for cattle, vegetables of $ 1,447.50, and hay of $ 27.00. Petitioner also reported rent of $ 250.00 under other farm income. Petitioner reported total expenses of $ 19,839.58 consisting of hired labor of $ 3,612.50 and various other items including repairs, feed purchased, fertilizer, and machine hire. Petitioner reported depreciation of $ 5,177.41, making total deductions of $ 25,016.99. For 1975 petitioner reported sales of purchased livestock of $ 2,900 with a cost of $ 1,850, resulting in a profit of $ 1,050. Under sales of market livestock and produce raised, petitioner reported cattle sales of $ 16,334.44, pecan sales of $ 1,807, and hay sales of $ 200, and under other farm income he reported machine work of $ 647.50, agriculture program payments, cash, of $ 346.50, making a total for market livestock and produce raised and other farm income of $ 19,335.44. Under expenses petitioner reported labor hire of $ 2,600 and various other items including repairs, feed purchased, and fertilizer290 purchased, resulting in total expenses of $ 18,622.22. Petitioner reported depreciation of $ 5,323.51, resulting in total deductions of $ 23,945.73. For 1976 petitioner reported sales of purchased livestock of $ 23,266.06 with a cost of $ 26,929.09, resulting in a loss from sale of purchased livestock of $ 3,663.03. Under sales of market livestock and produce raised petitioner reported cattle sales of $ 23,847.48, grain sales of $ 9,960.40, and seed sales of $ 5,039.40. Under other farm income petitioner reported miscellaneous income of $ 200, thus arriving at a gross profit of $ 35,384.25. Under expenses petitioner reported hired labor of $ 183.90 and various other items such as repairs, feed purchased, and fertilizer purchased, totaling $ 24,549.38. Petitioner claimed a depreciation deduction of $ 4,758.25, making total deductions of $ 29,307.63. For 1977 petitioner reported no sales of purchased livestock. Petitioner reported sales of market livestock and produce raised of cattle of $ 31,581.18, hay of $ 312.50, and seed of $ 2,760, resulting in total gross profits reported of $ 34,653.68. Under expenses petitioner took no deduction for hired labor, but claimed deductions291 for repairs, feed purchased, fertilizer purchased, and similar items, totaling $ 21,005.83. Petitioner claimed depreciation of $ 3,377.15, resulting in total deductions claimed of $ 24,382.98. For 1978 petitioner reported total sales of purchased livestock and other items purchased for resale of $ 1,930 with a cost of $ 1,248 and a profit of $ 682. Petitioner reported sales of raised livestock and produce and other farm income of cattle sales of $ 36,299, hay of $ 165, and miscellaneous income of $ 484. Under expenses petitioner claimed no deduction for labor hired, but did deduct items such as repairs, feed purchased, fertilizer purchased, and seed purchased, resulting in total expense deductions of $ 20,832. Petitioner claimed depreciation of $ 2,963, resulting in total deductions claimed of $ 23,795. On the schedule of farm income and expenses for 1979 petitioner reported sales of livestock and other items bought for resale of livestock only totaling $ 18,101 with a cost of $ 10,801, showing a profit of $ 7,300. Under sales of livestock and produce raised and other farm income petitioner reported cattle sales of $ 60,160, hay sales of $ 764, and crop damage payment of $ 600. 292 Under expenses petitioner reported cost of hired labor of $ 1,869 and reported other expense items such as repairs, and maintenance, interest, feed purchases, seeds, and fertilizer totaling $ 55,182. Petitioner claimed depreciation in 1979 of $ 1,906, making total farm deductions claimed of $ 57,088. Respondent in his notice of deficiency computed petitioners' income for each of the years here in issue on the increase in net worth plus expenditures basis and on this basis determined additional income of $ 90,189.73 for the year 1971, $ 54,653.20 for 1972, $ 105,392.56 for 1973, $ 153,746.64 for 1974, $ 172,551.99 for 1975, $ 99,577.73 for 1976, $ 91,418.61 for 1977, $ 114,586.54 for 1978, and $ 56,841.88 for 1979. Respondent in his notice of deficiency also determined that petitioner was liable for the addition to tax for fraud under section 6653(b) for each of the years here in issue. At the trial respondent made certain concessions with respect to the income as computed in the notice of deficiency, still computing petitioner's income on the net worth plus cash expenditures basis. At the trial and on brief respondent made various concessions with respect to the underreporting293 of income by petitioner. In his brief respondent contends that petitioner underreported his income for the year 1971 by $ 39,350. Respondent claims no underreporting for the year 1972, but concedes no deficiency in that year. For 1973 respondent now claims underreporting of $ 61,544, for 1974 underreporting of $ 133,426, for 1975 an underreporting of $ 124,742, for 1976 an underreporting of $ 97,531, for 1977 an underreporting of $ 109,483, for 1978 an underreporting of $ 139,362, and for 1979 an underreporting of $ 68,655. Petitioner in his brief concedes net worth items and expenditures which result in income underreported by petitioner for 1971 of $ 22,512, an overreporting in 1972 of $ 11,299, 809 underreporting in 1973 of $ 2,844, an overreporting in 1974 of $ 19,867, underreporting in 1975 of $ 10,743, an overreporting in 1976 of $ 11,301, an overreporting in 1977 of $ 7,719, an underreporting in 1978 of $ 30,220, and an overreporting in 1979 of $ 38,719. Petitioner takes the position that respondent has not established fraud in any of the years here in issue and that the only year not barred by the period of limitations at the time the notice of deficiency was issued was 1979. 294 He apparently does not contest respondent's contention that 1978 was open when the notice of deficiency was mailed because of petitioner's staying of compliance with the summons issued by respondent to a third-party recordkeeper pursuant to section 7609(b). OPINION Our findings show that based on a net worth plus cash expenditures basis using the cost of assets either agreed upon by the parties or as set forth in our findings, petitioners underreported their income in each year here involved except 1972 and possibly 1979. Therefore, since all of the years involved in this case, other than the years 1978 and 1979, are barred by the period of limitations absent respondent establishing fraud, we will first discuss the issue of fraud. We will discuss the year 1979 with respect to petitioner's activities that might be indicative of fraud. However, if there is no deficiency for 1979 based on the facts we have found, petitioner is, of course, not liable for any addition to tax for fraud for 1979. Until a recomputation of petitioners' income tax is made in this case under Rule 155 we are not sure whether there is a deficiency in petitioners' income tax for 1979. Respondent did not295 determine the additions to tax for fraud against Sandra Robinson Gunter, but in fact concedes that she is not liable for the addition to tax for fraud in any of the years here involved. Therefore, in discussing the additions to tax for fraud, the issue is with respect to petitioner Arlan Robinson only. Whether a taxpayer is subject to the addition to tax for fraud is a question of fact to be determined from a consideration of the entire record. Estate of Pittard v. Commissioner, 69 T.C. 391">69 T.C. 391, 400 (1977). Fraud is never presumed and is required to be established by affirmative evidence. Beaver v. Commissioner, 55 T.C. 85">55 T.C. 85, 92 (1970). By statute, the burden is on respondent to prove fraud and to carry this burden respondent must establish by clear and convincing evidence that petitioner intended to evade taxes known to be owing. Rowlee v. Commissioner, 80 T.C. 1111">80 T.C. 1111, 1123 (1983). Also, when fraud is determined for a number of years, as in this case, respondent must establish by clear and convincing evidence that some part of an underpayment296 of tax is due to fraud for each of the taxable years for which an addition is determined. Castillo v. Commissioner, 84 T.C. 405">84 T.C. 405, 409 (1985). Various factors have been considered to be indicative of fraud, but it has been held that respondent may prove fraud through circumstantial evidence since direct evidence of a taxpayer's intent is not often available. Bradford v. Commissioner, 796 F.2d 303">796 F.2d 303, 307-308 (9th Cir. 1986), affg. a Memorandum Opinion of this Court; Rowlee v. Commissioner, supra at 1123.The parties are not in disagreement as to the principles governing establishment of the intent to evade tax necessary to support the addition to tax for fraud or that the burden of establishing fraud is on respondent. Their arguments focus on the evidence. Respondent contends that the evidence is clear and convincing of taxpayer's intent to evade a tax known to be owing in each of the years here in issue, except the year 1972, which respondent has conceded. Petitioner contends that there is no such clear and convincing evidence of fraud in any of the years here in issue. We will begin with the taxable year 1971. From the computation297 of income on the net worth plus expenditures basis, which neither party argues is inappropriate in this case, there is an underpayment of tax in 1971, although the parties disagree as to the amount of such underpayment. Their disagreement centers on whether a dam and lake were constructed on petitioner's Stone County property in 1970 or 1971, and, regardless of the year in which constructed, the cost of the dam and lake. Respondent contends that the evidence shows that the dam was constructed in 1971 at a cost of $ 18,050. Petitioner contends that the dam was constructed in 1970 at a cost of $ 6,310 and that since it was part of petitioner's net worth in 1970, the cost of the dam is not an item that increases petitioner's net worth in 1971. The only item that respondent contends supports a fraud addition in 1971 is the construction of the dam. The other items comprising petitioner's net worth in 1971 are all agreed items. Respondent does contend that a consistent understatement of tax by petitioner throughout a series of years supports his claimed addition to tax for fraud in 1971. However, 1971 is the first year here involved and respondent has conceded that there is no deficiency298 or addition to tax for fraud in 1972. There is no showing of a consistent understatement for years prior to 1971 or for the following year. The evidence is not completely clear as to whether the dam was built in 1970 or 1971. If respondent was only required to show by a preponderance of evidence the time when the dam was built, or the burden was on petitioner to 810 show when the dam was built, we might conclude that it was built in 1971. However, there is no clear and convincing evidence of the date of the building of the dam or its cost. Furthermore, it is not clear whether petitioner paid the full cost of construction of the dam. If petitioner paid the cost of construction of the dam, this item would nevertheless increase his net worth in 1971, if first built in that year, but would not be indicative of fraud. Based on the evidence as a whole, we conclude that respondent has failed to establish fraud for the year 1971 and as previously stated, respondent has conceded the issue for 1972. Therefore, the statute of limitations bars the assessment and collection of any deficiency in petitioner's income tax for the years 1971 and 1972. This, of course, does not mean that these years299 may not be considered in determining the increases in petitioner's net worth for subsequent years, and the items that are included in the net worth statement for these years need to be determined in connection with the deficiencies in subsequent years. The evidence respondent has produced with respect to the years 1973 through 1979 is strongly indicative of fraud. The evidence shows that beginning in about the middle of 1973, Breland Trucking and Construction Company did work on petitioner's farm without compensation in order to obtain business through petitioner from Beat 5 of Harrison County. Starting in early 1974, cash payments were made on behalf of Breland Trucking and Construction Company to petitioner in order for Breland Trucking and Construction Company to obtain work on county projects in Beat 5 of Harrison County. The record is clear that petitioners did not include in their income, as reported, the value of the work done for petitioner on his farm in Stone County by Breland Trucking and Construction Company and that Breland Trucking and Construction Company was not paid by petitioner for that work. The record is equally clear that petitioner did not include in income300 the cash payments made on behalf of Breland Trucking and Construction Company to him in order to obtain work for Beat 5 of Harrison County. In fact, petitioner denies receiving any cash payments and denies that any appreciable work was done by employees of Breland Trucking and Construction Company on his farm in 1973 and 1974. Petitioner argues that there is no support in the record for the payments to him and the work done on his farm by employees of Breland Trucking and Construction Company except Rose Breland's testimony, and that she should not be believed but he should be believed in denying receiving these items. We do not believe petitioner's testimony that work was not done by employees of Breland Trucking and Construction Company on his farm or that cash payments were not made on behalf of that company to him. Contrary to petitioner's contention, there is support for Rose Breland's testimony. Wallace Love, an employee of Breland Trucking and Construction Company, testified as to working on petitioner's Stone County farm when he was an employee of Breland Trucking and Construction Company. There is support for Rose Breland's testimony of cash payments in the testimony301 of Joe Shelton with respect to his instructions to approve tickets for shortages when certain payments were made to Don Breland, Rose Breland's husband, for materials furnished to Beat 5 of Harrison County. There is also testimony by Joe Shelton and another supplier to Harrison County that cash kickbacks were made to petitioner. There is also testimony that it was customary for suppliers of services and products to Beat 5 of Harrison County during the period of time that petitioner was supervisor to make kickbacks to petitioner. We believe the testimony of Rose Breland that Breland Trucking and Construction Company employees did work on petitioner's farm, that equipment of the company was used for work on his farm, and that asphalt and other materials were furnished in connection with the work on petitioner's farm without any compensation to Breland Trucking and Construction Company from petitioner. The only evidence of any compensation for this work is a payment approved by petitioner of $ 12,000 to Breland Trucking and Construction Company from Harrison County for work that had not been done for Harrison County. Petitioner, himself, admitted that some asphalt was placed on302 his farm by Breland Trucking and Construction Company, but testified that it was low quality asphalt that was given to him by Don Breland, Rose Breland's husband. He also claims that Don Breland gave him some equipment that was old and not worth much. Don Breland was not called as a witness to confirm this testimony. We do not believe petitioner's testimony in regard to these gifts from Don Breland. If the testimony were true, Don Breland could have been called as a witness to verify the statements. The record in this case also shows that starting in 1976 county employees who were paid by the county worked off and on on a fairly consistent basis on petitioner's farm with no compensation from petitioner. Their entire compensation was received from Harrison County. Petitioner also denies that these employees worked on his farm while they were being paid by Harrison County. However, the record is replete with testimony from these employees that they did work on his farm without any compensation from petitioner while they were employed by and receiving pay from Harrison County. The value of these services was not included in petitioner's reported income. Likewise, there is evidence303 of use of 811 county equipment on petitioner's farm without compensation to the county beginning in 1975, as well as use of equipment of Breland Construction Company on his farm without compensation during 1973 and 1974. There is testimony that petitioner required Breland Construction Company to leave certain equipment with him without compensation. The work of the county employees and the county equipment extended throughout the years 1976, 1977, 1978, and 1979. There is also evidence that in 1975 a bridge was built on petitioner's farm by a contractor that did business with Harrison County without payment by petitioner. Petitioner claims this was a gift, but the evidence does not support petitioner's claim of a gift. The work was done for petitioner because he was in a position as supervisor of Beat 5 of Harrison County to give business to the company that built the bridge. It is clear that the cost of the bridge was not reported in petitioner's income. In our view the receipt of services, supplies, and cash from suppliers of services and equipment to Harrison County during the years 1973, 1974, 1975, 1977, and 1978, and the value of work done by employees of Harrison County who304 were being paid by Harrison County in 1976, 1977, 1978, and 1979, none of which was included by petitioner in his reported income, is clear and convincing evidence of fraud. The evidence also shows that gas tanks and pumps were furnished to petitioner by a well-driller who did work for Harrison County in 1978, and that a well was drilled by this contractor who did business with Harrison County for petitioner in 1978 and the compensation for the well was paid by Harrison County. This amount was not included by petitioner in his income. Petitioner also denies the well being drilled on his farm with payment being made by Harrison County. However, petitioner was convicted of diverting funds of the Federal government furnished to Harrison County with which to pay for work such as building the well by having the county pay for a well built on his property in 1978 and was also convicted of having work done by employees of Harrison County on his farm while they were being paid by Harrison County with funds furnished in part by the Federal government in the years 1977, 1978, and 1979. In spite of this conviction, petitioner denies that the well was paid for with Harrison County funds305 or that the employees of Harrison County while being paid by Harrison County worked on his farm in 1976, 1977, 1978, and 1979. We do not believe petitioner's testimony denying these facts. Clearly, the value of neither the well nor the work of the county employees was included in petitioner's reported income. In our view petitioner's failure to include these items in income and denying receipt of the items is clear and convincing evidence of fraud on the part of petitioner with intent to evade tax. See Blanton v. Commissioner, 94 T.C. (March 22, 1990), in which we held the taxpayer collaterally estopped to deny receipt of funds he had been convicted of receiving. Respondent does not argue collateral estoppel in this case, but does argue that petitioner's conviction is evidence of his receipt of labor and property paid for by Harrison County. By the net worth method respondent has shown that petitioner had unreported income in each of the years 1973 through 1978 and possibly for 1979. Since petitioner did not report the income he received from kickbacks and work done for him by county employees while being paid by the county, the conclusion is clear that some of the underreporting306 of income was due to this failure. Petitioner's failure to report income from kickbacks in cash, labor, and materials was due to fraud with intent to evade tax. There is other clear and convincing evidence of fraud in this case. Petitioner did not keep books and records from which his tax could be properly computed. He dealt in cash and he was uncooperative with the revenue agent investigating his tax liability, so that the agent was forced to compute the liability from third-party sources. In our view, the evidence in this record clearly shows that during the years 1973, 1974, 1975, 1976, 1977, 1978, and 1979 petitioner omitted from his returns as filed, income which he knew he should have reported with an intent to evade tax. Since we have concluded that petitioner's tax returns for each of the years 1973 through 1978 were false and fraudulent, the assessment and collection of tax due from petitioner in those years is not barred by the statute of limitations. We now turn to the computation of the amount of petitioner's unreported income for the years 1973 through 1979. Respondent in the notice of deficiency computed petitioners' income on a net worth plus cash expenditures307 basis. Respondent proceeded at the trial on this basis. On brief respondent makes some argument that might be interpreted, though it is not clear, that petitioners' underreporting of income might also be computed on an omitted items basis. If this is intended by respondent as an alternative argument raised for the first time on brief, we will not consider it. It is well settled that issues not raised by the pleadings or at trial, but argued for the first time on brief, should not be considered. Aero Rental v. Commissioner, 64 T.C. 331">64 T.C. 331, 338 (1975); Greenberg v. Commissioner, 25 T.C. 534">25 T.C. 534, 537 (1955). We will, therefore, only consider the amount of petitioners' underreporting of income computed on a net worth basis as respondent determined in the deficiency notice and contended at trial. 812 A net worth computation begins with an opening net worth which consists of the total net asset value of the taxpayer's assets at the beginning of a given year. It then shows308 the increases or decreases in the taxpayer's net worth for each succeeding year during the period involved and calculates the difference between the cost of the taxpayer's assets at the beginning and end of the years involved. The taxpayer's nondeductible expenditures, including living expenses, are added to these increases and if the resulting figure for any year is substantially greater than the taxable income reported for that year, the excess is stated to represent unreported taxable income. Holland v. United States, 348 U.S. 121">348 U.S. 121 (1954). The theory of the net worth method as a tax measuring device deals with cost or tax basis of assets rather than with changing values. As we stated in Bedeian v. Commissioner, 54 T.C. 295">54 T.C. 295, 299 (1970): The term "net worth" in this context does not mean the economic affluence of the taxpayer, but instead means the difference, as of the end of the taxable year, between the value of his assets in terms of actual expenditures therefor and his liabilities. The reference is to the tax basis of an asset, not to its309 fluctuating market value. * * Thus, items such as depreciation -- which affect value but entail no current outlay -- are taken into account only if they are deductible; otherwise the "net worth increase" for each year, which is one of the components of adjusted gross income as computed by the method, would be reduced by an amount which could not be deducted in computing taxable income. In a footnote we pointed out that were the decline in value of a nondepreciable asset reflected in the computation of the assets, the same amount would have to be added to the net worth increase as a nondeductible expenditure. The result would be the same as disregarding such diminution in the value in initially computing the value of assets. We further pointed out in Bedeian v. Commissioner, supra, that while values of assets may change from an economic standpoint, the net worth computed for the purpose of determining taxable income is not affected by such changes in values. In other words, the presumption from a net worth statement is that the assets acquired at their cost were acquired with taxable income, unless some source of nontaxable income for the acquisition310 can be shown, and that if a taxpayer has not reported taxable income sufficient to acquire these assets and cannot show a source of nontaxable income for their acquisition, the cost of the assets must constitute income to the taxpayer. In the instant case, the evidence shows that petitioner acquired numerous assets such as a bridge, a well, roads, land improvements, and the like, as income in kind. Therefore, here it is necessary to determine what the cost of these assets would be to petitioner by use of the value of the materials and services furnished for which petitioner did not pay. This does not affect the nature of a net worth computation, but merely increases the difficulty of making such a computation. In our view, petitioner is correct in his contention that where work done for him did not increase the value of his assets or create a new asset it does not affect his net worth even though on another basis of reconstructing income it would be considered income. As petitioner points out, such uncompensated-for labor did not add to the value of his assets and, therefore, is not to be considered in determination of petitioner's unreported income by the net worth method. 311 In this case there is little disagreement between the parties as to petitioners' beginning net worth. The only difference in the computation of net worth as of January 1, 1971, between the parties is that petitioner includes $ 6,310 as the value of the dam and lake which he contends was constructed in 1970 and respondent includes no item as of January 1, 1971, for the dam and lake. Since we have determined that respondent has failed to establish fraud for the year 1971 and, therefore, the year is closed, it makes no difference in a net worth statement whether the value of the dam and lake is included at the beginning of 1971 or as being acquired during 1971. We have held for respondent as to the value of the dam and lake of $ 18,000. However, since this item will be included in the net worth computation for every year for which a tax liability will be determined, the amount thereof is immaterial. Therefore, it is reasonable to say no issue exists as to petitioner's beginning net worth as of January 1, 1971, other than the issue as to cash on hand. Once the value of the dam and lake is disposed of, there is no difference in the net worth computations of petitioner and respondent312 as of the end of 1971, except petitioner shows cash on hand for the beginning and end of 1971 as $ 1,360, whereas respondent shows it as zero at the beginning of 1971 and $ 300 at the end of 1971. There is also a slight difference at the end of 1971 in the amount shown for furniture, fixtures, and jewelry. Petitioner shows $ 6,510 for this figure and respondent shows $ 5,000. For the end of the year 1972, the only difference in the computations of the parties is that petitioner shows furniture and fixtures at the end of this year as $ 7,914 which amount petitioner uses throughout the balance of the net worth computation, and respondent shows $ 10,000 and increases in the subsequent years. There is, of course, the same difference in the value of the dam and lake, but as previously stated, considering 813 the way a net worth statement is made, this is an immaterial difference. Another difference is that petitioner shows some purchased cattle on hand at the end of 1972 and respondent shows none, his first purchased cattle appearing in his net worth statement in 1973. We have resolved these differences in favor of respondent as set forth in our findings of fact. The testimony in this313 case supports the conclusion that in the first few years here in issue petitioner kept very little cash on hand and therefore respondent's showing of $ 300 at the end of each of the years 1971, 1972, and 1973 is more reasonable than petitioner's showing of $ 1,360. Beginning in 1974 respondent shows progressive increases in cash on hand and in our view the record supports respondent's computation in this regard. There is a showing in the record of cash payments to petitioner beginning in 1974. There is direct evidence of petitioner having cash on hand in excess of the amount petitioner includes in his computations. Rose Breland testified with respect to petitioner's statement to her about the cash he had available and about cash she saw at his farm. Considering the cash that petitioner was given as kickbacks in connection with work done for Harrison County, we conclude that respondent's computation is more reasonable than petitioner's and the computation of cash on hand which respondent argues on brief is supported by the evidence. We, therefore, conclude that petitioner's cash on hand at the end of 1971, 1972, and 1973 was $ 300 each year, at the end of 1974 was $ 2,500, at the314 end of 1975 was $ 5,000, at the end of 1976 was $ 7,500, at the end of 1977 was $ 10,600, and this same amount was on hand at the end of 1978 and 1979. We likewise sustain respondent's determination of increases in value of furniture, fixtures, and jewelry. During the years 1972 through 1979 petitioner was furnishing a house in Stone County. The only evidence petitioner produced of items purchased was some carpeting purchased in 1972. However, the record shows that petitioner's house was well furnished and was well fitted out with appliances. The evidence of the amount and type of furnishings in petitioner's house supports the amounts for which respondent contends. We have effectively dealt with the other items that make up the net worth statement in our findings of fact and based on those facts we hold as follows with respect to the items on which the parties disagree. The first of these items is land development by Breland. We have found the total amount of work done by Breland Trucking and Construction Company based on the amount it would have cost petitioner had he paid for the work. This amount was testified to by Rose Breland. However, we have also found that a portion315 of this work was not work that increased the value of petitioner's assets. Since this is a net worth computation based on asset cost only, the portion of this work that went to developing new assets for petitioner should be included in the net worth statement. We, therefore, have concluded that the land development done by Breland Trucking and Construction Company for which petitioner did not pay was $ 50,000 at the end of 1973 and $ 100,000 at the end of 1974 and each succeeding year. The next item of disagreement is the bridge built in 1975. We have found in our facts that the cost to petitioner had he paid for building of the bridge rather than have it given to him in return for approving work for a contractor for Harrison County would have been $ 25,750 and this amount is includable in the net worth computation at the end of 1975 and in every year thereafter. The bridge was a form of "kickback" to petitioner, not a gift. The next item is land development by county employees upon which the parties disagree. We have found that county employees did work for petitioner while they were paid by the county beginning in 1976 and continuing through 1979. We do not believe petitioner's316 testimony to the contrary. However, none of the work done by them that did not add to the value of petitioner's assets and was not capital in nature increased petitioner's net worth. Using our best judgment from the testimony, we have concluded that the additional asset value created by work of county employees on an accumulative basis was at the end of each of the years 1976 through 1979, $ 75,500, $ 32,975, $ 57,450, and $ 68,000, respectively. Of these amounts 70 percent was the cost of capital assets which increased petitioners' net worth. The next item on which there is disagreement is land development by county equipment and in our findings we have also disposed of this issue by holding that the capital improvement addition to asset value was at the end of each year as follows: 1975-$ 8,853, 1976-$ 17,700, 1977-$ 28,700, 1978-$ 39,700, and 1979-$ 50,700. The next item of disagreement is with respect to stables. Petitioner includes only $ 100 for this item and respondent includes $ 3,800 at the end of 1977 and the end of each year thereafter. As we have set forth in our findings, we agree with respondent that the stables had a cost basis to petitioner of $ 3,800 which is317 includable in the net worth computation at the end of each of the years 1977 through 1979. The final item on which there is disagreement is the cost of purchased cattle and we have set forth our determination in that regard in detail in our findings which is that the cost of purchased cattle was zero at the end of 1971 and 1972 and was $ 15,000, $ 43,800, $ 73,332, $ 109,998, $ 146,664, $ 183,330, and $ 220,000 at the end of 1973, 1974, 1975, 1976, 1977, 1978, 814 and 1979, respectively. Petitioner argues that a computation prepared by his accountant from information furnished by petitioner shows to the contrary of our findings. We do not believe petitioner's testimony that the records he furnished to his accountant to prepare this schedule were an accurate record of purchases and sales of cattle. Therefore, the schedule is worthless. Although the computations by the parties in their briefs show some difference in reserve for depreciation, neither party argues this point and presumably the parties will be able to dispose of this item in a Rule 155 computation. A recomputation of petitioner's tax liability on the net worth basis using the agreed-upon items and the items which are318 in controversy as we have found them will produce the amount of petitioner's underreporting of income in each of the years 1973 through 1979. The final issue in this case is whether Sandra Robinson Gunter who signed a joint return with her husband should be relieved of liability for any deficiency in tax including interest, penalty, and other amounts under the provision of section 6013(e) referred to as the "innocent spouse" provision. Respondent did not determine the addition to tax for fraud against Mrs. Gunter, but does contend that she is jointly and severally liable for the deficiencies. Section 6013(e)(1) provides that: (a) where a joint return was filed, (b) on that return there is a substantial understatement of tax (an amount in excess of $ 500) which is attributable to grossly erroneous items of one spouse, (c) the other spouse establishes that in signing the return he or she did not know and had no reason to know that there was such substantial understatement, and (d) taking into account all the facts and circumstances, it is inequitable to hold the spouse liable for the deficiency319 in tax for such taxable year attributable to such substantial understatements, the spouse to whom the substantial understatement was not attributable is relieved from liability for the tax on such substantial understatement. Here it is clear and has been stipulated that joint returns were filed. We have held that there is an understatement of tax for each of the years 1973 through 1978 and possibly for 1979 which meets the definition of substantial understatement. This leaves, therefore, in conflict between the parties, whether Mrs. Gunter in signing the return did not know and had no reason to know that there was a substantial understatement and whether it would be inequitable to hold her liable for the tax. The record here shows that while she was married to petitioner Mrs. Gunter did not actively participate in his business activities. Rather she primarily looked after keeping the home and caring for their three children. She received all of her support from petitioner. The record also shows that the joint income tax return for each of the years here involved was prepared by a certified public accountant from information furnished to the accountant by petitioner. However, 320 the record shows that in connection with her obtaining a divorce from petitioner, Mrs. Gunter was aware of the assets petitioner had and, in fact, even had her attorneys go out and count the cattle on the farms. The record shows that through the years as petitioner was acquiring various pieces of property, Mrs. Gunter, his then wife, was aware of the acquisitions. There is nothing in the record to show that Mrs. Gunter knew of the work done on the land by employees of contractors as a form of kickback to petitioner or of the cash kickbacks petitioner received or the work done by county employees prior to 1979. In fact Mrs. Gunter testified she was unaware of this until the FBI investigation started and we believe this testimony. On the other hand, Mrs. Gunter was aware not only of the land acquisitions but of the various improvements and it might be questioned whether she should have questioned if these improvements were possible with the amount of income being reported on their tax returns. Also, after the FBI investigation of petitioner started in early 1979, Mrs. Gunter should have become aware of the receipt by petitioner of unreported income. Prior to 1979 there is nothing321 in the record to indicate that she knew of this unreported income. This is not a case of no income or minimal amounts of income being reported. Mrs. Gunter testified that as far as she was aware she and the family were living on the income as reported. Mrs. Gunter's testimony impressed us as truthful. Until 1979 there was no specific fact to alert Mrs. Gunter to possible unreported income of petitioner. Mrs. Gunter, when she was petitioner's wife, received adequate support from petitioner. Mrs. Gunter's testimony was that she received no expensive gifts from petitioner during the years here in issue and we have no reason to doubt this testimony. The only advantage Mrs. Gunter appears to have obtained from the unreported income, unless her divorce receipts are considered to have come from the unreported income, was a few weeks each summer and some weekends at the farm. In the divorce Mrs. Gunter received the Biloxi house which was purchased prior to the years here in issue, $ 10,000, and a piece of real estate rented at $ 1,000 a month. This settlement appears to represent nothing more than normal support. Considering the record as a whole, we conclude that Mrs. Gunter is322 entitled to the relief provided for under section 6013(e) for each of the years here in issue except for the year 1979 (if there is a deficiency in that year) when, because of the FBI investigation 815 that had begun at that time, she should have known of petitioner's receipt of labor paid for by Harrison County and ascertained whether the amount was included in reported income. Decision will be entered under Rule 155. Footnotes1. All references are to the Internal Revenue Code of 1954 as applicable to the years here in issue.↩. Figures not in parenthesis are additions which increase net worth and figures in parenthesis are reductions which decrease net worth.↩. This item includes capital gains of $ 39,488.86 for 1972, $ 19,966.50 for 1973, $ 1,799.89 for 1974, $ 650.00 for 1975, $ 101.98 for 1977, $ 6,180.00 for 1978, $ 12,008.00 for 1979, and a capital loss of $ 335.00 for 1976.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621308/	Estate of William C. Chapin, by Lincoln Rochester Trust Company, Executor v. Commissioner.Estate of Chapin v. CommissionerDocket No. 3340-66,United States Tax CourtT.C. Memo 1970-7; 1970 Tax Ct. Memo LEXIS 351; 29 T.C.M. (CCH) 11; T.C.M. (RIA) 70007; January 12, 1970, Filed. Julian M. Fitch, 910 Union Trust Bldg., Rochester, N Y., for the petitioner. Ferdinand J. Lotz, III, for the respondent. IRWINMemorandum Findings of Fact and Opinion IRWIN, Judge: Respondent determined a deficiency of $35,384.51 in the estate taxes of the Estate of William C. Chapin. Petitioner agreed to all of respondent's adjustments except the inclusion in the decedent's estate of $208,528.67 as proceeds from an insurance policy on the life of the decedent. Three issues are left for our determination. First, we must decide whether a premium payment covering the first year of the above policy was made by the decedent in contemplation of death. Second, we must decide whether the funds used for a premium payment covering the second year of the above policy should be attributed to the decedent. (If we resolve this question in the affirmative, we must also decide whether this payment was made in contemplation of death.) Finally, if we dispose of either issue one or the parenthetical in issue two in the affirmative, we must then decide whether the amount to be included in the decedent's gross estate under section 2035 1 should be353 the insurance proceeds brought about by the decedent's death or an amount equal to the premium payments referred to above. Findings of Fact Most of the facts are stipulated, and the stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Petitioner is the Lincoln Rochester Trust Company (sometimes hereinafter Lincoln) a banking corporation organized under the laws of the State of New York and having its principal office in Rochester, N. Y. Lincoln is the executor of the Estate of William C. Chapin and filed the estate tax return with the district director of internal revenue at Buffalo, N. Y.The decedent, William C. Chapin (hereinafter sometimes William) was born on December 15, 1911. He married Janette K. Chapin (hereinafter sometimes Janette) on October 31, 1936, and a daughter and two sons were born of the marriage during 1938, 1941 and 1947, respectively. William and Janette were residents of Rochester at the time of his death. On May 22, 1962, William died of multiple injuries sustained in the crash of a commercial354 airplane. The Massachusetts commercial airplane. The Massachusetts Mutual Life Insurance Company (hereinafter Massachusetts) paid Janette $208,528.27 as the proceeds from the policy in question on William's life. The Commissioner held that these proceeds were includable in William's gross estate under one or more of sections 2033, 2035, 2042 or 2043. William J. Lee (hereinafter Lee) was for many years a personal friend of the decedent. Lee was an insurance representative for Massachusetts. On two occasions during the early and middle nineteen-fifties, Lee had sold William life insurance policies with an aggregate face amount of $53,000. For a period of about 1 1/2 years prior to March 21, 1961 - the date on which the insurance policy in question was signed - Lee and William discussed the possibility 12 of adding to William's life insurance coverage. Their discussions were oriented to determining the type of coverage best suited to the then needs of the decedent and his wife. On several occasions during their many discussions, Lee and William addressed themselves to the question of who would take out the policy. William eventually decided that his wife, Janette, should do355 so. Lee testified that William's reasons for this decision were twofold: (a) to minimize his estate tax; and (b) to protect Janette during her lifetime by making her the owner of a flexible policy. William had rejected the idea of having the corporation, over which he presided as president, purchase the insurance on his life because he felt the corporation (hereinafter referred to as Vanilla) needed to accumulate its available funds for the expansion of business. During these discussions, William apprised Lee of the fact that he (William) was indebted to the Lincoln Rochester Trust Company. William had borrowed the money constituting this indebtedness to invest in what William considered to be a speculative investment. The schedule below establishes the total amount borrowed by William and the dates on which the loans constituting this amount were obtained from Lincoln: DateAmountNovember 27, 1959$ 10,000February 16, 196010,000March 14, 196030,000May 25, 196017,000August 16, 196025,000August 26, 196015,000December 14, 196059,000April 12, 1962 26,000Total$192,000The following shares of Eastman Kodak Company common stock, all356 of which were registered in William's name, were pledged as collateral for the loans set forth above: Value PerShare asStipulatedDate PledgedShares[Parties[ValuebtTotalAugust 16, 1960455$121$55,367December 14, 19602,000113226,250October 9, 196130010130,431April 12, 196240011044,325The estate tax return for William's estate listed as a debt of the decedent demand loans owed to Lincoln aggregating $189,768.86 plus interest. Of the 4,806 shares of Eastman Kodak common stock included in William's estate, approximately 3,100 shares secured this debt at the time of William's death. The discussions between William and Lee culminated in Janette's applying for a life insurance policy on the life of her husband in the principal amount of $200,000. The application was executed by Janette on March 21, 1961. On March 22, 1961, Massachusetts issued to Janette insurance policy No. 3615006 on the life of her husband. As owner and beneficiary of the policy, Janette was entitled to assign it, change the beneficiary, and borrow from the insurer at five percent interest using the policy as security. The policy357 issued to Janette can be described as a normal or convertible life insurance policy with a higher rate of cash reserve value developing in the early years and leveling off to an ordinary rate in the later years. The following is a projection of the cash values of the policy commencing with the end of the first year when the insured was age 49: YearValueYearValue1$ 3,43811$55,56829,2941260,518315,1621365,428420,2401470,288525,3201575,098630,3981679,850735,4701784,538840,5281889,160945,5681993,7101050,5822098,184 The policy also provided for income payments to the beneficiary beginning at age 65 of the insured and in the amount of $498 per month for 10 years certain. The annual premium on the policy was $7,834. William paid the first premium with funds which he borrowed from Massachusetts against the security of his other insurance policies. He did not file a gift tax return for 1961. The second premium was paid by Janette on March 22, 1962, two months before William's tragic death, by borrowing against the cash surrender value of the policy here in issue. Though the cash358 surrender value at the beginning of the second policy year was only $3,438, by company practice the owner of a policy such as the one in issue is allowed to borrow at the beginning of a policy year an amount equal to 95 percent of the cash surrender value which would be established by payment of the premium for which the loan is being made. This practice 13 merely recognizes the fact that, given an insurance policy with a cash surrender value intact from the previous year, an owner is always free to pay the succeeding year's premium with his own funds and immediately thereafter borrow an amount equal to such premium from the cash surrender value thus established. Hence, in the case at bar, Janette was able to pay the second year's premium of $7,834 by borrowing against $9,294, the value placed on the cash surrender privilege at the end of the policy's second year. William would have paid the second premium had the necessary cash been available to him. Moreover, other than the cash surrender value of the policy, Janette had no means of her own at the time this second premium payment was made. Hence, the decision to borrow against the policy was in the nature of a temporary expedient359 brought on by William's unfavorable cash position. Janette understood that William had urged her to take out the policy in order to provide her with means of her own while he was alive and to provide additional means in the event of his death. Janette amended the policy on May 22, 1961. By this amendment, she made her three children equal owners and beneficiaries in the event she predeceased William and they, or any of them, survived her. Janette's estate was named owner and beneficiary in the event they all predeceased William. As a consequence of Janette's applying for the insurance on William's life, William, then age 49, underwent two physical examinations conducted by two doctors designated by Massachusetts. Prior to this time William had not been to a physician for about three years. William was at the time of his death a very athletic person. He was an excellent amateur golfer with little or no handicap, and had won several trophies in invitational and club tournaments. Lee, who played golf with him many times, felt William was one of the better golfers in the Rochester area. Both Lee and Janette believed William enjoyed excellent health up to the time of his death. 360 William executed his last will and testament on March 10, 1961, eleven days before Janette applied for the policy on William's life. One of the alleged reasons for executing the will at this time was to provide for the disposition of a large block of Vanilla stock in which William had a remainder interest bequeathed to him under the will of a Mrs. Brown who died sometime in 1958. Decedent's will made Janette the primary beneficiary of his estate. Among William's concerns in 1961 was that a large portion of Vanilla's business was centered around a dozen customers, one of whom accounted for about one-third of Vanilla's business. Opinion On March 22, 1961, Massachusetts insurance policy No. 3615006 on the life of the decedent herein was issued to the decedent's wife, Janette. Decedent, who was 49 years of age on the date of issuance, enjoyed very good health up to the time of his death in the crash of a commercial airliner on May 22, 1962. The first premium on the policy was paid by the decedent in 1961. The second premium on the policy was paid by Janette on March 22, 1962, with funds obtained by borrowing against the cash surrender value of the policy. Our task in this case361 is twofold: first, we must determine whether the premium payments described above were paid by or can be considered a transfer (payments) made by the decedent in contemplation of death; and second, if our answer to the above inquiry is wholly or partly in the affirmative, we must then decide the amount to be included in the decedent's gross estate under section 2035. 2 Issue 1 - Contemplation of Death Section 2035(b) creates a rebuttable presumption that all transfers of an interest in property made by a decedent within three years of death and for less than an adequate and full consideration in money or in money's worth are in contemplation of death. The burden of rebutting this presumption is on the petitioner. Reeves' Estate v. Commissioner, 180 F. v. Gidwitz' Estate, 196 F 2d 829 (C.A. 2, 1950). Long ago, the Supreme Court in United States v. Wells, 283 U.S. 102">283 U.S. 102 (1931), established the rationale to be employed in construing the words362 "in contemplation of death." In that case the Supreme Court stated: As the test, despite varying circumstances, is always to be found in motive, 14 it cannot be said that the determinative motive is lacking merely because of the absence of a consciousness that death is imminent. It is contemplation of death, not necessarily contemplation of imminent death, to which the statute refers. * * * The words "in contemplation of death" mean that the thought of death is the impelling cause of the transfer, and while the belief in the imminence of death may afford convincing evidence, the statute is not to be limited, and its purpose thwarted, by a rule of construction which in place of contemplation of death makes the final criterion to be an apprehension that death is "near at hand." In each case the central issue is one of fact: what was the impelling motive of the decedent when the transfer was made? Allen v. Trust Co., 326 U.S. 630">326 U.S. 630 (1946). As stated by the Supreme Court in Commissioner v. Culbertson, 337 U.S. 733">337 U.S. 733, 743 (1949): The Tax Court * * * must * * * [determine the intent with which a person acted] in every estate tax case in which it is contended363 that a transfer was made in contemplation of death for "The question, necessarily, is as to the state of mind of the donor." * * In arriving at this factual determination, the decedent's health at the time of the transfer is not conclusive, but merely evidence to be weighed in determining the decedent's motives. See, e.g., Commissioner v. Gidwitz' Estate 196 F.2d 813">196 F. 2d 813, 816 (C.A. 7, 1952), affirming 14 T.C. 1263">14 T.C. 1263 (1950). On the one hand, the fact that he might be relatively young and healthy does not necessarily preclude a determination that a transfer is in contemplation of death. On the other hand, the fact that he might be elderly and experiencing poor health does not necessarily call for a determination that a transfer is in contemplation of death. All the facts and circumstances surrounding the transfer must be weighed to arrive at a determination. In the instant case we are faced with a factual pattern which involves the payment of premiums on a policy covering the life of the decedent. Addressing ourselves, for the moment, to the premium payment made by the decedent in 1961, it is incumbent upon us to note that while transfers relating to insurance364 on the life of the donor-decedent may suggest a motive associated with death, the subject matter of the transfer is not determinative of the motive under which it was made. In each case, it is a circumstance to be considered and accorded a just degree of evidentiary weight. See, e.g., Estate of Edmund W. Mudge, 27 T.C. 188">27 T.C. 188 (1956). In the case at bar, however, we believe that the premium payment made by the decedent was prompted by a motive associated with death. We first note that the insurance policy which generated this premium payment was issued to Janette, as owner and beneficiary, only 11 days after William executed his will, the dispositive provisions of which made Janette the primary beneficiary of William's estate. Though the timing of the two such events in other circumstances might be regarded as happenstance, we believe that the facts of this case militate against such a conclusion. The bulk of William's estate was, at the time he executed his will, made up of 4,806 shares of Eastman Kodak stock. As of December 14, 1960, 2,455 of these shares (with a stipulated value totaling $281,617) were pledged as security on William's indebtedness to the Lincoln Rochester365 Trust Company. At the time of William's death, both the number of shares of Eastman Kodak stock pledged as security and the amount owed to Lincoln had increased. We believe these facts yield the inescapable conclusion that the short period of time which separated the execution of William's will and the issuance of the policy on his life was more than just coincidental and that, since Janette had no money of her own, William's impelling reason for paying the 1961 premium was to put into force a policy on his life, the proceeds of which could be used to free the pledged Eastman Kodak stock in the event of his death. In arriving at this conclusion, we are not unmindful of the fact that one of the reasons asserted for Williams' having executed the will at the time he did was to provide for the disposition of a large block of Vanilla stock in which he had a remainder interest bequeathed to him under the will of a Mrs. Brown. However, we also note that though Mrs. Brown died in 1958 and though her will was admitted to probate on May 14, 1959, decedent's will was not executed until March 10, 1961. We also note that both the execution of the will and the issuance of the insurance policy366 on William's life came at the conclusion of a 1 1/2 year period during which William and Lee had devoted extensive discussions to William's insurance position as well as his debt situation. Cf. 15 Estate of Edwin W. Rickenberg., 11 T.C. 1">11 T.C. 1 (1948). Nor do we find controlling Janette's testimony to the effect that William, while "interested in [the] death benefits of the policy," was "primarily interested in being able to provide me with something of my own. * * I was aware of the cash value of the policy and that it was mine." If this were so, regular deposits in a savings account would have yielded a substantially larger means of security, during his lifetime, than the cash surrender value of the policy. Moreover, though the insurance policy in question did have an annuity feature, which was to commence when William attained the age of 65, there can be no doubt that a straight annuity contract would have better served this end. Additionally, we cannot overlook Lee's testimony in which he indicates that estate tax considerations, as well as thoughts of protecting Janette during William's lifetime, influenced William in having his wife take out the policy on367 which the premium in question was paid. The desire to avoid estate tax clearly is a motive associated with death. Farmers' Loan & Trust Co. v. Bowers 68 F. 2d 916 (C.A. 2, 1934); McIntosh's Estate v. Commissioner, 248 F. 2d 181 (C.A. 2, 1957), affirming 25 T.C. 794">25 T.C. 794 (1956); Vanderlip v. Commissioner, 155 F. 2d 152 (C.A. 2, 1946), certiorari denied 329 U.S. 728">329 U.S. 728 (1946), affirming 3 T.C. 358">3 T.C. 358 (1944). With this in mind the most we can say in petitioner's favor is that, though the decedent, in making the 1961 premium payment, may have considered Janette's security during his life, it has not been shown to us that this life-associated motive was more impelling than either his wish to (a) avoid estate tax or to (b) provide a means of freeing the aforementioned shares of Eastman Kodak stock in the event of his death. Under these circumstances, we are compelled to find that petitioner has failed to satisfy the burden required of him under section 2035. See Farmers' Loan & Trust Co. v. Bowers, supra, at 923, where it was said that the taxpayer fails in his burden of proof when he is unable to establish368 which of two or more motives, each substantially inducing the transfer, was the "single dominating, controlling, or impelling motive"; and Estate of Arthur H. Hull, 38 T.C. 512">38 T.C. 512, 527 (1962), reversed on other grounds 325 F. 2d 367 (C.A. 3, 1963). Issue 2 - Premium Payment from Cash Surrender Value Turning our attention to the second premium payment, the question which confronts us is whether the funds used for this payment should be attributed to the decedent. Only if we resolve this question in the affirmative will it be necessary for us to determine whether the payment was made in contemplation of death. With regard to this question, respondent admits that the funds used by Janette to make this payment were obtained by her by borrowing against the cash surrender value of the policy. Respondent also recognizes that she was able to do so only because company practice assigned a fictional value to the loan feature of the policy at the beginning of the second premium period. Nevertheless, respondent urges that the full amount of the second premium payment is attributable to the payment made by the decedent in the prior year. We disagree. We believe the369 premium money transferred by William in 1961 constituted a completed gift at that time. What use Janette made of the gift thereafter is of no consequence to us. We think it well established that once a completed gift is made, any benefits which flow therefrom are to be deemed the property of the donee. See and compare Estate of Ralph Owen Howard, 9 T.C. 1192">9 T.C. 1192 (1947), where it was held that dividends received on a gift of stock, and thereafter deposited in a joint savings account with the donor, constituted property of the donee for purposes of the joint ownership provisions of what is now section 2040 of the Code. See also Swartz v. United States, 182 F. Supp. 540">182 F. Supp. 540 (D. Mass. 1960), and First National Bank of Kansas City v. United States, 223 F. Supp. 963">223 F. Supp. 963 (W.D. Mo. 1963), where, in similar circumstances, it was held that gain from the donee's sale of stock could not, for purposes of section 2040, be attributed to the donor even where the proceeds of such sale were used to acquire jointly held property with the donor. We believe the rationale of the cases cited above governs the question now before us. Though a donor's generosity may live on in370 the estimation of the person benefitted by his bounty, it cannot be made to live on interminably for purposes of the tax law. In so holding, we explicitly reject respondent's assertion that the issue before us is controlled by our decision in Estate of Clarence H. Loeb, 29 T.C. 22">29 T.C. 2216 (1957), affirmed, 261 F. 2d 232 (C.A. 2, 1958). In Loeb we were called upon to resolve an issue which arose under section 811(g) (2)(A) of the Internal Revenue Code of 1939 which provided, in part, that insurance proceeds on the life of the decedent, were includable in his gross estate if: purchased with premiums, or other consideration, paid directly or indirectly by the decedent, in proportion that the amount so paid by the decedent bears to the total premiums paid for the insurance * * * The specific question addressed to us in Loeb was whether (under the "premium payment test" of the above section) funds, which the decedent gave to his wife and which were used by her to make premium payments on a policy covering the life of the decedent, should be regarded as having been indirectly paid by the decedent. We held in the affirmative basing our371 decision on our finding that the decedent had made the gifts of money in question with the intent that these sums would be used by his wife in payment of the contested premiums. Recently, in Estate of Inez G. Coleman, 52 T.C. 921">52 T.C. 921 (1969), we stated that "[It] is clear from the legislative history that Congress sought to inter the 'premium payment' test [of section 811(g) with the ashes of the 1939 Code * ." Since Loeb, though factually related to the case before us, arose under the "premium payment test" of section 811(g) (2)(A) of the 1939 Code, we hold that our decision in that case is totally inapposite to our determination of the issue at hand. Issue 3 - Amount Includable in Decedent's Estate Having determined that the 1962 premium cannot be attributed to the decedent for purposes of section 2035, the only question remaining is the amount to be included in the decedent's gross estate as a result of the 1961 premium paid by the decedent in contemplation of death. We hold that the amount to be included in the decedent's estate under section 2035 is $7,834 - the premium paid by William in 1961. In this regard, we are governed by our recent determination372 in Estate of Inez G. Coleman, supra, wherein it was held that "the frontiers of section 2035 should not be extended to include the proceeds of life insurance simply because a decedent paid the premiums. Only the dollar amount of the premiums paid in contemplation of death is includable in the gross estate of the decedent * * *." Decision will be entered under Rule 50. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise designated.↩2. Consistent with our earlier characterization of the issues presented in this case, the discussion which follows will divide the questions for consideration into three separate issues. (See p. 2, supra.)↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621310/	Sidney H. Scheuer v. Commissioner.Scheuer v. CommissionerDocket Nos. 108979, 109888.United States Tax Court1943 Tax Ct. Memo LEXIS 295; 2 T.C.M. (CCH) 118; T.C.M. (RIA) 43242; May 21, 1943295 Harry Silverson, Esq., and Charles H. Meyer, Esq., for the petitioner. Clay C. Holmes, Esq., for the respondent. KERN Memorandum Findings of Fact and Opinion These proceedings, which have been consolidated for hearing, arise from the Commissioner's determination of deficiencies in petitioner's income taxes for the years 1937, 1938 and 1939, in the respective amounts of $6,667.85, $8,846.62 and $9,810.62, resulting from the inclusion in petitioner's gross taxable income of the entire net income of three trusts established on November 13, 1934, by petitioner for the benefit of his three minor sons, and of the entire net taxable income of a trust established April 3, 1923, by petitioner for the benefit of his parents. Findings of Fact A partial stipulation of facts was filed by the parties, and the facts so stipulated are found to be facts in this case, and in so far as we deem them material to the issues presented, are set forth here, together with such other pertinent facts as were established by the evidence. Petitioner, a resident of New York City, filed his income tax returns for the tax years 1937, 1938 and 1939 with the collector for the second district of New York. The 296 trusts which are the bases of these controversies fall into two general classes: (a) three separate trusts for the benefit of the three minor sons of petitioner; and (b) a trust for the benefit of the petitioner's parents. (a) The Children's Trusts. In 1934, petitioner was engaged, as a partner, in the textile brokerage business, involving the use of substantial capital, and was constantly aware of the fact that his personal, as well as his partnership assets were subject to the considerable risks of his business. On November 13, 1934, petitioner established three irrevocable trusts, virtually identical in terms, for the benefit of his three minor sons, then aged 11, 6 and 3, for the purpose of protecting them and their futures from the hazards of his business. He was aware of the fact that his tax liability might be somewhat lessened by the establishment of the trusts, but his principal purpose was the irrevocable setting aside, in bona fide trusts, of certain sums of money for the benefit of his children, because of the financial risks which his business involved. Petitioner established the trusts with corpora consisting of a total of approximately $100,000 in cash and securities. 297 It was understood that his father would contribute approximately $50,000 to the trusts almost immediately, and additional amounts from time to time. Petitioner's father contributed a total of approximately $65,000 to the three trusts, and petitioner's wife contributed approximately $25,000, from the separate funds of each such donor. Respondent concedes that the income of the trusts from the portions of the corpus of each contributed by petitioner's wife and father are not taxable to petitioner. Petitioner and his father were named initial trustees, with broad powers of management and investment, and both were active and vigilant in the administration of the trusts. Petitioner's experience in the field of finance and investment has been extensive and successful, and his father also has had considerable experience in such matters. For these reasons and because of the fact that he disapproves of the methods and policies of corporate fiduciaries, petitioner constituted his father and himself as co-trustees. Article First of each of the three trust indentures provides substantially as follows: FIRST: The Grantor hereby transfers and delivers to the Trustees the cash and securities 298 enumerated in Schedule A hereto annexed, IN TRUST, for the following uses and purposes: (1) To receive the income therefrom, or from so much thereof as may from time to time remain in their hands after making the payments provided for in clause (2) of this article "First" of this indenture, during the life of [Beneficiary], one of the sons of the Grantor, hereinafter referred to as the "Beneficiary" and to apply the net income, or so much thereof as they may deem advisable, to the education, maintenance and support of the beneficiary during his minority; to accumulate the surplus income over the sums so applied and pay over such accumulations to the Beneficiary upon his attaining his majority; and to pay over the entire net income to the Beneficiary after he has attained his majority and until his death. (2) To apply to the education, maintenance and support of the beneficiary at any time or from time to time during his minority, and to pay over to the Beneficiary at any time or from time to time after he has attained his majority, such portion or portions of the principal of the trust, if any, as the Trustees in their sole and exclusive discretion may consider proper. (3) Upon 299 the death of the Beneficiary, to pay over the principal of the trust, or so much thereof as then remains in their hands, to such person or persons and in such manner and proportions as the Beneficiary shall have designated in and by his last will and testament; or in default of such designation, or to the extent to which the same if made shall not be valid or effectual, to pay over the same to the Grantor. During the years in question, none of the income or principal of the trusts was expended for the education, maintenance or support of any of the beneficiaries, but all of the income was accumulated for distribution to the respective beneficiaries under the terms of the indentures. This policy was agreed upon between the petitioner and his father as settlors and trustees as a proper method of effecting their intentions in establishing the trust, and was set forth in an exchange of letters between them, but the trust indentures were not amended so as to reflect such an intention on the part of the settlors. The collateral agreement as to policy embodied in the correspondence referred to did not effect any change in the trust instruments. The total net taxable income of the trust 300 for the benefit of Robert Scheuer for the years 1937, 1938 and 1939 from that part of the corpus contributed by Sidney Scheuer, was $2,171.25, $4,421.74 and $3,455.88, respectively. The amounts expended by petitioner from his own personal resources for the education, support and maintenance of Robert during those years were, respectively, $2,936.80, $2,560.00 and $2,324. The total net taxable income from that part of the corpus of the trust for Thomas Scheuer contributed by petitioner for the years 1937, 1938 and 1939 was, respectively, $2,626.65, $3,907.23 and $2,915.32. The amounts expended by petitioner from his own personal funds for the education, support and maintenance of Thomas Scheuer during 1937, 1938 and 1939 were $1,997.96, $1,653 and $1,348. The total net taxable income arising from that part of the corpus contributed by petitioner for the benefit of James Scheuer, during the years 1937, 1938 and 1939 was $2,248.26, $3,735.30 and $3,215.25, respectively. The amounts expended by petitioner from his own personal funds for the support, education and maintenance of James Scheuer during 1937, 1938 and 1939 were, respectively, $1,476.92, $1,417 and $1,884. (b) The Parents'301 Trust. By indenture dated April 3, 1923, petitioner established a trust, with himself as the intial trustee, for the benefit of his parents, for the purpose of providing for a continuation of his policy of making voluntary contributions of money to them. At that time, petitioner's father was 56 years of age, his mother, 53, and the petitioner 29. The parents were then, and thereafter at all times continued to be, financially independent of petitioner, having means sufficient for their own support. Petitioner's father then had a net worth, exclusive of paid up insurance and other miscellaneous means, of approximately $25,000 to $30,000. By 1934, his net worth had increased to between $50,000 and $75,000. Petitioner had, for some time prior to 1923, made voluntary supplemental gifts to his parents, and he wanted to assure the payment of such sums to them in the future. After the creation of this trust petitioner made no other gifts of money to his parents. He had married in 1920, and established his own separate household. His business was then of the same general character as later, and as described hereinbefore, involved considerable financial risks. The trust indenture provided302 that "The trustee shall pay over to, or expend, for the benefit of my said parents, Henry Scheuer and Sarah Scheuer, and/or the survivor of them, at least once a year, or at shorter intervals within the discretion of my said trustee, all of the net income from the said trust." The trust estate was to revert to petitioner, if he survived both his parents. If not, then the disposition of the corpus was otherwise provided for upon the death of the last surviving parent. The instrument further provided: I. The trust shall be terminable at any time by the joint consent of my father, Henry Scheuer, and my mother, Sarah Scheuer, and the trustee hereunder then acting, and of myself and in such event, the said trust estate shall revert to myself. The instrument further provides that "the trustee shall have the right from time to time, and at any time, to change the character or nature of the properties or the securities representing the corpus of the trust estate, and shall have and is hereby given full power and absolute right and power to sell, transfer or otherwise dispose of any of the property (whether cash, securities or otherwise) at any time constituting said trust estate." And, 303 further, "In the handling of the trust estate the trustee hereunder shall not be limited to investments of the kind specified by the State of New York for the investment of trust funds, but may at all times exercise his discretion and judgment as to the kind and character of the property that shall constitute in whole or in part of the trust estate." The trust has never been terminated, in whole or in part, and the income thereof has been paid over to petitioner's parents each year since its establishment, and was so paid during 1937, 1938 and 1939. Petitioner, as trustee, maintained a separate bank account for the moneys of these trusts; a separate cash brokerage account; a separate set of books of account; and regularly filed fiduciary returns. By an amendment to the petition filed at the hearing herein petitioner alleged as an additional error on the part of respondent the latter's failure to allow to the children's trusts during 1939 certain capital losses. To this amendment respondent filed a denial. No evidence on this issue was introduced by petitioner and we, therefore, find that no losses, described and set out in said amendment to the petition, were sustained by the trusts304 established for petitioner's children during the year 1939. Opinion KERN, Judge: The Commissioner relies on Sections 22 (a), 166 and 167 of the Revenue Act of 1936, as authority for including the income from the trusts here involved in petitioner's taxable income. (a) The Children's trusts. These trust instruments were irrevocable and no question therefore arises under section 166. The income from these trusts could not be held or accumulated for future distribution to the grantor, not only by reason of the terms of the instrument itself, but also because of the provisions of the laws of the State of New York. (New York Personal Property Law, Section 16.) Section 167 (a) (1) is not applicable. Section 167 (a) (2) and Section 22 (a) present a different problem, however. So much of the income of each of these trust estates, and of the principal, as was deemed advisable by the trustees, was specifically made available for the education, support and maintenance of the respective beneficiaries, for which petitioner was legally responsible. Petitioner contends that the interests of petitioner's father, grandfather of the beneficiaries, and a co-trustee with petitioner, were substantially305 adverse to the grantor, and have the effect of taking the situation out of the purview of Section 167 (a) (2). He identifies that interest as the contingent legal liability of the grandfather for the support of the children, under the laws of New York. We do not consider this interest of the grandfather sufficiently adverse or substantial to meet the demands of this section. In the case of Mary A. Cushing, 38 B.T.A. 948">38 B.T.A. 948, we held the mother of the grantor not to be possessed of substantial or adverse interests, where her rights were contingent upon her surviving the grantor, or, if destitute, to demand support. The contingent liability of petitioner's father, in this case, for the support of the trust beneficiaries seems equally remote. The fact that none of the income was used for the support and maintenance of the minor beneficiaries, but all of it was, in fact, accumulated for them can not be regarded as important, since the decision of Helvering v. Stuart, 317 U.S. 154">317 U.S. 154. There the net income of each of the four trusts involved was in excess of $9,000 for each of the taxable years. In the case of three of the trusts, 306 none of that income was distributed for any purpose, the children having been supported and maintained entirely by the settlor, their father, from his own funds. In the other trust, relatively small amounts, $1,391.50 in 1934, and $1,882.50 in 1935, were distributed to the beneficiary, but no showing was made as to its use by such beneficiary. The Supreme Court held, as we interpret its decision, that the entire income was taxable to the grantor, and that decision is, of course, binding upon us. We conclude, therefore, that the entire income derived from that portion of the trusts contributed by petitioner is taxable to him. Respondent has conceded error in including in petitioner's income for the taxable years that income derived from the corpus contributed to the trusts by petitioner's father and petitioner's wife. (b) The Parents' Trust. The two theories advanced by respondent to justify his action with respect to the parents' trust are, first, that the interest of the beneficiaries, whose consent was required jointly with the grantor's to effect a revocation of the trust, was not substantially adverse to the grantor, and, second, that the grantor retained such control 307 of the corpus of the trust as to constitute a virtual retention by him of the ownership thereof. The parents of petitioner were the sole beneficiaries of the trust, and the entire income thereof was, by the terms of the indenture, required to be paid to them, annually or oftener, and was, in fact, so paid to them. Petitioner was under no present legal obligation to support his parents, since they were possessed of independent means amply sufficient for their maintenance. See Section 914, Code of Criminal Procedure, N. Y., wherein it is provided: The * * child * * * of a recipient of public relief, or of a person liable to become in need of public relief shall, if of sufficient ability, be responsible for the support of such person. * * * Constructive receipt by petitioner by reason of the satisfaction of his legal obligations, so as to render this income taxable to him under Section 22 (a), or Section 167 (a) (2), can not, therefore, be established. The degree of control which petitioner, as trustee, has in the management and investment of the trust estate, considered in connection with the other circumstances present in this case, does not justify holding him to be the owner308 thereof for tax purposes. Commissioner v. Armour, 125 Fed. (2d) 467. Since it was not within the discretion of petitioner, or any other person whatever, to distribute the income to petitioner, or to hold or accumulate the income thereof for distribution to petitioner, or to do anything with reference to that income except to pay it to the beneficiaries in accordance with the express terms of the trust indenture, and since the grantor owed the beneficiaries no legal obligation of support, Section 167 does not apply. Respondent urgently contends that the beneficiaries of this trust, parents of the grantor, did not have a "substantial adverse interest" in the disposition of the corpus, or the income thereof, within the meaning of Section 166, and that petitioner therefore had power to revest the corpus in himself. None of the cases cited by respondent in support of this contention sustains it. Here the beneficiaries have a vested, present right to receive the entire current income of the trust. A more substantial interest in the income is hard to imagine. And we think the interest is adverse, within the meaning of the statute. The parents here had their309 separate, independent means, and maintained their separate household. That the family relationship was affectionate and close is attested by the very existence of this trust, but there is no evidence whatever that the parents had sacrified their independence of spirit or action. There were, in reality, two separate, distinct economic units. This court has repeatedly and recently held the income beneficiary to have a substantial adverse interest. Robert S. Bradley, 1 T.C. 566">1 T.C. 566; James G. Heaslet, 47 B.T.A. 1006">47 B.T.A. 1006; Meyer Katz, 46 B.T.A. 187">46 B.T.A. 187; Mary W. Pingree, 45 B.T.A. 32">45 B.T.A. 32; Arthur F. Morton, 41 B.T.A. 742">41 B.T.A. 742. The income from the parents' trust is not taxable to petitioner. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621312/	HERBERT J. ZURSTADT, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentZurstadt v. CommissionerDocket No. 11050-85.United States Tax CourtT.C. Memo 1986-502; 1986 Tax Ct. Memo LEXIS 103; 52 T.C.M. (CCH) 745; T.C.M. (RIA) 86502; October 6, 1986. Herbert J. Zurstadt, pro se. Kevin M. Flynn, for the respondent. PANUTHOSMEMORANDUM OPINION PANUTHOS, Special Trial Judge: This case was heard pursuant to section 7456(d) of the Code. 1Resondent determined a deficiency in petitioner's Federal income tax for the taxable year 1982 in the amount of $605. The issues presented for decision are: (1) whether expenses incurred by petitioner in 1982 are deductible under section 162(a) as ordinary and necessary expenses paid or incurred in carrying on a trade or business, and (2) whether Herbert J. Zurstadt (hereinafter petitioner) is entitled to a home office deduction for the business use of his home. At the time the petition in this case was filed, petitioner resided in Orange, Connecticut. Petitioner and his wife, Betty K. Zurstadt, filed a joint Federal income tax return for 1982. 2105 Petitioner is an engineer and has been continually pursuing this profession since 1946. Since 1963, petitioner worked in research and development of "gas-absorbent thermometers". Petitioner worked on the development of the thermometer in his employment with several different companies. Petitioner worked at Dresser Industries (hereinafter Dresser) from 1970 until he was laid off in December of 1981. Petitioner was not employed by Dresser or any other employer during 1982. The only income received or reported by petitioner in 1982 was severance and vacation pay received from Dresser in the amount of $13,129.86. During the year at issue, petitioner sought reemployment with Dresser, as well as new employment with other companies. In addition, petitioner continued his research and development of gas-absorbent thermometers. Petitioner believed that continued work and development on this type of thermometer would enable him to convince a potential employer of its profitability. Petitioner contends that through his sole proprietorship, Thermetics, he was engaged in an engineering consulting business. Petitioner received no income from Thermetics, and because he believed he was still106 in the research and development stage, he did not make any attempt to sell his ideas concerning the gas absorbent thermometer during 1982. On Schedule C of his 1982 income tax return, petitioner reported no gross receipts and claimed the following as business deductions: Automobile expenses34.10Legal services (patent attorney)150.00Office supplies11.96Steno services99.34Home office depreciation1,666.50Home office expenses3 683.75Respondent disallowed the claimed auto expenses, legal fees, office supplies, and steno services as expenses not incurred in an activity engaged in for profit. Respondent disallowed the home office expenses and the home office depreciation based on the determination that the income requirements of section 280A(c)(5) were not met. First we consider whether petitioner is entitled to claimed business expenses (other than the home office). Section 162(a) allows a taxpayer a deduction for the ordinary and necessary expenses paid or incurred during the taxable year in his trade or business. Deductions are, however, 107 a matter of legislative grace. . Petitioner must qualify under the specific rules and regulations imposed by Congress in order to be allowed business expense deductions. . Respondent's notice of deficiency is presumed correct, and petitioner has the burden of proving it is erroneous. ; Rule 142(a).4Petitioner claimed a total of $295.40 in business expenses for 1982. Although petitioner paid these amounts, he has not produced persuasive evidence that these expenses are ordinary and necessary business expenses paid in his trade or business. Petitioner's overall testimony was ambiguous and conclusory with regard to the circumstances surrounding the claimed expenses. During trial, petitioner admitted the automobile expenses were, in fact, part of his itemized job search expenses. 5 Further, petitioner testified that he did not know whether the office supplies expense related to his108 job search or business. Petitioner did assert the legal fee and steno service expenses were incurred by him for his business. Since petitioner has failed to establish these payments were ordinary and necessary business expenses and that his activities constituted a trade or business, we sustain respondent's determination on this issue. Rule 142(a); Next we consider the deductibility of expenses for an office in the home. Section 280A(a) provides that "no deduction * * * shall be allowed with respect to the use of a dwelling unit which is used by the taxpayer * * * as a residence." Petitioner contends that he comes within the terms of the exception provided in section 280A(c)(1)(A) which excludes from the general rule those deductions allocable to a portion of the dwelling unit109 which is exclusively used on a regular basis as the taxpayer's principal place of business for any trade or business of the taxpayer. Petitioner argues that he conducted his engineering consulting business in his home. Based on our finding that petitioner was not engaged in a trade or business and, accordingly, none of the expenditures are ordinary and necessary business expenses under section 162(a), we believe that petitioner would not qualify for a home office deduction under section 280A(c)(1)(A) since that section requires that the taxpayer be engaged in a trade or business. Even if petitioner qualified under the provisions of section 280A(c)(1)(A) he would not be entitled to a home office deduction because of the limitations under section 280A(c)(5) which provides that even if the taxpayer comes within the exception of subsection (c)(1)(A): the deductions allowed * * by reason of being attributed to such use shall not exceed the excess of- (A) the gross income derived from such use * * * over (B) the deductions allocable to such use which are allowable * * * whether or not such [home office] was so used. Petitioner derived no income from his consulting, and research*110 and development. The only income petitioner received during 1982 was vacation and severance pay from his former employer. 6 In view of the foregoing, even if petitioner were considered to be engaged in a trade or business, his home office deduction, including depreciation, would be disallowed in full. Section 280A(c)(5). To reflect the foregoing, Decision will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. The issues here presented are attributable solely to the activities of petitioner, Herbert J. Zurstadt, and Betty K. Zurstadt is not a party to this action.↩3. Petitioner incorrectly claimed his home office expense as an itemized deduction on his return.↩4. Unless otherwise indicated, all rule references are to the Tax Court Rules of Practice and Procedure.↩5. Expenses incurred in either seeking or securing new employment within the taxpayer's established field are deductible. . However, based on the record we are unable to determine whether or not these amounts are a duplication of previously allowed expenses and therefore, are disallowed.↩6. Petitioner's argument that the funds received from Dresser should be taken into account in his sole proprietorship is without merit.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621315/	DON W. MOFFETT AND ALICE M. MOFFETT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMoffett v. CommissionerDocket No. 5026-85United States Tax CourtT.C. Memo 1992-522; 1992 Tax Ct. Memo LEXIS 545; 64 T.C.M. (CCH) 683; September 8, 1992, Filed 545 Held: The period of limitations upon assessment applicable to a partner's distributive share of partnership items is controlled by the filing of the partner's individual income tax return, as extended by any agreements relating thereto. See Siben v. Commissioner, 930 F.2d 1034">930 F.2d 1034 (2d Cir. 1991), affg. T.C. Memo. 1990-435; Stahl v. Commissioner, 96 T.C. 798">96 T.C. 798 (1991). For Petitioners: Declan J. O'Donnell. For Respondent: Randall L. Preheim. WHITAKERWHITAKERMEMORANDUM FINDINGS OF FACT AND OPINION WHITAKER, Judge: This matter is before the Court on petitioners' motion for summary judgment filed pursuant to Rule 121. 1 Respondent determined a deficiency in, and an addition to, Don W. and Alice M. Moffet's (petitioners) Federal income tax for the taxable year, and in the amounts, set forth below: Addition to TaxTax Year EndedDeficiencySec. 6653(a)December 31, 1980$ 4,801$ 240546 A notice of deficiency was mailed to petitioners on December 3, 1984. Petitioners resided in Westlake Village, California, at the time the petition herein was filed. The issue for decision is whether the period of limitations upon assessment applicable to a partner's distributive share of partnership items is controlled by the filing of the partnership's information return, or by the filing of the partner's individual income tax return, as extended by any agreements relating thereto. 2FINDINGS OF FACT Petitioners were validly subscribed members of Agosto Ltd. (Agosto), a limited partnership, for the taxable year ending December 31, 1980. On January 6, 1982, petitioners filed their 1980 individual income tax return. 547 Agosto filed its 1980 partnership information return on January 15, 1982. Consequently, as of December 3, 1984, the period of limitations upon assessment had not expired with respect to petitioners' taxable year 1980, and 3 years had not yet elapsed since the filing of Agosto's 1980 partnership information return. On April 13, 1992, petitioners filed a motion for summary judgment asserting that the period oflimitations upon assessment had expired with respect to their distributive share of losses, deductions, and credits from Agosto prior to the issuance of the notice of deficiency. 3548 OPINION The sole issue for decision is whether the period of limitations upon assessment applicable to a partner's distributive share of partnership items is controlled by the filing of the partnership's information return, or by the filing of the partner's individual income tax return, as extended by any agreements relating thereto. Petitioners contend that the period of limitations is controlled by the filing of the partnership's information return. Conversely, respondent contends that the period of limitations is controlled by the filing of the partner's individual income tax return. Petitioners' 1980 individual income tax return was filed on January 6, 1982, and Agosto's 1980 partnership information return was filed on January 15, 1982. A notice of deficiency was mailed to petitioners on December 3, 1984. As of December 3, 1984, less than 3 years had elapsed since the filing of petitioners' and Agosto's 1980 returns. Consequently, pursuant to section 6501(a), petitioners' motion for summary judgment is without merit as a matter of law regardless of whether the period of limitations is controlled by the filing of Agosto's partnership information return or by the filing *549 of petitioners' individual income tax return. 4In accordance with section 6501(a), petitioner's motion for summary judgment will be denied. An appropriate order will be issued. Footnotes1. Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code of 1954 in effect for the year in issue.↩2. The taxable year at issue antedates the enactment of secs. 6221-6233 which provide that the tax treatment of partnership income, loss, deductions, and credits is to be determined at the partnership level in a unified partnership proceeding for partnership taxable years beginning after Sept. 3, 1982.↩3. On Apr. 15, 1992, petitioners filed an amended petition wherein it was represented that "the parties have settled all issues on the merits of the case in a proposed Stipulation, subject to a determination of jurisdiction as requested herein." Similarly, in the motion for summary judgment, petitioners represent that "no trial on the merits is expected because the parties have executed a Stipulation, subject to jurisdiction." In the notice of objection to motion for summary judgment, however, respondent asserts that neither a stipulation of settled issues nor a closing agreement has been executed by the parties. Consequently, petitioners' motion for summary judgment is properly viewed as a motion for partial summary judgment. See Rule 121(c).↩4. In , we held that the filing of a partnership information return does not affect the period of limitations upon assessment applicable to the determination of a deficiency against individual partners of a partnership. See also , affg. ; , affg. on this issue .↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621318/	Big Four Industries, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentBig Four Industries, Inc. v. CommissionerDocket No. 94780United States Tax Court40 T.C. 1055; 1963 U.S. Tax Ct. LEXIS 45; September 30, 1963, Filed 45 Decision will be entered under Rule 50. Award received in patent infringement litigation held to include, in addition to compensation for lost profits which is conceded to be taxable as ordinary income, (a) reimbursement for litigation expenses, which is taxable as ordinary income, and (b) compensation for injury to capital structure and goodwill which is taxable as capital gain to the extent that such compensation exceeds basis. John J. Kelley, Jr., for the petitioner.Henry T. Nicholas, for the respondent. Raum, Judge. RAUM1055 OPINIONRespondent determined a deficiency in the income tax of petitioner in the amount of $ 168,424.36 for the calendar year 1959. All of the facts have been stipulated.The sole issue is whether the respondent erred in determining that the entire amount of damages received by petitioner in a patent infringement46 suit was taxable as ordinary income.Petitioner, an Ohio corporation with principal office in Mainville, Ohio, is engaged primarily in the business of manufacturing and selling tire-changing equipment. It is on an accrual basis and filed its Federal income tax return for 1959 with the district director of internal revenue, Cincinnati, Ohio.On August 17, 1951, petitioner and Robert D. Henderson entered into an agreement whereby petitioner was given the exclusive right to manufacture, lease, and sell certain tire mounting and dismounting devices to which Henderson held letters patent or applications for letters patent. The agreement further provided that the parties would share equally the proceeds of any award received as a result of an infringement of the patents and share equally any expenses incurred in any suit for patent infringement.On October 17, 1952, petitioner and Henderson were sued for patent infringement by Coats, Loaders & Stackers, Inc. (hereinafter referred to as Coats), in the U.S. District Court for the Southern District of Ohio, Western Division. Coats was then engaged in the manufacture and sale of mechanical tire removers similar to those being manufactured47 by petitioner.1056 On November 10, 1952, petitioner and Henderson filed an answer and counterclaim, in which they denied any patent infringement and alleged that Henderson was the owner of a certain patent for "Axially Compressing Type Tire Dismounting Apparatus," that petitioner was the exclusive licensee under that patent, that Coats in infringement of this patent had offered for sale and sold tire-dismounting apparatus, and that, after being notified of the infringement, Coats failed and refused to discontinue it to the great damage of petitioner and Henderson. Their prayer for relief read as follows:WHEREFORE, defendants pray for preliminary and final injunctions against further infringement by plaintiff, for damages and/or reasonable royalty for plaintiff's manufacture and sale of tire dismounting apparatus in infringement of the aforesaid patent, for an assessment of costs and interest against plaintiff, for defendants' attorneys' fees, and for such other and further relief as the Court may consider proper in the premises.On November 17, 1954, the District Court dismissed the complaint of Coats and sustained the counterclaim of petitioner and Henderson. Its interlocutory48 decree entered on that date provided, in part, as follows:(6) That the Defendants, Robert D. Henderson and Big Four Industries, Inc. recover from the Plaintiff damages adequate to compensate them for the infringement of the aforesaid Letters Patent, but in no event less than a reasonable royalty for the use made of the invention by the infringer together with interest and costs.(7) That the aforesaid accounting for damages shall be in accordance with the further orders of this court.On May 17, 1956, the U.S. Court of Appeals for the Sixth Circuit affirmed the decision of the District Court, 233 F. 2d 915, and, after denying a motion for rehearing, issued its mandate on June 28, 1956.On October 19, 1956, the District Court appointed Stanley A. Hittner as master commissioner in chancery to receive evidence and other testimony for the purpose of arriving at damages adequate to compensate petitioner for the injury caused by the infringement.In the hearings before the master petitioner asserted that the net income of Coats derived as a result of the infringement in the amount of $ 1,715,397.07 should be the measure of damages for the infringement. Coats49 contended that the measure of damages should be limited to a reasonable royalty, stated to be in the amount of $ 112,930.05. The master in his report filed October 24, 1958, noted that petitioner's operation was not as efficient as Coats', and recommended compensatory damages be awarded in the amount of $ 876,107, based on the loss of profits of petitioner as a result of the infringement.In his report the master stated that petitioner and Henderson requested that the damages be trebled on account of deliberate and willful infringement by Coats, and he noted therein certain acts of willfulness on the part of Coats which could form the basis for increased 1057 compensatory damages, or punitive damages. They included three "feeble" attempts by Coats to change the design of the infringing unit so as to circumvent the inventive principle set forth in the Henderson patent, continued manufacture and sale of the infringing unit after being notified by Henderson that the changes did not overcome Henderson's claims to priority, and the adoption of a plan of action to give the trade the impression that Coats was the owner of the patent and that petitioner and Henderson were wrongdoers. 50 The report contained the following statement with respect to punitive damages:The assertion of punitive damages is a matter entirely at the discretion of Your Honor as provided for by U.S. Code Title 35 section 284 -- subsections #33 and #49.I recommend that in this regard you give consideration to attorney fees and court costs.The District Court on December 29, 1958, filed its "Findings of Fact and Conclusions of Law in Accounting Matter" which provided, in part, as follows:5. Plaintiffs have raised certain objections to the Master's report to which the Court has given full and thorough consideration and in the light of Section 284, Title 35 U.S.C., which gives the Court the right to increase damages up to three times the amount found or assessed, the Court, in order to arrive at an equitable solution and to avoid penalizing plaintiffs, but in an effort to compensate defendant in some measure for damages to the corporate capital structure of Big Four Industries, Inc., and to likewise compensate defendant, in some measure for damages to good will of Big Four Industries, Inc., determines that defendants are entitled to an overall total judgment in the sum of $ 1,200,000.00. The51 increase in the award shall not be considered in any way as punitive damages.6. In all respects the Court adopts and approves the findings of the Master, which findings are based in their entirety upon facts and not upon assumptions or conjectures.7. The Court approves and adopts the findings of the Master Commissioner, and based thereon finds that the plaintiffs are entitled to recover the sum of $ 1,200,000.00 which includes in said total sum the following:(a) The fee of Stanley A. Hittner as Master Commissioner Thirty Thousand ($ 30,000.00) Dollars which defendants shall pay to said master.(b) Attorneys fees in the sum of One Hundred and Fifty Thousand ($ 150,000.00) Dollars.(c) Defendants expenditures as accountants fees in the sum of Seven Thousand Five Hundred ($ 7,500.00) Dollars.(d) All amounts due or paid to Robert Crawford by Defendants as court reporter.(e) All costs and every other claim of every kind and description which might be due defendants and which is in any way pertinent to this accounting proceeding.(f) The above includes interest to date, and no interest shall be assessed up to March 1, 1959.8. Although the Court has otherwise approved and adopted the52 Report of the Master Commissioner filed herein on October 24, 1958, the Court specifically 1058 rejects all observations and inferences of the Master regarding the conduct of plaintiffs' patent counsel, Mr. Rudolph Lowell, contained on pages 21-27 in Section B entitled "Regarding Willfulness"; and the Court finds that none of the activities of plaintiffs' counsel, Rudolph Lowell, was willful or done in bad faith.9. This is an exceptional case within the meaning of 35 U.S.C. 295, and the Court finds that an award in the amount of $ 150,000.00 toward the attorney fees of the attorneys for defendants is reasonable and proper.10. The reasonable value of the services performed by the Master herein is $ 30,000.00.The District Court on December 29, 1958, filed its final judgment which provided, in part, as follows:IT IS HEREBY ORDERED, ADJUDGED AND DECREED as follows:1. That the defendants, Robert D. Henderson and Big Four Industries, Inc., recover from the plaintiffs as damages the total sum of One Million Two Hundred Thousand ($ 1,200,000.00) Dollars which includes in said total sum the payment of the following items:(a) The fee of Stanley53 A. Hittner as Master Commissioner Thirty Thousand ($ 30,000.00) Dollars which defendants shall pay to said master.(b) Attorneys fees in the sum of One Hundred and Fifty Thousand ($ 150,000.00) Dollars.(c) Defendants expenditures as accountants fees in the sum of Seven Thousand Five Hundred ($ 7,500.00) Dollars.(d) All amounts due or paid to Robert Crawford by Defendants as court reporter.(e) All costs and every other claim of every kind and description which might be due defendants and which is in any way pertinent to this accounting proceeding.(f) The above includes interest to date, and no interest shall be assessed up to March 1, 1959.One of the parties in the action noted an appeal and the other filed a motion for rehearing, both of which actions were dismissed in 1959.Pursuant to their agreement, petitioner paid Henderson one-half of the $ 1,200,000 award, or $ 600,000. Petitioner and Henderson split the costs of the infringement action.Petitioner's one-half share of the court reporter's fees amounted to $ 3,912.30.Petitioner's one-half share of the expenses of the infringement action which included attorneys' fees, master's fees, accountants' fees, and court reporter's54 fees were deducted by petitioner in arriving at income. Of the total expenses incurred by petitioner, the following amounts were accrued as expenses in the year 1959:Wood, Herron and Evans -- Attorneys' fees$ 41,672.70J. Warren Kinney -- Attorneys' fees31,937.50Stanley A. Hittner -- Master commissioner15,000.00C. J. Keller & Co. -- Accountants' fees1,380.00Total89,990.201059 The award of $ 1,200,000 was reflected on an attachment to petitioner's 1959 income tax return as follows:Amount of judgment$ 1,200,000Big Four Industries, Inc. -- Share 1/2600,000Less: Punitive damages -- not taxable 323,893Taxable compensatory damages shown as a part of line 9 --page 1 -- Other income276,107Immediately prior to and during the years covering the patent infringement involved in this case, petitioner did55 not carry goodwill on its books and records with any cost basis.No damage resulted to any physical assets of petitioner as a result of the patent infringement.Respondent in his notice of deficiency determined that petitioner's one-half share of the $ 1,200,000 award represented ordinary income in the following language:It has been determined that, under the provisions of Section 61 of the Internal Revenue Code of 1954, you realized ordinary income for damages on a patent infringement in the amount of $ 600,000.00 instead of the $ 276,107.00 as reported by you on your return.Petitioner treated $ 323,893 of the $ 1,200,000 award as an amount awarded it by the District Court for damage done to its corporate capital structure and goodwill. It placed that amount in a reserve account entitled "Reserve for Loss of Good Will and Damage" and did not report it as income in its return for 1959.The parties are in agreement that $ 876,107 of the $ 1,200,000 awarded by the District Court represented damages for lost profits and therefore constitutes taxable income. They disagree as to the proper classification of the remaining $ 323,893; the Commissioner contends that this amount was also56 for lost profits or was otherwise taxable as ordinary income, whereas the petitioner argues that it was awarded for damages to its corporate capital structure and goodwill and represented a nontaxable replacement of capital. We hold that both parties are partly in error, and that the facts of record require a more refined treatment of the remaining $ 323,893.First, it is clear from the District Court's decree that the award was intended to include the master's fee, attorneys' fees, accountants' fees, court reporter's fees, and all other costs pertaining to the proceeding. 1060 The total of all such fees was $ 195,324.60. 1 The record also shows that petitioner deducted its share of the various fees and costs on its income tax returns. Plainly, the reimbursement of such fees constituted the receipt of ordinary income. Cf. Nicholas W. Mathey, 10 T.C. 1099">10 T.C. 1099, 1102, 1105, affirmed 177 F. 2d 259 (C.A. 1), certiorari denied 339 U.S. 943">339 U.S. 943; Sager Glove Corporation, 36 T.C. 1173">36 T.C. 1173, 1179, affirmed 311 F. 2d 210 (C.A. 7).57 Second, the District Court's findings explicitly state that the $ 1,200,000 award was intended in part to provide compensation "in some measure for damages to corporate capital structure of Big Four Industries, Inc., and to likewise compensate defendant, in some measure, for damages to good will of Big Four Industries, Inc." On this record, we could hardly conclude that the $ 128,568.40 remaining portion of the $ 1,200,000 award (after subtracting $ 876,107 lost profits and $ 195,324.60 fees), represented anything other than compensation for damages to capital structure and goodwill. To be sure, as argued by the Commissioner, petitioner nowhere specifically asked for such damages in its pleadings. But it did pray "for such other and further relief as the Court may consider proper in the premises," and we are satisfied that the District Court did intend to grant such relief. We cannot ignore the explicit language that it used. 258 However, having concluded that the $ 128,568.40 component of the award represents damages to petitioner's capital structure and goodwill, that is not the end of the matter. To the extent that such amount did not exceed the basis of the capital interest or goodwill destroyed it would be nontaxable, but it would be taxable as capital gain to the extent of any excess over basis. Sager Glove Corporation, 36 T.C. 1173">36 T.C. 1173, 1180, affirmed 311 F. 2d 210 (C.A. 7); Ralph Freeman, 33 T.C. 323">33 T.C. 323, 327; Raytheon Production Corp. v. Commissioner, 144 F. 2d 110, 114 (C.A. 1), certiorari denied 323 U.S. 779">323 U.S. 779, affirming 1 T.C. 952">1 T.C. 952; Durkee v. Commissioner, 184">162 F. 2d 184, 187 (C.A. 6), reversing 6 T.C. 773">6 T.C. 773; Telefilm, Inc., 21 T.C. 688">21 T.C. 688, 694-695. The report of the master shows that there was considerable damage to petitioner's goodwill. The parties have stipulated that no damage resulted to any physical assets of petitioner as a result of 59 the infringement and that it had no cost basis for goodwill. In the circumstances, all of the $ 128,568.40 is taxable as capital gain.1061 In order to give effect to the reclassification of the components of the award in accordance with the foregoing conclusions,Decision will be entered under Rule 50. Footnotes. ↩Total amount of judgment rendered by Hon. Judge John H. Druffel1,200,000Less: Compensatory damages recommended by Stanley A. Hittner, mastercommissioner in chancery, in report dated Oct. 24, 1958876,107Punitive damages -- Loss of goodwill and damage to capitalstructure323,8931. The components were as follows:↩Attorneys' fees$ 150,000.00Master's fee30,000.00Accountants' fees7,500.00Court reporter's fees7,824.60Total195,324.602. In this crucial respect this case differs from Nicholas W. Mathey, 10 T.C. 1099">10 T.C. 1099, affirmed 177 F. 2d 259 (C.A. 1), certiorari denied 339 U.S. 943">339 U.S. 943, upon which the Commissioner relies.Nor, in view of the last sentence in paragraph 5 of the Findings of the District Court herein, supra, p. 1057, can any portion of the award be regarded as punitive damages, which would be taxable income. Cf. Commissioner v. Glenshaw Glass Co., 348 U.S. 426">348 U.S. 426↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621320/	MASCOT STOVE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Mascot Stove Co. v. CommissionerDocket No. 91265.United States Board of Tax Appeals40 B.T.A. 1057; 1939 BTA LEXIS 760; December 7, 1939, Promulgated 760 A corporation was adjudged an involuntary bankrupt. Its assets, at bankruptcy sales, were conveyed subject to encumbrances, to trustees for a corporation to be formed and representing a large portion, but not all, of the stockholders of the old company, who from date of adjudication considered a plan of reorganization. Held, that there was no reorganization of the old company; held,further, that the new company through its agents or trustees was the purchaser at bankruptcy sale and the basis to it of the assets acquired was the price paid at such sale, but that even if the agreeing stockholders and not the corporation were the purchasers at bankruptcy sale, the stock of the new company was received by them in substantially the same proportion as their ownership of the assets exchanged, and the basis is the price paid at bankruptcy sale. Robert A. Littleton, Esq., for the petitioner. L. W. Creason, Esq., and A. H. Monacelli, Esq., for the respondent. DISNEY1057 OPINION. DISNEY: This proceeding involves income tax liability for the fiscal year ended June 30, 1934. The deficiency determined by the Commissioner is $3,197.22. 761 The Mascot Stove Manufacturing Co. (hereinafter called the old company) was adjudicated a bankrupt on June 20, 1933. Its real estate, situated in Hamilton County, Tennessee, and its machinery, tools, and other equipment located on its premises and fully described in an inventory filed with the trustee in bankruptcy, together with the good will of the old company, were encumbered by a mortgage to Adolph S. Ochs, which mortgage, with interest and taxes, amounted to in excess of $30,000; and the property covered by the mortgage was appraised in the bankruptcy proceedings for less than the amount of the mortgage. 1058 On July 3, 1933, the trustee in bankruptcy received an offer from one Luke O. Morin, as trustee for himself and a corporation to be organized, to pay $50 for a conveyance of the property mortgaged to Ochs, subject to the mortgage and existing liens. As the trustee, under the circumstances, had been preparing to disclaim interest in the property, the offer was accepted, and deed of conveyance was by the court ordered made upon payment of the $50. On July 7, 1933, Alvin Ziegler, trustee, made an offer to pay $7,500 for the old company's assets, not covered762 by the mortgage, consisting in the main of an inventory of castings, stove parts, stoves, materials, and an equity in accounts receivable, which were subject to a lien of $11,297.26 to a finance company and which equity was appraised at $2,351.75. The remainder of the assets purchased by Ziegler was appraised at $9,280.50. Ziegler's offer was accepted. The order of the court confirming the sale to him directed the purchaser to pay to the trustee in bankruptcy the sum of $2,500 and execute for the balance three notes, each for the sum of $1,000, and one note for $2,000, all payable to the trustee, respectively, in 30, 60, 90, and 120 days after date. The order further provided: "The title to the assets herein sold shall remain vested in the trustee in bankruptcy until the balance of the purchase price is paid. * * Upon the payment of said notes evidencing the payment of the purchase price, the trustee will execute a bill of sale transferring and conveying the property herein described to the purchaser." Alvin Ziegler, trustee, in purchasing the inventories, accounts receivable, etc., assets of the old company, acted for himself and for most, but not all, of the stockholders763 of the old company and a corporation to be formed. In the transaction, Ziegler represented the following named persons, who held stock in the old company in the amounts set opposite their names: SharesShares heldJohn O. Fowler, 208 shares of the preferred stock, being all of the preferred and 369 shares of the common577Mary E. Fowler75Lena S. Fowler89Ben W. Fowler, deceased, Frank E. Fowler, administrator75John O. Fowler, Jr9987Frank E. fowler150Richard C. Fowler9James Sterchi Fowler3W. R. Samuels, 200 shares issued in the name of Alvin Ziegler, trustee, and 272 issued in the name of Agnes O'Connell, maiden name of wife of Samuels, but all considered and treated as Samuels' stock.472O. T. Tindell, Jr., 340 shares issued in name of O. T. Tindell, Sr.; 60 shares issued in the name of Nell Hall (maiden name of O. T. Tindell, Jr.'s wife); 30 shares issued in the name of Nell Hall Tindell (wife of O. T. Tindell, Jr.) and 827 shares in the name of O. T. Tindell, Jr., all treated as the stock of O. T. Tindell, Jr.1,257Alvin Ziegler67W. J. Lammers20George L. Dover15A. R. Hudson258Total3,076764 1059 The entire stock, preferred and common, of the old company, was approximately 3,800 shares. The exact number of shares is not shown by the record. On July 7, 1933, application for a charter was made to the State of Tennessee, and on July 8, 1933, it was issued to the petitioner herein, the Mascot Stove Co. (hereinafter called the new company). The incorporators were R. B. Cooke (Ochs' attorney), Alvin Ziegler (a lawyer), and L. D. Hill, a stenographer in Ziegler's office. The maximum number of shares of stock the company was authorized to have outstanding at any time was 5,500, of which 500 shares were to be preferred stock, having a par value of $100 per share, or an aggregate authorized preferred stock of $50,000, and 5,000 shares were to be common stock without any par value. The first meeting of the incorporators of the new company was held on July 14, 1933, at the office of R. B. Cooke, the following persons, incorporators, being present: R. B. Cooke, Alvin Ziegler, and L. D. Hill - Cooke serving as chairman and Ziegler as secretary. The charter of the new company was presented and accepted, and the following action was taken, as shown by the minutes: 765 On motion duly made, seconded and carried it was ordered that the books of the company be opened for subscription to preferred stock, and the following subscribers for such preferred stock were announced: NAMENO. SHARESPAR VALUETOTALAlvin Ziegler10$100.00$1,000.00Alvin Ziegler, Trustee25100.002,500.00Alvin Ziegler Trustee25100.002,500.00Alvin Ziegler reported that in his own name as trustee he had purchased the finished goods, accounts receivable, both pledged and unpledged of the old Mascot Stove Manufacturing Company by an order which had been entered in the Bankruptcy Court for the sum of $7,500, $2,500.00 cash and the remainder represented by four notes, the first three for $1,000.00 each and the 4th note for $2,000.00, maturing 1, 2, 3 and 4 months after date respectively. Mr. Ziegler also reported to the meeting that the plant of the Mascot Stove Manufacturing Company, consisting of land, buildings, machinery, equipment 1060 and patterns, was covered by a mortgage owned and held by Mr. Adolph S. Ochs; that an associate, Luke O. Morin, held a conveyance of this property from the trustee in bankruptcy; that Adolph766 S. Ochs had foreclosed on the mortgage, but on account of the identity of the individuals whom he (Ziegler) represented and who are organizing the Mascot Stove Co., he is willing for the new company to take over the plant upon execution of a new mortgage to him and payment of the accrued taxes and other expenses. Mr. Ziegler then offered to transfer to the new company the assets acquired from the trustee in bankruptcy and the privilege of acquiring the plant, upon the following terms: Payment of$7,500.00To be paid $2,500.00 in cash and notes to himself to correspond to the notes which he had executed to the trustee in bankruptcy.Taking the Accounts Receivable subject to the claim of the Manufacturers Finance Corporation for11,297.26Assuming and paying expenses of532.00Assuming and paying accrued taxes of2,090.13Executing To Adolph S. Ochs a mortgage, secured by the plant, for33,000.00Issuance to his order of 5,000 shares of no par common stock, having a stated value on the books of the Mascot Stove Company of70,124.00On motion duly made, seconded and carried, it was ordered that the above offer be accepted and that the officers of the company767 be authorized and instructed to do the things necessary to complete the transaction and acquire the property. The incorporators then tendered their resignations as members of the board of directors to become effective when a meeting of stockholders was held, and a new board was elected. Upon motion duly made, seconded and carried, it was ordered that said meeting be adjourned. Twenty-five shares of preferred stock subscribed for by Alvin Zielger, trustee, as above indicated were for W. R. Samuels and the other 25 preferred shares similarly subscribed were for John O. Fowler. The preferred stock was paid for in cash, $6,000. Immediately after the meeting of the incorporators, on July 14, 1933, the first meeting of stockholders was held. There were present Alvin Ziegler, individually and as trustee, and O. T. Tindell, Jr., and O. T. Tindell, Sr., by proxy. The only business transacted was adoption of bylaws and election of L. O. Morin, A. R. Hudson, O. T. Tindell, Jr., George Dover, and Alvin Ziegler as directors. The board of directors of the new company, on July 14, 1933, elected the following officers: L. O. Morin (who had been president of the old company) was elected768 president of the new company; A. R. Hudson was elected vice president, O. T. Tindell, Jr., treasurer and general manager, and Alvin Ziegler, secretary. The interest of each person in the property acquired by Alvin Ziegler, trustee, at the bankruptcy sale was in the same ratio that the number of shares held by each in the old company bore to the total number of shares in the old company represented by the group, and the amount of stock in the new corporation which each was 1061 entitled to receive and did receive, was in substantially the same proportion as his ownership of the assets exchanged for stock, although the stock certificates issued at a later date were not in the same proportion. The transferors were in control of the new corporation immediately after the exchange. The new company, by transfer through Alvin Ziegler, trustee, acquired the inventoried assets and accounts receivable of the old company, and the assets that were covered by the mortgage to Ochs were deeded by Ochs to the new company and it executed back to Ochs a mortgage for $33,000, paid the expenses incident to the transaction, amounting to $532, and paid the accrued taxes, amounting to $2,019.13. 769 The real estate, machinery, tools, and equipment and the patterns that had been used in manufacturing the inventoried parts and finished goods and included in the sale under the mortgage to Ochs, and the conveyance to Luke O. Morin by the trustee in bankruptcy were included in the transfer by Alvin Ziegler, trustee, to the new company, Ziegler having acquired the right to deal therewith, though the record does not otherwise show a conveyance to Ziegler of the rights of Luke O. Morin. The new company paid Alvin Ziegler, trustee, for the assets that he transferred to it, $2,500 in cash and executed to him $5,000 in four notes and issued to him and stockholders whom he represented 5,000 shares of no par common stock. The four notes were in the same amounts and due on the same dates as the notes which Ziegler himself had originally executed to the trustee in bankruptcy for said assets. All four notes were paid by the new company. The $2,500 paid by Ziegler, trustee, on the purchase of the assets, was supplied by W. R. Samuels and 25 shares of the preferred stock of the new company of the par value of $100 a share was issued to Alvin Ziegler, trustee, for W. R. Samuels, as hereinabove770 set forth. From the time the old company was adjudicated a bankrupt down to and including the acquisition by the new company of the real estate, equipment, inventories, and accounts receivable of the old company, Ziegler, trustee, Morin, and their associates contemplated the organization of another corporation and acquiring for it the assets of the old company and carrying on the same character of business. On September 18, 1933, the entire common stock of the new company was issued to or for the hereinafter named individuals whom Alvin Ziegler, trustee, represented in the purchase from the trustee in bankruptcy of the old company's assets, which were to be and were turned over to the new company. In the division of the stock of the new company no distinction was made as between the preferred and common stock held by John O. Fowler in the old company. 1062 The common stock of the new company was divided and issued as follows: SharesO. T. Tindell, Jr1,000Alvin Ziegler1,000John O. Fowler1,200Mrs. Mary E. Fowler75Ben W. Fowler (Frank E. Fowler, administrator)75Frank E. Fowler150,A. R. Hudson150W. J. Lammers70T. B. Hannah15Irma K. Dover65W. R. Samuels1,200Total5,000771 The face amount of good accounts receivable acquired by the new company is shown to have been $11,311.66 (book figures $22,608.92 less $11,297.26 sold to finance company to discharge mortgage thereon). Of the $7,500 paid the trustee in bankruptcy, the respondent determined $2,148 thereof was for the accounts receivable. The respondent determined that during the fiscal year ended June 30, 1934, there remained a realizable profit in the amount of $9,163.66 of accounts receivable when collected, that at the end of the fiscal year ended June 30, 1934, there remained uncollected $1,747.48, making the profit realized during the taxable year ended June 30, 1934, $7,416.18. Respondent adjusted inventories and reduced the opening inventory at the beginning of the taxable year from $28,184.34 (as per taxpayer's books) to $5,352 (portion of the $7,500 purchase price allocated to inventories). The closing inventory at the end of the taxable year (June 30, 1934) was, by respondent, reduced from $30,426.24 to $21,393.30, predicated upon the fact shown by the record that about 40 percent of the opening inventory was on hand at the close of the taxable year, 60 percent thereof having been772 disposed of. Realizable profit on all inventories was determined by the respondent to be $22,832.34, being the amount of the opening inventory, $28,184.34, less $5,352 purchase price, 60 percent thereof, or $13,699.40, being the profit realized from said inventories during the taxable year. The first question herein presented for determination is as to what is the proper base to be used in calculating profit or loss to petitioner during the taxable year from certain of the assets acquired as above set forth by petitioner. Profit was determined by respondent (a) by adjustment in petitioner's inventory of assets because of sales during the taxable year, and (b) because of profit in collection of certain accounts receivable during the taxable year. Respondent contends that the base to be applied in computing profit or loss is the price paid for the assets at the bankruptcy sale, on the theory that Ziegler, trustee, 1063 the buyer, was agent or trustee for the petitioner corporation, or, if not, that he and those represented by him were in control of the petitioner corporation immediately after the exchange of property for stock of the corporation, and received stock substantially773 in proportion to their interests in the assets exchanged, under the provision of section 112(b)(5), Revenue Act of 1932, and that therefore under section 113(a)(8)(A) the base is the same as that of the transferors, and therefore the price paid at the bankruptcy sale by Ziegler, trustee; whereas petitioner contends that the base is the fair market value at time of acquisition on July 14, 1934, contending in effect that Ziegler and those for whom he was trustee acted individually, not as agents or trustees for the new corporation, and, though admitting that the transferors of the assets to the petitioner in exchange for stock were in control of the company immediately after the exchange, affirming that the statutes relied upon by respondent do not apply because the amount of petitioner's stock received by the transferors was not substantially in proportion to the interest of each transferor in the assets exchanged for stock. We hold that there was no reorganization. There was no continuity of interest between the old company and the new, no exchange of stock or securities for stock or securities, under section 112(b)(3) of the Revenue Act of 1932, the only section relied upon to774 prevent recognition of gain or loss on the exchange, and the old company did not pursue a plan of reorganization, the only plan being that of about three-fourths of the stockholders, acting not as such but as individuals, there being no corporate action. There was no representation of the old company by creditors or bondholders as in . A mere purchase of assets at bankruptcy sale does not demonstrate reorganization. ; ; affd., ; . Upon brief petitioner asserts that respondent, in contending that petitioner was the purchaser at the bankruptcy sale, has varied from the deficiency notice, without affirmative pleading. We think the respondent's present position is within the purview of the determination of deficiency. No increase of amount of deficiency is sought. Examination of the record herein indicates, we think, that the petitioner corporation was, as contended by respondent, the purchaser at bankruptcy775 sale and takes as basis the price then paid for the assets in question. That a new corporation was contemplated at all times after the adjudication can not successfully be denied in the face of the fact that Luke O. Morin, in purchasing the equity of the bankrupt estate in the other assets of the old company, that is, the real estate, machinery, equipment, stove patterns, etc., covered by the Ochs mortgage, purchased "as trustee for a new corporation to be organized." 1064 This expression occurs three times in the record of that sale. In fact, title to the same property acquired by Morin later passed directly to the new corporation, when Ochs conveyed same. Morin was an associate of Alvin Ziegler, who purchased the assets here involved, that is the inventory (of stoves, parts, etc.) and accounts receivable. That they were cooperating can not be overlooked. Though Ziegler as trustee purchased the last named assets, the title could not pass, under the order of the bankruptcy proceeding, until the last note, due in 120 days, was paid. By that time, of course, the new corporation had long been formed. Though the record is silent as to whether title then passed directly from776 the trustee in bankruptcy to the new corporation, title could not have passed to it from Ziegler at the date of the exchange on July 14, because at that time, prior to payment of the notes, Ziegler had no title to convey. Though in a sense Ziegler did represent in the purchase at bankruptcy sale a part of the former stockholders, we think he represented them as trustee in an agreement to form the new corporation, in the same position in that respect as was Morin for the other assets. Tindel was "working up the corporation * * * working the deal through * * * trying to continue the business." Ziegler was his attorney. The new corporation stepped into the shoes of the trustee, Ziegler, made notes in the same amounts and payable at the same times as had Ziegler to the trustee in bankruptcy. Though there was testimony that propositions other than incorporation were mentioned, the fact is that on the day of Ziegler's purchase, July 7, application for the corporate charter for petitioner was applied for, and charter was issued the next day and the first meeting held less than a week later. It is obvious that the parties intended to, and did, proceed at once with a new corporation. We777 believe that the old stockholders who entered into the block represented by Ziegler as trustee had a right to the formation of the new corporation to hold the property, that Ziegler as trustee was under that duty, and that when the whole sequence of events is considered he must be considered as purchasing as trustee for the new corporation; and that therefore the basis to the petitioner is the price paid at the bankruptcy sale. This conclusion is sustained by the petition, which recites that a part of the old stockholders "entered into a plan or arrangement between themselves, the trustee in bankruptcy and the secured creditors * * to perfect a reorganization, by organizing a new corporation * * * in the name of the Mascot Stove Company to acquire the assets of the Mascot Stove Manufacturing Company by the payment of $7,500 in cash * * ," etc. Though this did not result in reorganization, it does outline the plan which was consummated. This conclusion is supported too by O. T. Tindell's testimony that the new corporation was "formed to take over that 1065 property," and, referring to the plant of the old company (sold under mortgage to Ochs, "Mr. Ziegler acquired the778 right to transfer this property into a new company for the purpose of going ahead with the stove business." (Emphasis supplied.) We hold that the purchase at the bankruptcy sale by Ziegler, trustee, was for and by the petitioner through trustee. That the price at such sale was a low or bargain price, because the inventory of stoves and parts had small value, unless acquired by one owning the patterns, is immaterial; that price represented cost to the petitioner. However, even if we were incorrect in the above conclusion, the same basis was properly applied by the respondent for there was, in our opinion, the substantial equivalence between ownership of assets prior to exchange and stock in petition after the exchange as required by section 112(b)(5) of the Revenue Act of 1934. The petitioner relies upon the fact that the stock certificates in petitioner corporation, when issued to the transferors of assets, were not in substantially the same proportion as they had owned the assets. The stock certificates were issued September 18, 1933, as to the entire 5,000 shares, whereas the exchange was, under petitioner's own theory, effected on July 14, 1933. Issuance of certificates779 in certain amounts on September 18 does not, of itself, determine ownership of the stock on July 14. It has been held that the control which affects the question of computation of gain or loss on base, must be "immediately after the exchange." ; ; ; sec. 112(b)(5), Revenue Act of 1932. Obviously, the same thought applies to the ownership of stock in proportion to previous ownership of stock transferred, for the base involved in the exchange is determined by the situation at the time of exchange. Later acts, such as transfer of stock owned at time of exchange, can not affect the base. But ownership of stock is not dependent upon possession of certificates therefor. ;; , citing , and 780 . Petitioner, therefore, has not met its burden of proof merely by showing that the certificates issued September 18, 1933, were out of proportion with the ownership of assets prior to July 14, 1933. The record contains no evidence that the actual ownership of stock immediately after the exchange was the same as represented by the stock certificates at a later date. Indeed, the stock book, showing the 5,000 shares issued September 18, had to be explained and was explained, for in a number of instances the stock was issued in one name when the stock was owned by another. Regardless, however, of the burden, we think it 1066 plain that the evidence of the petitioner shows that, at the time of the exchange, title to the stock was received in proportion to previous ownership of assets; O. T. Tindell, Jr., prominent officer in both corporations, in explaining the stock certificates received by him, testified: A After we undertook to divide the new stock based on our holdings, Mr. A After we undertook to divide the new stock based on our holdings, Mr. Samuels wanted more stock on account of having advanced781 the money and Mr. Fowler insisted that the stock be divided according to the original agreement, and that I get as much stock anyway as I had in the old one, and that is the reason that the 200 shares were issued in my name and endorsed by me to Mr. Ziegler, because I was interested in getting the business going, primarily, but, as a matter of fact, I would have taken less stock than I did, as I was not putting any money into it. Q You were not putting any money into it? A No, sir, outside of - I put my equity in the accounts receivable and the merchandise purchased out of the Bankrupt Court. We think it is beyond question from this language that an attempt was made to divide the new stock "based on our holdings", which can reasonably only mean on the basis of holdings in the assets conveyed, that there then arose a desire on the part of some for a disproportionate amount of stock, particularly a desire by Ziegler for more stock because of his activities and by Samuels because of his advancement of money, whereas Fowler "insisted that the stock be divided according to the original agreement." This, too, plainly indicates that the original agreement for division of stock was782 for division in accordance with the holdings, or if not that, means that there was some agreement for division of the stock different from the manner or proportion in which the stock was finally divided. Witness Tindell merely "put my equity in the accounts receivable and the merchandise purchased" into the matter. We think this strong indication that such was the basis upon which the other owners of the assets were entitled to stock. Tindell testified further, discussing the question as to whom Ziegler represented: "I told all smaller stockholders that they would come in on the same basis as the larger ones, their equity in the property." Again he stated, as to stock, "I took less than what I was supposed to get." He testified also, "I was the man who was working up the corporation; I was handling it for myself and the rest of the former stockholders and working the deal through, and I was trying to protect myself and the stockholders' interest and continue the business." It is plain that the 5,000 shares of stock were the consideration for the exchange of assets and the owners of the assets were obviously entitled to stock in proportion thereto. The test is the comparative value783 of holdings, before and after exchange, rather than number of shares. . No change in proportion 1067 as to value of holdings after exchange of assets for corporate stock was shown herein. In our opinion, the stock was owned upon the acquisition of the assets by the corporation, and in consideration thereof, by the owners of the assets substantially in proportion to their holdings of the assets, and, therefore, under sections 112(b)(5) and 113(a)(8) of the Revenue Act of 1932, the basis of the property acquired and sold in the taxable year, to wit, the inventory and the accounts receivable, is the same as it was in the hands of the transferors, that is to say, the price paid for it by Ziegler as trustee at the bankruptcy sale, or $7,500. The only question remaining is as to proper allocation of the base between the inventory and the accounts receivable. Of the $7,500 base above approved by us, the respondent allocated $2,148 to accounts receivable and $5,352 to inventory. Since at the hearing petitioner accepted as correct respondent's valuation of $11,311.66 for the equity in the accounts receivable*784 ($22,608.92 book value, less $11,297.26 for discharge of encumbrance to finance company), and since petitioner's books set up the inventory as of a value of $28,184.34, mere mathematical calculation discloses that the allocation made by the respondent is substantially in accord with petitioner's book values, after discharge of existent lien on accounts receivable. Petitioner's argument for comparative values of $21,000 and $28,000 for accounts receivable and inventory neglects the necessity of deducting the encumbrance upon the accounts. We therefore find no error in respondent's allocation of the base of $7,500. Petitioner has shown no error in respondent's computation of the profit realized upon the accounts realized, or in adjustment of inventory, upon the basis of $7,500 and allocated as above approved. The above opinion modifies the memorandum opinion originally entered herein. Reviewed by the Board. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621321/	WELLS-GARDNER & COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Wells-Gardner & Co. v. CommissionerDocket No. 61138.United States Board of Tax Appeals34 B.T.A. 1075; 1936 BTA LEXIS 598; October 13, 1936, Promulgated 598 Petitioner, a wholly owned subsidiary, kept its books on the basis of a fiscal year ended June 30, and filed its separate income tax return for the fiscal year 1930. The parent corporation kept its books and filed its returns on a calendar year basis. Petitioner and its parent corporation filed a consolidated return for the calendar year 1930. Held, the filing of a separate return by petitioner for its fiscal year 1930 did not preclude the filing of a consolidated return by the affiliated corporations for the calendar year 1930, under section 141 of the Revenue Act of 1928, and regulations promulgated thereunder; held, further, respondent properly determined a deficiency in tax against petitioner for the period July 1 to December 31, 1929. E. H. McDermott, Esq., for the petitioner. H. D. Thomas, Esq., for the respondent. HILL 1076 This proceeding is for the redetermination of a deficiency in income tax of $11,797.30 for the period July 1 to December 31, 1929. The only matter in controversy is the correctness of the respondent's action in determining the petitioner's tax liability for the six-month period from July 1 to December 31, 1929, as599 a separate taxable period instead of as a part of the twelve-month period beginning July 1, 1929, and ending June 30, 1930. FINDINGS OF FACT. The petitioner is an Illinois corporation organized in 1925. The Gulbransen Co. is an Illinois corporation organized in 1906. Each has its principal place of business in Chicago, Illinois. The Gulbransen Co. is engaged in the manufacture and sale of pianos and player pianos. Petitioner is engaged in the business of manufacturing and selling radio receivers and accessories. On and after May 1, 1929, all of petitioner's capital stock was owned by the Gulbransen Co. At all times material to this proceeding the books and records of the Gulbransen Co. were kept upon the basis of calendar years. From its organization up to and including June 30, 1930, petitioner's books and records were kept upon the basis of fiscal years ending June 30. On December 31, 1930, petitioner closed its books and records and thereafter maintained them on the basis of calendar years. On September 10, 1929, petitioner duly filed with the collector its separate income tax return on form 1120-A for its fiscal year ended June 30, 1929, showing thereon a tax600 of $2,386.59. On March 15, 1930, the Gulbransen Co. duly filed with the collector its separate income tax return on form 1120 for its calendar year 1929, showing thereon a net loss and no tax liability. On May 1, 1930, the Gulbransen Co. applied to the respondent through the collector of internal revenue at Chicago, Illinois, for permission to change its accounting period from the taxable year ending December 31, 1930, to the taxable year ending Juen 30, 1930. In its application it also requested permission to file a consolidated 1077 return at June 30, 1930, to include twelve months of the operations, July 1, 1929, to June 30, 1930, of its subsidiary, the petitioner, and six months of its own operations, January 1 to June 30, 1930. It further stated in the application that, if the respondent should refuse to permit it to file a consolidated return including the operations of itself and the petitioner as thus set out, then it desired to withdraw the application for a change in its accounting period. On May 3, 1930, the Gulbransen Co. addressed a letter to the respondent advising him that it and the petitioner had filed separate returns for their taxable years ended601 respectively on December 31, 1929, and June 30, 1929. The Gulbransen Co. also requested that the respondent give his permission for it either to file an amended consolidated return for the year ended December 31, 1929, or in the future to file its returns including therein the income and deductions of the petitioner as consolidated returns of both companies, the first of such returns to be filed as of June 30, 1930, the closing of the fiscal year of the petitioner. In reply to this letter the respondent on May 21, 1930, advised the Gulbransen Co. that since it (the parent company) had filed a separate return for 1929 it had exercised its privilege and under the provisions of article 10 of Regulations 75 an amended return on a consolidated basis was not acceptable for 1929. He further advised the company that since under the provisions of section 141 of the Revenue Act of 1928 and article 1 of Regulations 75 affiliated corporations had the privilege of making a consolidated return for the taxable year 1929 or any subsequent taxable year in lieu of separate returns, his permission for the filing of a consolidated return for 1930 was not necessary. The respondent also called the attention602 of the company to article 14 of Regulations 75, providing that where a subsidiary corporation has a different taxable year to that of the parent the income of the subsidiary must be adjusted to conform to the accounting period and taxable year of the parent. He also advised the corporation that if a consolidated return were filed by it for 1930 such return should be for the calendar year ending December 31, 1930, unless permission was granted by him to change such basis, as this represented the accounting period and taxable year of the Gulbransen Co. (the parent company). On July 8, 1930, the respondent advised the collector of internal revenue at Chicago that the application made May 1, 1930, by the Gulbransen Co. for permission to change its accounting period from December 31 to June 30 was denied because it was conditioned upon the company being permitted to file a consolidated return for itself and the petitioner in which would be included the income of the company for the period January 1, 1930, to June 30, 1930, and of the petitioner for the fiscal year ended June 30, 1930. He informed 1078 the collector that there was no authority for accepting a consolidated return603 filed on that basis. A copy of the respondent's letter to the collector was furnished the Gulbransen Co. by the collector on July 12, 1930. On September 15, 1930, petitioner duly filed with the collector its separate income tax return on form 1120-A for its fiscal year ended June 30, 1930, showing thereon a tax of $9,739.95. On October 30, 1930, the petitioner made application to the respondent through the collector of internal revenue at Chicago for permission to change its accounting period from the taxable year ended June 30 to the taxable year ended December 31, stating that this change was desired in order to make its accounting period conform to that of the Gulbransen Co., of which it was a wholly owned subsidiary and with which it desired to file a consolidated return. On October 30, 1930, the Gulbransen Co. addressed a letter to the respondent in which reference was made to the application of the petitioner for permission to change its accounting period from June 30 to December 31. In this letter the Gulbransen Co. requested permission to file a consolidated return for itself and the petitioner for the calendar year ending December 31, 1930, stating that such return604 would only include the operations of the petitioner for the period July 1 to December 31, 1930. In reply to this letter of the Gulbransen Co. the respondent, on November 8, 1930, advised the company that section 141(a) of the Revenue Act of 1928 granted affiliated corporations the privilege of making a consolidated return for the taxable year 1929 or any subsequent taxable year in lieu of separate returns, and that specific permission for the filing of a consolidated return by it and the petitioner was not required. He further advised the company as follows: Under article 10 of Regulations 75, the privilege of making a consolidated return is exercised at the time of filing the return of the parent corporation. In regard to the proper preparation of a consolidated return for the calendar year 1930, since Wells-Gardner and Company closes its books on the basis of a fiscal year ending June 30, article 14 of Regulations 75 provides that the taxable year of the parent corporation shall be considered as the taxable year of the affiliated group which makes a consolidated return, and the consolidated net income must be computed on the basis of that taxable year. Article 13(a) of605 Regulations 75 provides that except for changes in an affiliated group by way of additions of new companies becoming affiliated or of elimination of old companies ceasing to be affiliated, a consolidated return must include the income of the parent and of each subsidiary for the entire taxable year. Accordingly, the income of Wells-Gardner and Company, for the period January 1 to June 30, 1930, should be included in the consolidated return to be filed for the calendar year 1930 and its return for the fiscal year ending June 30, 1930 should be amended so as to cover the period from July 1 to December 31, 1929, only. 1079 On November 15, 1930, the respondent advised the collector of internal revenue at Chicago as follows with respect to the application of the petitioner for permission to change its accounting period: Permission is hereby granted Wells-Gardner & Company to change the basis of computing its income and filing income tax returns from the fiscal year ending June 30 to the calendar year, effective as of December 31, 1930, provided the proper adjustments are made in its books of account and returns of income. To effect the change, the corporation will be required606 to close its books on Dec. 31, 1930 and to file a return on or before March 15, 1931, covering the period July 1 to December 31, 1930. This return should be accompanied with a statement to the effect that the books of the corporation have been adjusted to conform to the calendar year. Returns for subsequent years must be made on the basis of the full calendar year and will be due on or before March 15 of each year. The attention of the corporation should be directed to the fact that in determining the tax on the return covering the period July 1 to Dec. 31, 1930, the net income must be placed on an annual basis and the tax computed in accordance with section 47(c) of the Revenue Act of 1928. The enclosed copy of this letter should be forwarded to the corporation with instructions to attach it, or a copy thereof, to the return for the period July 1 to December 31, 1930, as authority for the change herein granted. A copy of the foregoing letter was furnished the petitioner by the collector on November 19, 1930. On February 4, 1931, the Gulbransen Co. advised the respondent by letter that in filing its return for the year 1930 it would include the taxable income of the petitioner, 607 its wholly owned subsidiary. On March 14, 1931, petitioner and the Gulbransen Co. filed a tentative consolidated return for the calendar year 1930. Pursuant to extension of time granted, petitioner and the Gulbransen Co. duly filed on May 15, 1931, a consolidated return for the calendar year 1930, including therein the incomes and deductions of the Gulbransen Co. and petitioner for said calendar year and showing thereon a large net loss. On March 13, 1931, the petitioner executed for the calendar year 1930 form 1122, designated "Authorization and Consent of Subsidiary Corporation Included in a Consolidated Income Tax Return and Return of Information", which accompanied the tentative consolidated return filed by the petitioner and the Gulbransen Co. In the form 1122 the Gulbransen Co. was named as the parent corporation. This form also contained the following provisions: The above-named subsidiary corporation hereby authorizes the above-named parent corporation (or in the event of its failure, the Commissioner or the Collector) to make a consolidated return on its behalf for the taxable year for which this form is filed, and for each taxable year thereafter that a consolidated608 return must be made under the provisions of Article 11(a) of Regulations 75. The above-named subsidiary corporation, in consideration of the privilege of joining in the making of a consolidated return with the above-named parent corporation, hereby consents to and agrees to be bound by the provisions of Regulations 75 prescribed prior to the making of this return. This consent is applicable 1080 to the taxable year for which this form is filed and to each taxable year thereafter that a consolidated return must be made under the provisions of Article 11(a) of Regulations 75. At or before the time required by law, petitioner and the Gulbransen Co. filed a consolidated return for the calendar year 1931, including therein the incomes and deductions of the Gulbransen Co. and petitioner. Said return showed a large net loss. For the period July 1 to December 31, 1929, the petitioner had a substantial net income in excess of all credits. For the period January 1 to June 30, 1930, it had a substantial net loss. For the period July 1 to December 31, 1930, it had a substantial net income in excess of all credits. The Gulbransen Co. had a loss for the calendar year 1930. 609 Its loss for the last six months of the year was in excess of the petitioner's net income for such six months. The deficiency here involved was determined by the respondent for the six-month period ended December 31, 1929. In determining the deficiency the respondent gave the petitioner credit for the amount of tax shown on the petitioner's return for the entire fiscal year ended June 30, 1930, and paid for such fiscal year. OPINION. HILL: The question for determination here is whether the petitioner and its parent corporation were authorized to make a consolidated return for the calendar year 1930, which was the taxable year of the parent corporation, notwithstanding that the petitioner had previously made and filed a separate return for the fiscal year ended June 30, 1930. Such authority, if it existed, must be found in the provisions of section 141 of the Revenue Act of 1928 1 and the regulations prescribed by the Commissioner thereunder. 610 Section 141 confers upon an affiliated group of corporations the privilege of making a consolidated return for the taxable year 1929 or any subsequent taxable year, upon condition that all corporations of such affiliated group consent to all the regulations under subsection (b) prescribed prior to the making of such return. It is provided further in that section that the making of a consolidated return shall be considered as such consent. Subsection (b) of section 141 gives the Commissioner authority, with the approval of the Secretary, the prescribe such regulations as he may deem necessary 1081 to determine, compute, assess, collect, and adjust the tax liability of an affiliated group of corporations and of each corporation of the group in such manner as to reflect clearly the income and prevent avoidance of tax liability. Pursuant to that authority the Commissioner, with the approval of the Secretary, prescribed in Regulations 75 for the carrying into effect of the provisions of section 141. Article 10 of these regulations requires that the privilege of making a consolidated return for any taxable year of an affiliated group must be exercised at the time of filing611 the return of the parent corporation for such year. Article 14 provides that the taxable year of the parent corporation shall be the taxable year of the affiliated group which makes a consolidated return, and that the consolidated net income must be computed on the basis of the taxable year of the parent corporation. The consolidated return in this case was made in strict accordance with the provisions of section 141, supra, and of the regulations prescribed thereunder. The consolidated return was made voluntarily and in the exercise of a privilege granted by section 141 after the corporations involved affirmatively consented to the provisions of said regulations in addition to the consent imposed by statute upon the filing of a consolidated return. Petitioner contends, however, that the consolidated return was made without authority of law, for the assigned reason that petitioner had previously made a separate return for the fiscal year ended June 30, 1930, covering the first six months of the taxable year for which the consolidated return was made. This contention is based on the argument that the petitioner by making the separate return had elected not to join in a612 consolidated return for the calendar year 1930 and that the election was irrevocable and binding upon petitioner, its parent corporation and the respondent, notwithstanding the subsequent making and filing of the consolidated return. We find that neither the provisions of section 141 of the Revenue Act of 1928 nor the regulations thereunder support this argument. The petitioner has cited and relies upon a number of cases based upon the provisions of previous revenue acts relating to the filing of separate and consolidated returns by affiliated corporations. There is clearly a difference between the provisions of section 141(a) of the Revenue Act of 1928 and section 240(a) of the Revenue Act of 1921. Under section 141(a) of the 1928 Act an affiliated group of corporations has the privilege of filing a consolidated return for the taxable year 1929 or any subsequent taxable year, and such privilege is not lost or forfeited by postponing the election to file such return to any taxable year subsequent to the taxable year 1929. Under section 240(a) of the Revenue Act of 1921 an affiliated group of corporations was permitted to file either a consolidated return or 1082 613 separate returns for any taxable year beginning on or after January 1, 1922, but the kind of return (consolidated or separate) filed for the first taxable year beginning on or after January 1, 1922, was required to be the basis for returns for subsequent taxable years by such corporations unless and until such basis was changed by permission of the Commissioner. Under the 1928 Act the election applies only to consolidated returns and may be exercised as to any taxable year subsequent to the taxable year 1928, but when the privilege to file a consolidated return is once exercised, the basis can not be changed without permission of the Commissioner, whereas under the 1921 Act the privilege of election applied to separate as well as consolidated returns and could be exercised only for the first taxable year beginning on or after January 1, 1922. Section 240(a) of the Revenue Act of 1924 and section 240(a) of the Revenue Act of 1926 are identical with section 240(a) of the Revenue Act of 1921, except in [] to the first taxable years to which the later acts apply. Under the Acts of 1921, 1924, and 1926 the filing of a separate return constituted an election to continue to file614 return for subsequent taxable years until permission to change to a consolidated return basis was granted by the Commissioner. Also under those acts the filing of a consolidated return for the first taxable year constituted an election to continue to file such return for subsequent taxable years until permission to change to the basis of separate returns was granted by the Commissioner. Under the 1928 Act the filing of a separate return does not constitute an election to continue to file such return until permission to change is granted by the Commissioner, but the filing of a consolidated return under that act does constitute an election to continue to file consolidated returns on such basis until permission to change is granted by the Commissioner. Therefore, the filing by the petitioner of a separate return for the fiscal year ended June 30, 1930, constituted no legal hindrance or impediment to the making of a consolidated return by petitioner and its parent corporation for the calendar year 1930, whcih was the taxable year of the parent corporation. Section 141 of the Revenue Act of 1928 is new law that prospectively supersedes and annuls those provisions of section 240615 of the Revenue Acts of 1921, 1924, and 1926 constituting the filing of a separate return an election to continue to make returns on that basis. Hence, the cases cited and relied on by petitioner in support of its contention that the filing of its separate return for the fiscal year ending June 30, 1930, foreclosed it from joining in the consolidated return for the calendar year 1930 have no pertinency in the instant case. 1083 The petitioner, exercising its legal right to join in a consolidated return for the calendar year 1930, included therein its income and losses during the period from January 1 to June 30, 1930, its losses substantially exceeding its income for that period. Its net loss was deducted from its substantial net income for the last half of the calendar year 1930. Petitioner in its separate return for its fiscal year 1930 also deducted its net losses sustained during the period from January 1 to June 30, 1930, from its income for the period July 1 to December 31, 1929. Petitioner, therefore, had a double deduction of the loss sustained in the period January 1 to June 30, 1930, and in each return the loss was absorbed. 616 The petitioner and its parent corporation, in exercising their legal privilege to file a consolidated return for the calendar year 1930, pursued a course which safely assured the avoidance of any tax liability for either corporation for such taxable year. This course involved, however, a double deduction of the loss sustained by petitioner during the period January 1 to June 30, 1930. The law does not contemplate nor countenance the avoidance of tax liability through such device. As bearing upon the question of the double deduction of losses, the following citations are pertinent: ; ; ; . In the last case the court said: "Double credits equally with double taxation are to be avoided where possible in construing laws passed by Congress." It is obvious that petitioner is not entitled to deduct its loss incurred in the period January 1 to June 30, 1930, from both its income for its fiscal year 1930 and its income for the calendar year 1930. Petitioner's tax liability617 for its fiscal year ending June 30, 1930, was determined by its separate return for that taxable year. But subsequent to the determination of that tax liability petitioner joined with its parent corporation, the Gulbransen Co., in exercising the privilege granted by statute to make a consolidated return for the calendar year 1930. Under this consolidated return petitioner's tax liability for the entire calendar year 1930 was determined, and upon that basis it was found that petitioner had no tax liability for such year. Exercise of the privilege of filing a consolidated return imposed upon the petitioner and its parent corporation acceptance of the following conditions: (1) That they consent to all the regulations prescribed prior thereto under subsection (b) of section 141 of the Revenue Act of 1928; (2) that the consolidated return be made at the time of filing the return of the Gulbransen Co., the parent corporation; (3) that the consolidated return be made for the taxable year of the parent corporation, which was the calendar year 1930; and (4) that the consolidated net income be computed on the basis of the taxable year of the parent corporation. 1084 Under no618 other conditions and on no less than all of the conditions named is a consolidated return authorized under the statute and the regulations, which have the force of a statute. No question as to the validity of the regulations referred to has been raised. In , the Supreme Court, referring to consolidated returns under the above act and Regulations 75, prescribed under section 141(b) thereof, said: The making of the consolidated return constituted acceptance by petitioner and its subsidiaries of the Regulations that had been prescribed. No question of validity is raised. The same position was taken on that question in , and in the same case at . The petitioner not only consented to filing a consolidated return for the parent's taxable year 1930, but consented to all the regulations prescribed prior thereto. Such consent can not be withdrawn or revoked after the consolidated return is filed. Art. 12(b). Regulations 75. If petitioner's contention herein should be upheld it would avoid a portion of its tax liability by reason of the fact619 that it has twice deducted from its income the loss sustained in the six-month period from January 1 to June 30, 1930 - once from the income for the period July 1, 1929, to June 30, 1930, and again for the period January 1, to December 31, 1930. In order to reflect properly the income of petitioner and determine its correct tax liability for the overlapping periods of the fiscal year 1930 and the calendar year 1930, it was necessary that there be an adjustment of the return of one of those taxable years. The Commissioner accepted the consolidated return, as he was compelled to do under section 141 of the Revenue Act of 1928 and articles 10 and 14 of Regulations 75, and determined the tax liability thereon for the calendar year 1930. This operation reflected properly the income and tax liability covered by the period of such return, but disturbed the tax liability of petitioner as previously determined on the basis of its separate return for the fiscal year ending June 30, 1930. Hence, it became necessary, in order to reflect properly the taxable income of petitioner for the eighteen-month period from July 1, 1929, to December 31, 1930, to adjust the separate return for the620 fiscal year 1930 by limiting it to the period July 1 to December 31, 1929. It was the duty of the Commissioner to make such adjustment. His action is, therefore, approved. Reviewed by the Board. Judgment will be entered for the respondent.Footnotes1. SEC. 141. CONSOLIDATED RETURNS OF CORPORATIONS - 1929 AND SUBSEQUENT TAXABLE YEARS. (a) Privilege to file consolidated returns.↩ - An affiliated group of corporations shall, subject to the provisions of this section, have the privilege of making a consolidated return for the taxable year 1929 or any subsequent taxable year, in lieu of separate returns. The making of a consolidated return shall be upon the condition that all the corporations which have been members of the affiliated group at any time during the taxable year for which the return is made consent to all the regulations under subsection (b) prescribed prior to the making of such return; and the making of a consolidated return shall be considered as such consent. * *	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621322/	CLIFFORD BIEDERSTADT AND DOROTHY L. BIEDERSTADT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBiederstadt v. CommissionerDocket No. 23357-87.United States Tax CourtT.C. Memo 1989-235; 1989 Tax Ct. Memo LEXIS 235; 57 T.C.M. (CCH) 395; T.C.M. (RIA) 89235; May 15, 1989; As corrected Patrick R. McKenzie, for the petitioners. Catherine M. Brady, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined a deficiency in petitioners' income tax and additions236 to tax for the calendar years 1982 and 1983 in the following amounts: YearDeficiencySec. 6653(b)(1) 1Sec. 6653(b)(2)Sec. 6661(a)1982$ 1,552.00$ 776.00 --1983$ 9,045.00$ 4,523.00$ 2,261.25In the notice of deficiency , respondent determined, in the alternative, additions to tax under section 6653(a)(1) and (2). Some of the issues raised by the pleadings have been disposed of by agreement of the parties leaving for decision: (1) whether any portion of petitioners' understatement of their 1982 and 1983 tax liabilities was due to fraud; (2) whether assessment of deficiencies and additions to tax for petitioners' 1982 tax year is barred by the statute of limitations; (3) whether, if petitioners' understatement of their 1983 tax liability was not due to fraud, any portion of such understatement was due to negligence or intentional disregard of the rule or regulations; 237 and (4) whether petitioners are liable for the addition to tax under section 6661(a) because they substantially understated their 1983 income tax liability and, if so, whether the percentage rate of such addition is 25 percent or 10 percent. FINDINGS OF FACT Petitioners, Clifford and Dorothy Biederstadt, lived in Mission Viejo, California at the time the petition in this case was filed. During 1982 and 1983, the years at issue, petitioners utilized the cash receipts and disbursements method of accounting and computed their Federal income tax liability on the basis of a calendar year. In August 1981, Mr. Biederstadt began working for Nacom Industries, Inc. (Nacom or the company) as a prototype machinist. Mr. Biederstadt never finished high school. However, he did pass a high school equivalency exam and thus received a Graduation Equivalency Diploma (G.E.D.). In addition, Mr. Biederstadt attended a trade school for four years in order to become a tool and die maker. Mr. Biederstadt underwent open-heart surgery in the late 1970's. Despite his lack of formal education, by 1982, Mr. Biederstadt had been promoted to plant manager at Nacom. In addition, Mr. Biederstadt performed238 work as an independent contractor for Nacom in 1981 and during the years here at issue. He would manufacture certain specialized parts from blueprints provided by Nacom or by Nacom's customers. Nacom supplied all materials and facilities so that Mr. Biederstadt had very few expenses. However, Mr. Biederstadt subcontracted with other individuals to perform Nacom work and, thus, was required to pay some subcontracting expenses. He paid these subcontracting expenses in cash and retained the invoices which represented these expenses. Mr. Biederstadt issued one invoice for $ 68.00 dated November 20, 1981, to Nacom. Mr. Biederstadt issued four invoices to Nacom in the total amount of $ 3,950 for the parts he manufactured and the services he performed as an independent contractor in 1982. He retained, for his records, copies of the invoices he issued to Nacom in 1982. In 1982, Nacom issued to Mr. Biederstadt four separate checks which totaled $ 3,950 in payment of the invoiced amounts. He immediately cashed these checks. He did not pay any subcontracting expenses in 1982. Mr. Biederstadt issued 39 invoices to Nacom in the total amount of $ 23,654.50 for the parts he manufactured239 and the services he performed as an independent contractor in 1983. He retained, for his records, copies of the invoices issued to Nacom in 1983. In 1983, Nacom issued to Mr. Biederstadt 31 checks which totaled $ 23,654.50 in payment of the invoiced amounts. Mr. Biederstadt immediately cashed these checks. He paid a total of $ 4,294.72 in subcontracting expenses in 1983. He retained the invoices which represent these subcontracting expenses. During the years at issue, Nacom employed approximately 50 persons. Only three or four of these persons, including Mr. Biederstadt, performed independent contracting services for Nacom. In January 1982, Ms. Dorothy Baker began working for Nacom as a bookkeeper. In her capacity as bookkeeper, Ms. Baker prepared Nacom's financial statements, the company's weekly payroll, and the quarterly payroll tax returns. She also prepared, on a yearly basis, the Forms W-2 issued by Nacom to its employees and the Forms 1099 issued by Nacom to its independent contractors. After preparing the Forms 1099 for the year, Ms. Baker would prepare a Form 1096, Annual Summary and Transmittal of U.S. Information Returns, on which she would report the number240 of Forms 1099 issued by Nacom in that year. Ms. Baker would also prepare a Form 596, Annual Summary and Transmittal of Information Returns, for the State of California. The Form 596 required much of the same information required by the Form 1096. After preparing and signing the Form 1096, Ms. Baker would give the form to Nacom's president for review. Ms. Baker would then mail the Form 1096. Finally, Ms. Baker would hand-carry the Forms 1099 to the employees who performed independent contracting services. Ms. Baker prepared and signed Nacom's Form 1096 for the 1982 calendar year. The form is dated February 9, 1983 and on or about February 9, 1983, she hand-delivered to Mr. Biederstadt his Form 1099 for the 1982 calendar year. The Form 1099 disclosed that $ 3,950 had been paid to Mr. Biederstadt in his capacity as an independent contractor. Nacom also issued to Mr. Biederstadt a Form W-2 for 1982 showing that he received a total of $ 40,511.78 in compensation from Nacom in his capacity as an employee. Ms. Baker prepared Nacom's Form 1096 for the 1983 calendar year. The form is dated January 27, 1984 and within a week of such date, Ms. Baker hand-delivered to Mr. Biederstadt241 his Form 1099 for the 1983 calendar year. The Form 1099 reported that $ 23,654.50 had been paid to Mr. Biederstadt in his capacity as an independent contractor. Mr. Biederstadt placed the Form 1099 in his pocket. Nacom also issued to Mr. Biederstadt a Form W-2 for 1983 showing that he received a total of $ 42,680 in compensation from Nacom in his capacity as an employee. In December 1986, Nacom was acquired by Fluorocarbon, Inc. (Fluorocarbon). Mr. Biederstadt left Nacom shortly after the acquisition. In August 1987, Mr. Biederstadt started his own company, Beco Industries, Inc., which competes directly with Fluorocarbon. Mr. Biederstadt did not prepare petitioners' tax returns. He would collect records and documents and give them to Mrs. Biederstadt who would, in turn, take them to the tax preparer or accountant who prepared petitioners' income tax returns. Mr. Biederstadt did prepare a ledger of sorts for the calendar year 1983 in which he recorded invoice numbers, amounts charged to Nacom, and amounts paid to subcontractors. He prepared a similar ledger for 1984. Mr. Lloyd A. Bennett, a tax return preparer, prepared petitioners' 1982 Federal income tax return. Mr. Bennett242 had not previously prepared petitioners' tax returns. It was Mr. Bennett's practice, when preparing the tax returns of new clients such as petitioners, to solicit certain information from the clients. For example, Mr. Bennett would ask to see the clients' tax return for the previous year. He would then ask to see the clients' Forms W-2 and Forms 1099. Finally, he would ask the clients whether they had any other sources of income. Mrs. Biederstadt brought petitioners' 1982 calendar year records to Mr. Bennett's office. Mr. Biederstadt did not accompany Mrs. Biederstadt to Mr. Bennett's office. On the 1982 return prepared by Mr. Bennett, petitioners reported total wages, salaries, and tips in the amount of $ 44,067 ($ 40,511.78 earned by Mr. Biederstadt plus $ 3,555 earned by Mrs. Biederstadt, rounded off to the nearest dollar). The return also contained miscellaneous entries for commission income, employee business expenses, and charitable contributions. The income from Mr. Biederstadt's contracting services was not reported on petitioners' 1982 tax return and no Schedule C profit and loss statement was filed with the return. Mr. Jorge Ramos, a certified public accountant, 243 prepared petitioners' 1983 Federal income tax return, as well as their returns for 1984 and 1985. It was Mr. Ramos' practice, when preparing a client's tax return, to give the client a worksheet or client interview sheet on which they were requested to disclose financial information relevant to the preparation of their income tax returns. However, some clients complained that the worksheet was too complicated and did not answer the questions on the worksheet. Mr. Ramos would then go through the information (if any) supplied on the worksheet and also solicit further information pertaining to other income or expenses. In 1984, Mrs. Biederstadt brought petitioners' 1983 calendar year records to Mr. Ramos' office. Mr. Biederstadt did not accompany Mrs. Biederstadt even though Mrs. Biederstadt was still recovering from recent back surgery. On the 1983 return prepared by Mr. Ramos, petitioners reported total wages, salaries, and tips in the amount of $ 42,680. The return also contained miscellaneous entries for interest income, state and local income and personal property tax deductions, deductions for tax return preparation fees, and charitable contribution deductions. No income244 from Mr. Biederstadt's independent contracting services was reported on petitioners' 1983 tax return and no Schedule C profit and loss statement was prepared or filed with the return. Consequently, Mr. Ramos charged petitioners only for the preparation of a long-form return with no Schedule C or self-employment tax computation. A Schedule C profit and loss statement was prepared for both petitioners' 1984 tax return and petitioners' 1985 tax return. These schedules disclose significant gross receipts and expenses attributable to the independent contracting services performed by Mr. Biederstadt in 1984 and 1985. They indicate that the source of the income for 1984 and 1985 is machine parts. Mr. Ramos maintained files for petitioners' 1983, 1984, and 1985 tax years. At the time of trial, his file for petitioner's 1983 tax year contained only the Form W-2 issued to Mr. Biederstadt by Nacom. It did not contain a financial information worksheet, nor did it contain the original or a copy of the Form 1099 issued by Nacom to Mr. Biederstadt. The file also did not contain any records pertaining to interest income, deductions for taxes paid, deductions for tax preparer fees, or charitable245 contribution deductions. Mr. Ramos often solicited such information from his clients and then returned the records (i.e., the Form 1099) from which the information was derived to the clients. Finally, the file did not contain a ledger prepared by Mr. Biederstadt for 1983 in connection with his independent contracting services. The file for petitioners' 1984 tax return, which was also prepared by Mr. Ramos, contained the Form W-2 issued by Nacom to Mr. Biederstadt for 1984. It also contained a Form 1099 for the amount of $ 42,869.54 issued by Nacom Industries to Mr. Biederstadt for 1984. In addition, the file contained a copy of a Form 1099 issued by Mr. Biederstadt to a subcontractor, some notes containing information relating to petitioners' tax return, and a copy of the ledger prepared by Mr. Biederstadt for 1984 in connection with his independent contracting services. The file for petitioners' 1985 tax return, which was also prepared by Mr. Ramos, contains a client interview sheet and a Form W-2 issued by Nacom to Mr. Biederstadt. It contains a Form 1099 for the amount of $ 29,900.69 issued to Mr. Biederstadt in connection with his independent contracting work, and a Form246 1099 issued by Mr. Biederstadt to a subcontractor. The file also contains various other work papers and documents. The file does not contain a ledger similar to that prepared by Mr. Biederstadt for 1984. In April 1986, Mr. Chuck Pruzinec, an agent of the Internal Revenue Service (the Service), contacted petitioners regarding the examination of their income tax return for the calendar year 1983. The return had been selected for examination because the Service had received information from Nacom indicating that payments had been made to Mr. Biederstadt, which income had not been reported on petitioners' 1983 return. In this initial contact letter, Agent Pruzinec scheduled an appointment for April 21, 1986 with petitioners and asked petitioners to bring any records pertaining to all payments they received from Nacom in 1983. Both Mr. and Mrs. Biederstadt attended the conference. However, the only document they brought with them was a copy of their 1983 return with the 1983 Form W-2 attached. Agent Pruzinec informed petitioners that the Service had received information from Nacom for petitioners' 1983 tax year. Mr. Biederstadt explained that he manufactured specialized parts247 at night and on weekends as an independent contractor for Nacom but stated to Agent Pruzinec that he did not begin to perform such work until 1984. Agent Pruzinec suggested that Mr. Biederstadt check his records. On April 30, 1986, Agent Pruzinec spoke with Mr. Biederstadt on the telephone. In that conversation, Mr. Biederstadt told Agent Pruzinec that he had obtained a copy of the 1983 Form 1099 from Nacom and that the Form 1099 had refreshed his memory as to the contracting work he performed in 1983. Mr. Biederstadt indicated his concern over how such a large amount of income could have been omitted from petitioners' return and that he was attempting to obtain an appointment with Mr. Ramos to discuss the matter. Immediately after he finished his conversation with Mr. Biederstadt, Agent Pruzinec drove to Mr. Ramos' office in order to examine petitioners' file for 1983 and interview Mr. Ramos. Mr. Ramos stated that he had not heard from petitioners since the last time he prepared their tax return. Mr. Ramos and Agent Pruzinec then reviewed petitioners' file for the 1983 taxable year. At that time, Mr. Ramos told Agent Pruzinec that he did not believe petitioners had informed248 him of the existence of any Form 1099 income. Agent Pruzinec also reviewed petitioners' files for the 1984 and 1985 tax years and discovered the Forms 1099 issued by Nacom to Mr. Biederstadt for those years. Agent Pruzinec had a second and final meeting with petitioners on May 22, 1986. Petitioners brought various records pertaining to Mr. Biederstadt's 1983 contracting work, including invoices, receipts for subcontracting expenses, and the ledger of contracting income and expenses which Mr. Biederstadt had prepared for the 1983 tax year. The 1983 ledger was similar to that prepared by Mr. Biederstadt and retained by Mr. Ramos for 1984. Mr. Biederstadt indicated that, after reviewing his records, he had discovered that he had, indeed, started doing contracting work in 1983. He also indicated that, as far as he could tell, the omission must have been Mr. Ramos' fault. Agent Pruzinec then told petitioners about his earlier meeting and conversation with Mr. Ramos. In response, Mr. Biederstadt stated that, because he didn't think Mr. Ramos was lying, he must have forgotten to give the necessary documents to Mr. Ramos. Also during this interview, petitioners revealed that they249 had previously been audited by the Service for a year not here in issue and that a large deficiency and a great deal of collection activity had resulted. Mr. Biederstadt indicated that he felt bitterness towards the Service because of all the tax problems he had in prior years. On May 30, 1986, subsequent to the second and final meeting with petitioners, Agent Pruzinec visited Nacom and spoke with Ms. Baker regarding Mr. Biederstadt's records. Ms. Baker reviewed Mr. Biederstadt's file with Agent Pruzinec. At that time, the file contained Forms 1099 for petitioners' 1982, 1983, 1984, and 1985 tax years. Ms. Baker stated that she was positive she had given Mr. Biederstadt his 1983 Form 1099. In addition, the file contained the original invoices issued to Nacom by Mr. Biederstadt and copies of the checks issued by Nacom in payment of the invoiced amounts. The file also contained worksheets prepared by Ms. Baker on which she recorded the amount and check number of each check issued to Mr Biederstadt. During this visit, Agent Pruzinec first became aware that Mr. Biederstadt had received contracting income in 1982. Agent Pruzinec subsequently expanded his audit to include petitioners' 250 1982 tax year. On April 13, 1987, respondent issued a notice of deficiency for petitioners' 1982 and 1983 tax years. In his notice of deficiency, respondent increased petitioners' 1982 income by $ 3,950, the amount received by Mr. Biederstadt from Nacom as an independent contractor and omitted from petitioners' 1982 return. The increase in income resulted in a deficiency in income tax of $ 1,552 for petitioners' 1982 tax year. Respondent increased petitioners' 1983 income by $ 22,980, the amount received by Mr. Biederstadt from Nacom as an independent contractor in 1983 less subcontracting expenses. 2 The increase in income resulted in a deficiency in income tax of $ 9,045. 251 Respondent also determined that petitioners' underpayment of their 1982 and 1983 income tax was due to fraud and, therefore, petitioners were liable for additions to tax under section 6653(b)(1) and section 6653(b)(2). Respondent determined, in the alternative, that petitioners' underpayment of their 1982 and 1983 income tax was due to negligence or intentional disregard of the rules and regulations and, therefore, petitioners were liable for additions to tax under section 6653(a)(1) and section 6653(a)(2). Finally, respondent determined that petitioners were liable for the 25-percent addition to tax for substantial understatement of their 1983 income tax liability. OPINION The first issue for decision is whether petitioners' underpayment of their 1982 and 1983 income tax was due to fraud. A finding of fraud with intent to evade tax for petitioners' 1982 tax year will have two consequences. First, respondent will not be barred from assessing a deficiency and additions to tax for petitioners' 1982 tax year by the 3-year period of limitations contained in section 6501(a)3 and second, petitioners will be liable for additions to tax under section 6653(b)(1) and section 6653(b)(2)252 for their 1982 tax year. 4 A finding of fraud for petitioners' 1983 tax year will render petitioners liable for additions to tax under section 6653(b)(1) and section 6653(b)(2) for that year. 253 The existence of fraud is a question of fact to be determined from the entire record. Edelson v. Commissioner,829 F.2d 828">829 F.2d 828, 832 (9th Cir. 1987), affg. a Memorandum Opinion of this Court; Recklitis v. Commissioner,91 T.C. 874">91 T.C. 874, 909 (1988). Respondent bears the burden of proving the existence of fraud by clear and convincing evidence. Section 7454(a); Edelson v. Commissioner, supra at 832; Rule 142(b). Thus, in order for his determination of fraud to be sustained, respondent must prove by clear and convincing evidence that petitioners engaged in intentional wrongdoing with the specific intent to avoid a tax known to be owing. Bradford v. Commissioner,796 F.2d 303">796 F.2d 303, 307 (9th Cir. 1986), affg. a Memorandum Opinion of this Court; Akland v. Commissioner,767 F.2d 618">767 F.2d 618, 621 (9th Cir. 1985), affg. a Memorandum Opinion of this Court; Recklitis v. Commissioner, supra at 909. Similarly, in order for254 the unlimited period of assessment provided for in section 6501(c)(1) to apply, respondent must prove by clear and convincing evidence that petitioners filed a fraudulent return with the intent to evade tax. A finding of fraud with an intent to evade tax under section 6653(b) on the part of a taxpayer also results in the period of limitations not barring the assessment and collection of tax in accordance with section 6501(c)(1). Considine v. United States,683 F.2d 1285">683 F.2d 1285, 1288 (9th Cir. 1982); Meier v. Commissioner,91 T.C. 273">91 T.C. 273, 303 (1988). Since direct proof of a taxpayer's fraudulent intent is rarely available, fraud may be proven by circumstantial evidence and the reasonable inferences that can be drawn therefrom. Edelson v. Commissioner, supra at 832; Bradford v. Commissioner, supra at 307; Akland v. Commissioner, supra at 621; Meier v. Commissioner, supra at 297. Such circumstantial evidence or indicia of fraud include: (1) understatement of income; (2) inadequate records; (3) failure to file tax returns; (4) implausible or inconsistent explanations of behavior; (5) concealing255 assets; and (6) failure to cooperate with tax authorities. Edelson v. Commissioner, supra at 832; Bradford v. Commissioner, supra at 307. The taxpayer's knowledge, or lack thereof, of the income tax laws is also significant. Rutana v. Commissioner,88 T.C. 1329">88 T.C. 1329, 1336 (1987). In addition, the taxpayer's entire course of conduct may be examined to establish the requisite fraudulent intent. Recklitis v. Commissioner, supra at 910. However, fraud is never presumed. Kotmair v. Commissioner,86 T.C. 1253">86 T.C. 1253, 1260 (1986). According to respondent, petitioners' entire course of conduct evidences the requisite fraudulent intent. Respondent paints the following picture of the events which transpired: Petitioners received Forms W-2 and Forms 1099 from Nacom for their 1982 and 1983 tax years. Mr. Biederstadt, a successful and intelligent businessman, prepared and retained a multitude of invoices evidencing his performance of independent contracting work in 1982 and 1983. During 1983, Mr. Biederstadt maintained a ledger of the contracting income received and subcontracting expenses paid out in that year. 256 Despite the existence of these extensive records, which were within petitioners' possession, petitioners purposefully withheld these records from their tax return preparers and intentionally caused the omission of substantial amounts of contracting income from their 1982 and 1983 returns. To compound this fraudulent omission, petitioners, when contacted by Agent Pruzinec with respect to their 1983 return, denied that they received contracting income in 1983 and did not bring all their records to an initial appointment with Agent Pruzinec. After he was confronted with evidence that he did, indeed, receive contracting income in 1983, Mr. Biederstadt claimed that his memory was suddenly refreshed but that the omission was probably the return preparer's fault. Mr. Biederstadt brought his extensive records to a second meeting with Agent Pruzinec and, after being confronted with the results of the interview conducted by respondent's agent with Mr. Ramos, finally admitted that the substantial omission of income was his fault. However, petitioners paint a very different picture. According to petitioners, Mr. Biederstadt is a man of limited education and intelligence, although he is257 a hard worker. He does not understand Federal income tax law. His lack of education and intelligence is further aggravated by the memory lapses which plague him. Mr. Biederstadt does not remember receiving his Forms 1099 from Ms. Baker, the bookkeeper at Nacom. In any event, Mr. Biederstadt is not "a man of paperwork" and gave whatever records he received or prepared to his wife who, in turn, gave the records to petitioners' tax return preparers. During the years at issue, Mrs. Biederstadt was recovering from extensive back surgery and suffered from extensive physical problems herself. She was not aware of Mr. Biederstadt's performance of contracting work or assumed it was part of his job as plant manager. Mrs. Biederstadt cannot recall what records she was given by Mr. Biederstadt, although she is sure that she gave all the records she received from Mr. Biederstadt to petitioners' return preparers. If any Forms 1099, which Mr. Biederstadt received from Nacom, were omitted from the materials given to the return preparers, the omission was inadvertent. Mr. Biederstadt did not accompany his wife to the return preparers' offices. Furthermore, petitioners claim that both Mr. 258 Bennett and Mr. Ramos, on whose expertise they extensively relied in the preparation of their 1982 and 1983 tax returns, failed to ask petitioners if they had any sources of income, other than those reflected in the materials petitioners had produced. Thus, Mr. Biederstadt's contracting income was inadvertently omitted from the returns prepared by Mr. Bennett and Mr. Ramos. Petitioners claim they failed to detect the omission because neither reviewed the returns prior to signing and mailing them. When petitioners were contacted by Agent Pruzinec regarding the examination of their 1983 return, Mr. Biederstadt simply did not remember that he had received the contracting income in 1982 and 1983. After contacting Nacom and reviewing his own records, Mr. Biederstadt realized that he had received omitted income in 1983 and, thereafter, cooperated fully with respondent. He provided Agent Pruzinec with all of his records and, according to petitioners, at that time prepared a 1983 ledger coordinating the various invoices and receipts he had retained. Thus, petitioners contend their omissions were not fraudulent nor did they intend to evade a tax they knew that they owed. Although respondent259 points to other factors, his argument that fraud has been shown relies to a large extent on the fact that petitioners omitted substantial income from their tax returns. Respondent is correct in asserting that a consistent pattern of underreporting income, especially when accompanied by other circumstances showing an intent to conceal, can justify an inference of fraud. Lollis v. Commissioner,595 F.2d 1189">595 F.2d 1189, 1191 (5th Cir. 1979), affg. a Memorandum Opinion of this Court (taxpayers omitted over 85 percent of their income in each of four consecutive years; fraud addition sustained); Truesdell v. Commissioner,89 T.C. 1280">89 T.C. 1280, 1302 (1987) (taxpayer omitted over $ 110,000 in income over a 3-year period; other indicia of fraud present; fraud addition sustained); Brooks v. Commissioner,82 T.C. 413">82 T.C. 413, 431 (1984), affd. without published opinion 772 F.2d 910">772 F.2d 910 (9th Cir. 1985) (taxpayer omitted over $ 337,000 in income over a 7-year period, omitting over $ 90,000 in a single year; other indicia of fraud present; fraud addition sustained). However, courts generally will not infer fraud from mere understatements of income unless260 there has been a pattern of consistent underreporting over several years. Rutana v. Commissioner,88 T.C. 1329">88 T.C. 1329, 1336 (1987). See Holland v. United States,348 U.S. 121">348 U.S. 121, 129 (1954). We conclude that, in the instant case, respondent has not demonstrated a consistent pattern of underreporting and omission of income on the part of petitioners. At trial, respondent introduced evidence relating to petitioners' 1981, 1982, 1983, 1984, and 1985 tax years. Respondent produced evidence that petitioners received gross income of $ 68.00 from Nacom in 1981 for Mr. Biederstadt's services as an independent contractor, but did not place into evidence petitioners' 1981 income tax return or any other evidence which would show whether petitioners included the contracting receipts in income. In 1982, petitioners received income from Nacom for Mr. Biederstadt's services as an independent contractor, which petitioners failed to include on their return. However, the amount omitted, $ 3,950, was relatively small in comparison to the amount of income, $ 42,075, which petitioners did report on their 1982 return. Respondent also showed that in 1983, petitioners received261 income from Nacom for Mr. Biederstadt's services as an independent contractor, which was omitted on their income tax return. The net income omitted, $ 19,359.78, was substantial in relation to the net income petitioners reported, $ 40,313. The record also shows that, in 1984 and 1985, petitioners received a substantial amount of income, $ 42,869.54 and $ 29,900.63, respectively, from Nacom for Mr. Biederstadt's services as an independent contractor. However, petitioners reported all of such income on their tax returns. The evidence clearly shows only an omission of income by petitioners in two out of the five years. The omission in 1982 was less than 9.4 percent of petitioners' total income. After omitting a substantial amount in 1983, petitioners reported even larger amounts in 1984 and 1985. These facts do not show that petitioners' overall conduct amounts to "a pattern of consistent underreporting." However, respondent argues that there are other indicia of fraud which corroborate his theory that petitioners' omissions were fraudulent. Respondent relies, to a great extent, on the fact that, in petitioners' initial meeting with Agent Pruzinec, Mr. Biederstadt stated that262 he did not start his independent contracting work for Nacom until 1984. It is true that false and misleading statements to respondent's agents are an indicia of fraud. Truesdell v. Commissioner, supra at 1303; Grosshandler v. Commissioner,75 T.C. 1">75 T.C. 1 (1980). However, the evidence here is insufficient to clearly show that petitioner knew his statements were false or misleading at the time he made them. Mr. Biederstadt testified that, at the time of the meeting, he simply did not remember receiving income from Nacom in 1983. He testified that his memory was impaired as a result of his heart problems. When his memory was refreshed through looking at his records, Mr. Biederstadt did not deny receiving the income. The record shows that Mr. Biederstadt informed the agent that he was mistaken in saying he had not received contract income from Nacom in 1983 and told the agent the amount of that income before the agent interviewed his 1983 return preparer. After Mr. Biederstadt determined he had received 1983 income from Nacom as an independent contractor, petitioners cooperated fully with respondent's investigation and supplied respondent with all263 records Mr. Biederstadt had maintained. Petitioners' 1983 return preparer, Mr. Ramos, had very little in his file with respect to petitioners' 1983 return. The only documents he had in that file were copies of the return and a copy of Mr. Biederstadt's Form W-2. However, the fact that some interest income was reported and itemized deductions claimed, showed that Mr. Ramos used other information when the return was prepared but had not retained copies of the information. Certainly omission of income, particularly in the amount omitted by petitioners in 1983, creates a suspicion of fraud. The facts show that the return preparer had no records from which he prepared petitioners' 1983 return except a copy of a Form W-2. This leaves us to speculate as to other documents he may have had and not kept and the questions he may have asked petitioners before preparing their 1983 return. Petitioners both testified that they did not review the return before signing and mailing it. If true, such inattentiveness to filing a proper return is inexcusable, but does not establish fraud. On the basis of this record, we conclude that respondent has not proved by clear and convincing evidence264 that any part of petitioners' underpayment of tax for 1982 or 1983 was due to fraud with intent to evade tax. We conclude that petitioners were grossly negligent in omitting Mr. Biederstadt's contract income from their 1983 return. Petitioners clearly received the 1983 Form 1099 from Nacom. If they lost such form before bringing their records to Mr. Ramos, their actions were negligent. If their 1983 records were somehow lost during the transportation to Mr. Ramos' office, this too was negligent. If they successfully transported their records to Mr. Ramos' office and Mr. Ramos simply failed to include the income on their return, they were negligent in not reviewing the return before signing and submitting it. Mr. Biederstadt was negligent when he refused to become involved in the preparation of petitioners' 1983 return. In view of Mr. Biederstadt's claimed complete abdication of his responsibilities, Mrs. Biederstadt was also negligent in not reviewing the return and verifying that all income was reported. We conclude that petitioners' entire underpayment of their 1983 income tax was due to negligence and, therefore, we sustain respondent's alternative determination that petitioners265 are liable for additions to tax under section 6653(a)(1) and section 6653(a)(2). The final issue for determination is whether petitioners are liable for additions to tax under section 6661(a) for their 1983 tax year and the appropriate percentage rate of such addition. In his notice of deficiency, respondent determined that the section 6661(a) addition was applicable and that the appropriate rate of such addition was 25 percent. Section 6661(a) provides for an addition to tax where there is a substantial understatement of income tax liability unless there is substantial authority for the taxpayer's treatment of the item which caused the understatement or the taxpayer adequately discloses the facts surrounding his treatment of the item which caused the understatement. Section 6661(b)(2)(B). A substantial understatement exists if the amount of the understatement exceeds the greater of 10 percent of the income tax liability which should have been reported or $ 5,000. Section 6661(b)(1)(A). Petitioners have conceded that a substantial understatement of income tax liability exists. Petitioners266 also concede, in effect, that there was no adequate disclosure on their return of the facts surrounding Mr. Biederstadt's contract income nor was there any authority for the failure to include such amounts in income. However, petitioners claim that respondent erred in utilizing a 25-percent rate when determining the addition to tax under section 6661(a). Petitioners claim that the appropriate rate is 10 percent. We have previously decided in Pallottini v. Commissioner,90 T.C. 498">90 T.C. 498 (1988), that where respondent asserts the higher rate, the appropriate rate of the addition to tax under section 6661(a) is 25 percent. We, therefore, sustain respondent's utilization of the 25-percent rate. 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, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩. 50 percent of the interest due on the deficiency. ↩2. In the notice of deficiency, the sum of $ 26,735 appears beside the caption "1099 Issued by Nacom Industries" for 1983. "Offsetting Expenses, verified" for 1983 is stated to be $ 3,755, resulting in the increase in income of $ 22,980. However, the 1983 Form 1099 entered into evidence jointly in this case, shows a total amount paid to Mr. Biederstadt in 1983 of $ 23,654.50. The parties have also stipulated that petitioners received only $ 23,654.50. The parties have not attempted to explain this discrepancy in the notice of deficiency.↩3. Section 6501(a) provides that: (a) GENERAL RULE. -- Except as otherwise provided in this section, the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed (whether or not such return was filed on or after the date prescribed) * * * and no proceeding in court without assessment for the collection of such tax shall be begun after the expiration of such period. Section 6501(c)(1) provides that: (c) EXCEPTIONS. -- (1) FALSE RETURN. -- In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time. ↩4. Section 6653(b) provides: (b) FRAUD. -- (1) IN GENERAL. -- If any part of any underpayment (as defined in subsection (c)) of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment. (2) ADDITIONAL AMOUNT FOR PORTION ATTRIBUTABLE TO FRAUD. -- There shall be added to the tax (in addition to the amount determined under paragraph (1)) an amount equal to 50 percent of the interest payable under section 6601 -- (A) with respect to the portion of the underpayment described in paragraph (1) which is attributable to fraud, and (B) for the period beginning on the last day prescribed by law for payment of such underpayment (determined without regard to any extension) and ending on the date of the assessment of the tax (or, if earlier, the date of the payment of the tax).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621323/	THOMAS S. MERRITT AND BARBARA H. MERRITT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMerritt v. CommissionerDocket No. 28142-90United States Tax CourtT.C. Memo 1992-443; 1992 Tax Ct. Memo LEXIS 465; 64 T.C.M. (CCH) 397; August 5, 1992, Filed 465 Decision will be entered for petitioners. For Petitioners: Stephen M. Feldman and Marc L. Prey. For Respondent: Eric M. Nemeth and Stewart Todd Hittinger. COLVINCOLVINMEMORANDUM FINDINGS OF FACT AND OPINION COLVIN, Judge: Respondent determined that petitioners had a $ 22,814.77 income tax deficiency for 1987. In 1987 petitioners received lump-sum distributions, as a result of Thomas S. Merritt's 1986 retirement, from his profit-sharing plan, pension plan, and employee stock option plan. Petitioners timely rolled over the pension plan and stock option plan distributions. They elected 10-year averaging for the profit-sharing plan distribution on their 1987 return. The issue to be decided is whether petitioners qualify under section 1124(a) of the Tax Reform Act of 1986 (TRA), Pub. L. 99-514, 100 Stat. 2085, 2475, for 10-year averaging for this distribution. We hold that they do. Younger v. Commissioner, T.C. Memo. 1992-387. In light of our decision on this issue, we need not decide petitioners' alternative claim that they qualify for 10-year averaging for their profit-sharing plan lump-sum distribution under TRA section 1122(h)(3), 100 Stat. 2470. Unless466 otherwise specified, all section references are to the Internal Revenue Code in effect for the year in issue. 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. 1. PetitionersPetitioners are husband and wife who resided in Howe, Indiana, when they filed their petition in this case. All references to petitioner in the singular are to Thomas S. Merritt. Petitioner retired from General Telephone Co. of Indiana (GTE) on March 1, 1986. He was 51 years old when he retired. While an employee of GTE, petitioner participated in: (a) The GTE Savings, Investment and Tax Deferral Plan (profit-sharing plan); (b) the GTE Service Corporation General Pension Trust (pension plan); and (c) the GTE Consolidated Employee Stock Option Plan (ESOP). All three plans were qualified under sections 401 and 501. 2. Distributions from Petitioner's Employee PlansPetitioner received distributions of his balances in these three plans as a result of his retirement. On February 28, 1987, petitioner received a $ 70,110.15 lump-sum distribution of his balance in the profit-sharing plan. On March467 1, 1987, petitioner received a $ 232,124.34 lump-sum distribution of his balance in the pension plan. Petitioner timely rolled this amount over to a qualified individual retirement account (IRA). Also, on or about March 1, 1987, petitioner received a $ 9,571 lump-sum distribution of his balance in the ESOP (ESOP distribution). Petitioner timely rolled all but $ 132 of this amount over to a qualified IRA. GTE sent petitioners a notice with the distributions, which included the following: If an employee separates from service in 1986 and receives a lump sum distribution in 1987, but before March 16, 1987, on account of his separation from service, he may elect to treat the distribution as if he received it in 1986. In that event, the distribution would be taxed under tax rates in effect in 1986 and would not be subject to the 10% tax on early distribution, the 15% tax on large distributions, or the new rules regarding lump sum distributions. 3. Petitioners' Income Tax ReturnsA certified public accounting firm prepared petitioners' 1987 income tax return. Petitioners gave the GTE notice to their accountants to help prepare their return. The accountants researched 468 how to treat petitioners' lump-sum distributions, and concluded that petitioners were entitled to elect 10-year averaging for the profit-sharing plan distribution on their 1987 income tax return. Petitioners timely filed their income tax return for 1987 on April 10, 1988. In it, petitioners elected to roll the $ 232,124 pension plan distribution and $ 9,439 of the $ 9,571 ESOP distribution into an IRA under section 408. Petitioners treated $ 132 of the ESOP distribution as ordinary income. Petitioners elected 10-year averaging for the $70,110.15 profit-sharing plan lump-sum distribution. Petitioners attached Form 4972, Tax on Lump-Sum Distributions for 1987, to their return. Petitioners correctly calculated the tax, using 1986 rates. Petitioners also attached the following statement to their 1987 return: STATEMENT 2 - PENSION AND ANNUITY INCOME GENERAL RULE INVESTMENTEXPECTEDPCT OFAMOUNTDESCRIPTIONINRETURNINCOMERECEIVEDCONTRACTEXCLUDEDTHIS YR(H) GTE-SVGS & TAX DEF. PLAN8,838(H) GTE-CONS. ESOP2,098ROLLOVER FROM A QUALIFIEDPLANAMOUNTDESCRIPTIONOFDISTRIBUTION(H) GTE PENSION TRUST232,124(H) GTE-CONS.ESOP9,571TAXABLE INCOME FROMQUALIFIED PLANDISTRIBUTIONSSUMMARY FOR ALL PENSIONSAND ANNUITIESOTHER PENSIONS ANDANNUITIESTOTAL AMOUNT RECEIVED252,631TAXABLE AMOUNT469 TAX-FREETAXABLEDESCRIPTIONPORTIONPORTION(H) GTE-SVGS & TAX DEF. PLAN8,8380(H) GTE-CONS. ESOP2,0980ROLLOVER FROM A QUALIFIEDPLANAMOUNTTAXABLEDESCRIPTIONOFPORTIONROLLOVER(H) GTE PENSION TRUST232,1240(H) GTE-CONS.ESOP9,439132TAXABLE INCOME FROM132QUALIFIED PLANDISTRIBUTIONSSUMMARY FOR ALL PENSIONSAND ANNUITIESOTHER PENSIONS ANDANNUITIESTOTAL AMOUNT RECEIVEDTAXABLE AMOUNT132The statement did not indicate that the election was pursuant to TRA section 1124(a). OPINION Amounts distributed from a qualified pension or profit-sharing plan are generally taxable to the recipient in the year of distribution. Sec. 401(a). For distributions received before January 1, 1987, section 402(e)(1) provided 10-year averaging for lump-sum distributions. The Tax Reform Act of 1986 amended section 402(e)(1) to replace 10-year averaging with 5-year averaging for distributions after December 31, 1986, and to phase out capital gains treatment of certain distributions for pre-1974 benefits over a 5-year period. TRA sec. 1122(a)(2) and (b), 100 Stat. 2466-2467. Congress provided some470 relief for these changes by enacting transition rules. One transition rule allows individuals who separated from employment in 1986 and who received lump-sum distributions between January 1 and March 16, 1987, on account of their separation to treat the 1987 distributions as if received in 1986. TRA sec. 1124(a), 100 Stat. 2475-2476. TRA section 1124(a) allows taxpayers to treat a lump-sum distribution made in 1987 "as if" made in 1986. TRA section 1124(a) provides: (a) IN GENERAL. -- If an employee separates from service during 1986 and receives a lump sum distribution (within the meaning of section 402(e)(4)(A) of such Code) after December 31, 1986, and before March 16, 1987, on account of such separation from service, then, for purposes of the Internal Revenue Code of 1986, such employee may elect to treat such lump sum distribution as if it were received when such employee separated from service. Thus, under TRA section 1124(a), a taxpayer may use 10-year averaging for a lump-sum distribution made in 1987 if four requirements are met: (1) The taxpayer separated from employment during 1986; (2) the taxpayer received a lump-sum distribution within the meaning of section 402(e)(4)(A); 471 (3) the taxpayer received such distribution between January 1 and March 15, 1987; and (4) the taxpayer elects to treat the distribution as if received when the employees separated from service. Respondent concedes that petitioners satisfy the first three requirements. However, respondent contends that petitioners did not properly elect to use the provision. Notice 87-13, 1 C.B. 432">1987-1 C.B. 432, 443, provides that: (1) The election under TRA section 1124(a) must be made on a 1986 original or amended return; (2) a statement must be attached to the return indicating that the lump-sum distribution is to be treated as a TRA section 1124 lump-sum distribution, and (3) the deadline for such an election is the due date for the 1987 return with extensions. Respondent argues that petitioners failed to comply with the first and second of these provisions. That is, respondent contends that petitioners' TRA section 1124(a) election was improper because it was made on a 1987 return rather than a 1986 original or amended return, and because petitioner did not state that the election was made under TRA section 1124(a). Section 7805 gives the Secretary authority to issue regulations472 including to specify the time and manner for making elections. National Western Life Insurance Co. v. Commissioner, 54 T.C. 33">54 T.C. 33, 40 (1970). The Secretary has promulgated no regulations under TRA section 1124(a). Neither section TRA 1124(a) nor the related committee reports specify how to make the election. See H. Conf. Rept. 99-841 (1986), 1986-3 C.B. (Vol. 4) 1, 458-463; H. Rept. 99-426 (1985), 1986-3 C.B. (Vol. 2) 1; S. Rept. 99-313 (1986), 1986-3 C.B. (Vol. 3) 1. Petitioners used the 10-year averaging section on Form 4972. Petitioners used 1986 tax rates for the profit-sharing plan distribution. Respondent concedes that petitioners' calculation of tax on the profit-sharing plan distribution was correct. Respondent's Form 4972 is labeled "1987" in the upper right-hand corner and contains provisions for 10-year and 5-year averaging. This form was intended, as its instructions state, to apply to the election of 10-year averaging for lump-sum distributions received by persons age 50 or over on January 1, 1986. Petitioners could reasonably believe from the form that it could properly be filed with the 1987 473 return. Section 1011A(d)(1) of the Technical and Miscellaneous Revenue Act of 1988 (TAMRA), Pub. L. 100-647, 102 Stat. 3342, 3476, provides that the taxpayer may treat a lump-sum distribution under TRA section 1124(a) as if made in 1986 "for purposes of the Internal Revenue Code of 1986". The Ways and Means and Finance Committee reports for TAMRA state that under TRA section 1124(a), the employee "could treat the lump-sum distribution as received in 1986 for all purposes." These committee reports also state that, under TAMRA, an election to treat the distribution as if received in 1986 is "for all purposes under the Code." H. Rept. 100-795, at 173 (1988); S. Rept. 100-445, at 181 (1988). We do not rely on the legislative history accompanying TAMRA in 1988 to construe TRA section 1124(a), but even if we did look at it, it fails to shed significant light on the subject. Younger v. Commissioner, T.C. Memo 1992-387">T.C. Memo. 1992-387. We also emphasize that the transitional rule at issue is a relief provision of limited applicability, which should be liberally construed; and that, permitting the election to be made on a timely filed 1987 return prejudices neither petitioner nor 474 respondent. Younger v. Commissioner, supra. If the election is not valid, the distribution is taxable in 1987. Sec. 451(a). We conclude that TRA section 1124(a) permits either an election on an original or amended 1986 return filed by the due date for the 1987 year, or an election for 1987 on a timely filed return for 1987. Younger v. Commissioner, supra.Decision will be entered for petitioners.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621325/	Appeal of STEVENS MANUFACTURING CO.Stevens Mfg. Co. v. CommissionerDocket No. 661.United States Board of Tax Appeals1 B.T.A. 610; 1925 BTA LEXIS 2861; February 25, 1925, decided Submitted January 26, 1925. 2861 Taxpayer shown to have kept its books on a fiscal year basis which clearly reflected its income and is therefore entitled to file its returns on that basis. James V. Giblin, C.P.A., for the taxpayer. Arthur H. Fast, Esq. (Nelson T. Hartson, Solicitor of Internal Revenue) for the Commissioner. 610 Before JAMES, STERNHAGEN, TRAMMELL, and TRUSSELL. This appeal involves income and profits taxes for the taxable year 1921. It is based upon the contention of the taxpayer that it should be permitted to file its income and profits tax return upon a fiscal year basis ending September 30, instead of upon a calendar year basis. FINDINGS OF FACT. The taxpayer is a corporation organized and existing under the laws of Massachusetts. It filed its income and profits tax returns for prior years, as well as the year involved in this appeal, upon a calendar year basis. It took inventories four times a year, one of which times was as of September 30. The only time, however, that physical inventories were taken was in September. At other times the inventories were merely book adjustments. Books were closed at approximately September 30 of each year. An2862 annual statement was 611 made as of September 30, which showed a summary of the expenses which included the statements which had been made for the prior quarterly periods. The minutes of the directors' meetings at the time of the organization of the corporation in 1892 show that a fiscal year basis was established as of September 30 and no change has been made in the accounting period since that date. DECISION. The taxpayer is entitled to file returns upon the fiscal year basis ending in September and its tax liability should be redetermined accordingly. Final determination of the deficiency, if any, will be settled on 10 days' notice in accordance with Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621326/	Appeal of CHARLES R. GOW CO.Charles R. Gow Co. v. CommissionerDocket No. 1542.United States Board of Tax Appeals1 B.T.A. 1023; 1925 BTA LEXIS 2700; April 15, 1925, decided Submitted March 24, 1925. 2700 Upon the evidence produced the taxpayer is not entitled to classification as a personal service corporation. John F. Malley, Esq., and John N. O'Donohue, Esq., for the taxpayer. J. A. Adams, Esq., for the Commissioner. GRAUPNER 1024 Before GRAUPNER, LANSDON, and SMITH. This appeal involves a deficiency in the amount of $4,940.54, due to the denial of personal service classification of the taxpayer by the Commissioner. Oral and documentary evidence was presented at the hearing and from such evidence the Board makes the following FINDINGS OF FACT. 1. The taxpayer was incorporated under the laws of Massachusetts, with its principal place of business in the City of Boston, on January 25, 1918, for the purpose of taking over the engineering and contracting business theretofore conducted by Charles R. Gow and his brother, Fred W. Gow, as a copartnership. 2. Charles R. Gow is an underground engineer of long experience and high standing in Boston and its vicinity. In January, 1918, he was called upon by the United States Government to volunteer his professional services in connection with construction work which had then been undertaken2701 by this Government for the furtherance of its part in the World War. Gow had been engaged in specialized underground engineering work since 1914 in Boston, in partnership with his brother, Fred W. Gow. He was the inventor and patentee of a type of caisson which was designed to be used in the construction of foundation piers or footings in certain localities in Boston where soil conditions prohibited the erection of ordinary foundations. The partnership and its successor, the taxpayer, engaged to construct foundation piers or footings which required the use of the apparatus invented by Gow. This work required the use of labor and materials, as well as the employment of the patented caisson and the technical skill of Gow. For this work the taxpayer owned motor trucks, iron or steel cylinders, pumps, derricks, and other tools and equipment. 3. Fearing that his work for the United States Government would take him away from Boston and that he would not be available for supervision and consultation, and that the partnership might not have any net income but might sustain heavy losses, for which he would be personally responsible, Gow formed a corporation to take over the business. 2702 He subscribed for 80 per cent of the capital stock; his brother and partner 10 per cent; and Harold B. Robinson, a trusted employee who had been with him many years, subscribed for the remaining 10 per cent. 4. The entire capital stock, amounting to $10,000 par value, all common, was issued to the following persons and was held by them without change during the year 1918: Charles R. Gow$8,000Fred W. Gow1,000Harold B. Robinson1,00010,000The consideration for which this capital stock was issued was as follows: Cash$5,000Plant5,00010,0001025 5. Upon the acceptance of his services by the United States Government, Gow was commissioned as a Major in the Construction Corps and assigned to supervise construction at the Army Base at South Boston, and his entire term of service for the Government, which continued throughout the year 1918, was spent there. His headquarters were about a mile and a half from the office of the taxpayer. During his entire term of service, his brother, Fred w. Gow, who was president of the taxpayer, visited him substantially every working day at the Army Base, and spent an hour or more of2703 each day with him, considering the various engineering projects on which the company was engaged, and discussing the difficulties encountered and the best methods to be used in meeting them. At some of these conferences, Fred W. Gow brought the samples of underground borings for advice as to the nature and character of the underground strata and the reports and recommendations thereon to be made to the company's clients. Whenever it appeared necessary, Gow personally went out and examined properties and locations. He was frequently called on the telephone, when difficulties arose which Fred W. Gow or Harold B. Robinson found themselves unable to meet. In this way Gow gave an average of about two hours per day of his time to the service of the taxpayer during the year 1918. 6. The business conducted by the partnership since 1914, and by the taxpayer in 1918, consisted of three different branches: (a) making underground test borings in the soil to obtain samples and advising as to the nature of the strata encountered and as to the best foundation methods to be used; (b) professional advice on general questions of underground engineering; and (c) designing, contracting for, and2704 installing a special type of foundation support which required for its installation a very intimate knowledge of the soil conditions, engineering skill, and continuous close supervision of the process by a skilled underground engineer to solve the various problems which the method entailed. For the two branches of the work first mentioned the taxpayer received professional fees and for the third branch it received payments based upon the cost of the labor and materials, plus a percentage. A small trained corps of experienced workmen was constantly employed to facilitate doing the manual labor necessary in installing the caissons and constructing the special foundation piers or footings, and was regularly retained on the pay roll, in order that their trained services might be continually at the disposal of the taxpayer. The gross income of the taxpayer from services and operations for the year 1918 was$165,185.53Expenses for the year show:Pay rolls$87,367.65Materials and supplies40,942.39Teaming3,175.97Officers' salaries4,202.00Rents, insurance, taxes, and sundry items8,932.51144,620.52Leaving a net income for 1918 of20,565.012705 1026 Salaries were paid to the stockholders as follows: Fred W. Gow$2,546Harold B. Robinson1,6564,202No salary whatever was paid to Gow. He received only the dividends paid on his stock as compensation for such services as he rendered. 7. The taxpayer filed an income-tax return as a personal-service corporation for the calendar year 1918. The Commissioner disallowed the claim of the taxpayer to personal-service corporation classification, found that its net income for the calendar year 1918 was $20,565.01, and mailed a deficiency letter to it, dated November 17, 1924, proposing the assessment of income and profits taxes upon the said income amounting to $4,940.54. DECISION. The determination of the Commissioner is approved. OPINION. GRAUPNER: The taxpayer asserts that it is entitled to personal-service classification and contends that it comes within the definition of a "personal service corporation" contained in section 200 of the Revenue Act of 1918. This definition provides that such a corporation is one "whose income is to be ascribed primarily to the activities of the principal owners or stockholders who are themselves2706 regularly engaged in the active conduct of the affairs of the corporation and in which capital (whether invested or borrowed) is not a material income-producing factor * * *." The evidence shows that Charles R. Gow, the owner and holder of 80 per cent of the capital stock, organized the taxpayer corporation in anticipation of leaving the business and entering the Army and to relieve him from personal liability for losses which might be sustained during his absence. It may not be said that he devoted his entire time and attention to the affairs of the taxpayer, though he did, to some degree, regularly engage in the active conduct of the affairs of the corporation. However, it is apparent that capital was a necessary and material income-producing factor. Therefore the taxpayer is not entitled to personal service classification.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621327/	Joseph A. Indelicato, Petitioner, v. Commissioner of Internal Revenue, RespondentIndelicato v. CommissionerDocket Nos. 92999, 93000United States Tax Court42 T.C. 686; 1964 U.S. Tax Ct. LEXIS 80; June 30, 1964, Filed 80 Decisions will be entered approving the basic deficiencies but disapproving the section 6653(b) additions for fraud. The Commissioner determined deficiencies in income tax and additions to tax for fraud, based upon alleged expenditures in excess of reported income and any known nontaxable sources. The parties filed a stipulation of facts which gave some support to the Commissioner's position. Petitioner presented no competent evidence that would prove error in the Commissioner's determination. When called as a witness by the Government he gave only his name and address and refused to answer all other questions, claiming privilege against self-incrimination under the fifth amendment. The Government conceded that it had failed to carry its burden of proof to establish fraud. Held, petitioner failed to carry his burden of proof in respect of the basic deficiency, which must therefore be approved. E. David Rosen, for the petitioner.James D. Burroughs, for the respondent. Raum, Judge. RAUM687 OPINIONThe Commissioner determined the following deficiencies in petitioner's income tax for the years 1957-59:Additions to tax,I.R.C. 1954Year:Deficiencysec. 6653(b)1957$ 11,358.76$ 5,679.38195894.641959741.80302.35The deficiencies were based upon unreported income from undisclosed sources, measured by estimated expenditures by petitioner during each of the years in excess of his reported income and any known nontaxable resources.The parties filed a stipulation of facts which incorporated petitioner's returns for each of the 3 years and contained some materials supporting the Commissioner's determination to some extent in respect of petitioner's personal living expenses.At the trial petitioner's counsel called only two witnesses. The first, a Government revenue agent, testified simply as to his reliance upon certain material in petitioner's 1959 return as the basis for his recommending in his report that a certain item be included 82 in petitioner's 1957 income. The second was an attorney who had prepared petitioner's 1959 return. Petitioner's counsel sought to obtain testimony from him as to the substance of certain documents relied upon by him in preparing the 1959 return, in order to establish that the foregoing item was improperly included in petitioner's 1957 income. The witness, however, had no first-hand knowledge whatever about the transaction, and the documents relied upon by him were not admissible in evidence.Since the transaction involved alleged payments by the petitioner for certain stock and since the petitioner himself undoubtedly could give direct evidence on the matter, the Court, upon learning that petitioner was in the courtroom, suggested to counsel that it would be a simple matter to put the petitioner upon the stand and ask him directly about the payments. Counsel mysteriously replied, "I cannot do that, your Honor." The reason appeared shortly. After some further discussion between counsel and the Court and after counsel unsuccessfully sought to introduce the foregoing documents in evidence, he rested, whereupon the Government called petitioner as a 688 witness. Apart from giving83 his name and address he answered each question in substance as follows: "Upon advice of counsel, I respectfully decline to answer on the ground it may tend to incriminate me."Such claim of privilege under the fifth amendment was plainly improper as to some of the questions, e.g., as to the amount of salary received during the year 1957. United States v. Sullivan, 274 U.S. 259">274 U.S. 259, 263-264. Again, another question relating to the length of petitioner's employment "by the Indies Motel in 1957," was entirely proper since his 1957 return revealed the Indies Motel as his employer, and whatever privilege he may have had in that respect had been waived by that disclosure.Upon failing to get any answers to its questions, the Government rested.This case must be disposed of upon the basis of burden of proof. The burden was upon the petitioner in respect of the basic deficiencies, but it was upon the Government in respect of the section 6653(b) additions for fraud. Recognizing that it had been unable to carry its burden the Government conceded the additions for fraud, and asked the Court to rule that petitioner was liable for the basic deficiencies for failure84 of proof. The Court indicated that it was favorably inclined to reach that result, but, upon request of petitioner's counsel, authorized the filing of a brief. However, no such brief has been filed.We hold that, in view of the state of the record, and wholly apart from any inferences that the Court might draw from petitioner's refusal to answer any questions that were not the proper subject for a claim of privilege, there has been a failure of proof by petitioner. In the circumstances,Decisions will be entered approving the basic deficiencies but disapproving the section 6653(b) additions for fraud.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621328/	Winter Paper Stock Company, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentWinter Paper Stock Co. v. CommissionerDocket No. 18501United States Tax Court14 T.C. 1312; 1950 U.S. Tax Ct. LEXIS 152; June 28, 1950, Promulgated 152 Decision will be entered for the respondent. Petitioner, a waste paper dealer in Cleveland, seeks relief under section 722 (b) (2) of the Internal Revenue Code, from excess profits tax for 1943 on the ground that its base period earnings were depressed because of a price war. Held, petitioner is not entitled to relief, as it has not established that its average base period net income is an inadequate standard of normal earnings, or that its business or the industry of which it is a member was depressed on account of temporary economic events unusual in the case of such industry. Edward M. Kovachy, Esq., and Evelyn P. Kovachy, Esq., for the petitioner.Lawrence R. Bloomenthal, Esq., for the respondent. Harron, Judge. HARRON 1312 This proceeding is for review of the respondent's disallowance of petitioner's153 application for excess profits tax relief under section 722 of the Internal Revenue Code, as amended, for the taxable year ended December 31, 1943. The petitioner filed an application for relief in which it requested an increase in the excess profits credit through the determination of a constructive average base period income.The respondent rejected the application for relief and disallowed a claim for refund asserted in the application for relief. The same letter also gave petitioner formal notice of certain final adjustments in its declared value excess profits tax and its excess profits tax for 1943 which resulted in deficiencies of $ 2.07 and $ 12,719.85, respectively.The petitioner does not contest the determinations which resulted in the above deficiencies and confines its assignment of error to the disallowance of its claim for relief under section 722. However, in so doing, the petitioner claims a refund of excess profits tax for 1943 in the amount of $ 32,389.59.The only question is whether the respondent erred in disallowing the petitioner's application for relief under section 722 (b) (2).Petitioner filed its income and excess profits tax returns for the year 1943154 with the collector for the eighteenth district of Ohio, in Cleveland.The record in this proceeding consists of a stipulation of facts, testimony, and exhibits, from which we make the following findings of fact.FINDINGS OF FACT.The stipulated facts are found as stipulated and are incorporated herein as part of the findings of fact by this reference.1313 Petitioner is a corporation, organized under the laws of the State of Ohio, with its principal office and place of business in Cleveland, Ohio. It is engaged in the business of collecting, grading, and packing waste paper, which it, in turn, sells to boxboard and other paper mills. The waste paper is collected by a fleet of trucks and brought into the plant, where it is sorted and cleaned in an operation which separates the various kinds and grades of paper. The more valuable grades are segregated and packed separately. The end product of this operation is known as "mixed paper," which goes through a separate cleaning operation, after which it is hydraulically pressed into large bales weighing up to a ton and then shipped to paper mills which use it as raw material in the manufacture of new paper.Petitioner buys its waste155 paper from department stores, office buildings, printing houses, schools, Boy Scout troops, and various industries in the Cleveland area. The purchase price of the waste paper is determined by a number of factors, including the amount of paper, cost of collecting, the cleanliness and grade of the paper, and the price paid by the paper mills for the waste paper.The gross profit, operating costs, and net operating profit per ton on paper handled by the Winter Paper Stock Co., exclusive of brokerage, during the years 1925 through 1939 were as follows:Per tonCalendar yearGrossLaborOther operatingNet operatingTonsprofitcostcostsprofithandledor (loss)1925$ 6.99$ 2.70$ 3.21$ 1.08 10,35119267.752.993.121.64 12,00119276.632.302.971.36 14,27719287.472.533.271.67 13,436Averages7.212.633.141.44 12,51619294.822.492.70(.37)14,61719304.331.932.43(.03)15,51619313.932.112.64(.82)14,38919322.771.302.76(1.29)12,54719333.961.602.79(.43)10.06519344.252.683.63(2.06)8,12519354.021.922.35(.25)10,675Averages4.012.002.76(.75)12,27619365.682.302.67.71 10,07519375.842.562.54.74 11,23519384.422.222.38(.18)11,95019393.891.991.98(.08)14,025Averages4.962.272.39.30 11,821156 Petitioner also carries on extensive operations as a broker of waste paper. In its brokerage transactions, petitioner pays the vendor approximately 95 per cent of the net price which petitioner receives for the waste paper from the paper mills. This paper is never delivered to or processed in the plant of petitioner, but is shipped directly to the mills by the vendor. Petitioner realizes an estimated gross profit 1314 of 5 per cent on brokerage sales, from which estimated other costs of 2 1/2 per cent of the net brokerage sales are deducted, resulting in an estimated net profit on brokerage sales of 2 1/2 per cent. The net brokerage sales, estimated gross profit and net profit, tons sold, average sales price per ton, and percentage which brokerage sales bore to total sales for the years 1925 through 1939 were as follows:EstimatedYearNet salesGross profitNet profit1925$ 79,319.81$ 3,776.95$ 1,888.48192674,291.793,537.501,768.75192784,661.104,031.222,015.611928123,355.365,874.062,937.03Averages, 4 years90,407.014,304.932,152.47192998,822.394,705.822,352.91193076,564.893,645.931,822.971931116,914.115,567.442,783.72193242,541.772,025.581,012.79193397,187.324,628.272,314.13193451,456.102,450.381,225.19193540,505.981,928.84964.84Averages, 7 years74,856.083,564.611,782.30193668,556.993,264.611,632.311937165,016.197,858.093,929.04193862,285.112,966.061,483.031939111,604.565,314.502,657.25Averages, 4 years101,865.714,850.822,425.41157 AveragePercentageYearTonssales priceof brokerageper tonsales tototal salesPercent19254,993$ 15.89$ 27.9519264,77115.5726.2819275,98614.1425.9719287,80415.8133.46Averages, 4 years5,88815.3528.4219296,73614.6727.9819308,0349.5330.59193112,6869.2245.2719325,8657.2530.3719337,14813.6044.3819345,4629.4238.3219354,5938.8229.04Averages, 7 years7,21810.3735.1319366,05511.3234.14193711,98513.7647.7819388,4627.4036.71193910,77010.7841.87Averages, 4 years9,31810.9340.13Petitioner's sales to the paper mills during the base period years consisted of approximately 50 per cent mixed paper, 20 per cent newspaper, 20 per cent corrugated paper, and 10 per cent high grade paper, including krafts, ledgers, and magazines. Because of the high freight rates, the principal customers for the waste paper collected by petitioner during the base period years were various paper mills located within a 300-mile radius of Cleveland, including the Ohio Boxboard Co., at Rittman, Ohio; the United States Gypsum Co., Gypsum, Ohio; the158 Geiger-Richardson Co., at Middletown and Lockland, Ohio; the Kalamazoo Paper Co. and the Allied Mills, at Kalamazoo, Michigan; and the Consolidated Paper Co. and the River Raisin Paper Co., at Monroe, Michigan. During the base period years, as well as for a number of years prior thereto, the prices paid by the paper mills for waste paper were determined in advance for a period of one month. The various mills execute purchase orders on or about the first of each month, stating the quantities of the various grades of paper that they would buy during that month and the price that they would pay for each grade shipped to them in that month. With the knowledge of the selling prices at the beginning of the month, the normal practice is for the waste paper dealer to adjust his buying prices so as to recover his costs and realize a profit per ton of paper handled.1315 The average cost per hundredweight of waste paper purchased by the petitioner during the years 1925 through 1939 was as follows:IncludingExclusive ofYearbrokeragebrokeragetransactions1925$ 0.65$ 0.631926.54.481927.53.511928.61.531929.64.611930.37.321931.36.301932.26.2419330.460.401934.33.291935.31.261936.42.371937.58.501938.27.231939.42.37159 The price paid by the paper mills for waste paper was fairly uniform through the middle western part of the United States. However, the prices offered by the paper mills for paper stock and the prices paid by waste paper dealers to their sources of supply fluctuated widely from month to month and year to year during the base period and for many years prior thereto.It is customary in the waste paper business to institute a service charge when the price paid by the mills for the paper stock falls below the cost of operations. However, despite the fluctuation of the mill prices during the base period years, no service charge for picking up the paper was made to its suppliers by petitioner. The purchase of paper from the sources of supply ordinarily was handled on a monthly basis, although a small portion of petitioner's business was under contracts which gave a standing order for a six-month period. While the department stores and office buildings have to get rid of their waste paper every day, they expect to be paid for it and will deal with whichever firm offers the best price and service.Petitioner's net sales including brokerage, gross profit, and net income or loss for the160 years 1923 through 1939 were as follows:Net sales,Net incomeYearincludingGross profitGross profitor (loss)brokeragePer cent1923$ 232,943.15$ 42,602.3718.29($ 11,047.51)1924248,341.8452,894.0121.30(387.89)1925283,774.7876,140.4326.8411,055.82 1926282,738.7296,525.9234.1318,018.84 1927325,937.4598,612.1630.2519,026.17 1928368,713.73106,229.5728.8123,827.65 1929353,173.2375,138.1321.28(3,636.94)1930250,262.0970,790.0328.301,348.54 1931258,264.8162,167.4224.08(13,226.74)1932140,087.7136,765.5226.25(15,198.22)1933218,979.9944,475.5520.31(5,929.96)1934134,293.7237,012.5627.56(16,273.32)1935139,469.6744,802.6432.12(2,449.11)1936200,840.0260,417.8830.087,722.86 1937345,396.8873,427.3021.269,886.30 1938169,665.2955,840.8432.91(3,059.20)1939266,556.3759,816.2922.44(1,372.16)1316 A competitor entering the waste paper business on a large scale in Cleveland from 1925 through 1939 could succeed only by developing adequate sources of waste paper. Accounts could be obtained by a new firm only by 161 offering more money for waste paper than was being paid by established concerns. To maintain and protect their own business the established dealers would be forced to meet the price offered by a new competitor.The National Waste Material Co. (hereinafter referred to as "National") entered the waste paper business in Cleveland in April, 1925, and continued in active operation until 1940, when it sold out to another company. During that period there were at least 60 or 70 other companies which were engaged in handling waste materials, such as rags, iron, bottles, and paper. Petitioner and National, however, were among the few concerns dealing exclusively in waste paper. During the years 1926 to 1939 National was the only new competitor to enter the waste paper business in Cleveland. National was owned in approximately equal shares by R. W. Joyce and his wife and by one Shapiro and his wife.On November 22, 1932, R. W. Joyce, president of National, was convicted on charges of violating the Interstate Commerce Commission Act and was fined $ 1,500 by the United States District Court. He believed that petitioner and other members of the waste paper industry in Cleveland were responsible162 for his indictment and conviction. While the Federal criminal case against Joyce was pending, National filed a petition in the Common Pleas Court of Cuyahoga County, Ohio, charging that petitioner and ten other concerns had violated the Ohio antitrust laws, sections 6390 to 6400 of the Ohio General Code, by conspiring to interfere and by interfering with National's business. This action never came to trial, but was settled in 1939. Soon thereafter National sold out to the Oco Waste Paper Co.During the base period years 1936 to 1939, Joyce bore a grudge against the petitioner and other members of the waste paper industry in Cleveland because he believed they were responsible for his indictment and conviction on charges of violating the Interstate Commerce Commission Act. During this period Joyce instructed his solicitors to obtain as many accounts of National's competitors as they could and told them that they could pay the suppliers as much as the mills would pay to National for the paper. National offered the ordinary price to its own customers, but would offer much higher prices to its competitors' customers by means of cards, letters, and telephone calls. Some of these cards163 were shown to National's customers by its competitors to prove that National was engaged in double dealing. Since the waste paper business is built on good service and fair and honest treatment of suppliers, National acquired a very poor name in the 1317 trade. Many sources of supply which maintained regular salvage departments became suspicious when they were offered as much for their waste paper as could be gotten for it from the mills. They felt that National might not be good for the money or that it did not give correct weights. Consequently, many of the suppliers refused to give their business to National. The net effect of National's policy of offering higher prices to its competitors' customers than to its own was to discredit it in the Cleveland area, causing it to lose tonnage during each of the years of the base period. During those same years the average tonnage purchased by petitioner increased.The following schedule shows the amount by which the tonnage of paper purchased by the petitioner fluctuated from year to year during the period 1925 to 1939, inclusive:Tons increaseor (decrease)Total tonsCalendar yearoverpurchasedBrokerageOtherprior year19252,792 15,2484,99310,25519261,531 16,7794,77112,00819273,338 20,1175,98614,13119281,168 21,2857,80413,481Total, 4 years73,42923,55449,8751929847 22,1326,73615,3961930908 23,0408,03415,00619314,986 28,02612,68615,3401932(10,068)17,9585,86512,0931933(18)17,9407,14810,7921934(3,263)14,6775,4629,2151935(1,552)13,1254,5938,532Total, 7 years136,89850,52486,37419362,814 15,9396,0559,88419378,225 23,15411,98511,1691938(2,502)20,6528,46212,19019393,802 24,45410,77013,684Total, 4 years84,19937,27246,927Averages:1925-2818,3575,88812,4691929-3519,5577,21812,3391936-3921,0509,31811,732164 Petitioner's average base period net income does not constitute an inadequate standard of its normal earnings within the meaning of section 722. Petitioner's business was not depressed in the base period because of temporary economic circumstances, unusual in the case of petitioner, or because of temporary economic events unusual in the industry of which petitioner was a member.Petitioner is not entitled to excess profits tax relief under section 722 (b) (2).OPINION.The only question in this proceeding is whether the respondent erred in disallowing petitioner's application for excess profits tax relief under the provisions of section 722 of the Internal Revenue Code. If the petitioner establishes that the tax computed without benefit of this section "results in an excessive and discriminatory 1318 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," then it must prevail. Sec. 722 (a). The petitioner relies upon section 722 (b) (2), under which the tax computed without benefit of section 722 shall be considered to be excessive and discriminatory if the taxpayer's average base165 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.Petitioner does not take the position that the industry of which it was a member was depressed during the base period years. But it does contend that its own business was depressed during those years, with the result that its average base period net income is an inadequate standard of normal earnings.We do not believe, however, that the petitioner has shown that its average base period net income was an inadequate standard of normal earnings. During the base period years 1936 and 1937, petitioner had net operating profits, exclusive of brokerage income, for the first time since 1928. In 1938 and 1939 it had net operating losses, exclusive of brokerage sales, which were substantially lower than the losses for any of the years since 1928, with the exception of the year 1930. Its average net operating166 profit per ton handled, exclusive of brokerage, during the base period was 29.75 cents, although in the seven prior years it had an average net loss per ton of 75 cents. During the base period years petitioner had an average net profit on brokerage sales of $ 2,425.41 on an average of 9,318 tons handled as broker. This compared favorably with the average net profit on brokerage sales of $ 2,152.47 from 1925 through 1928 on an average of 5,888 tons handled and $ 1,782.30 average net profit on brokerage sales from 1929 through 1935 on an average of 7,218 tons handled. 1167 Petitioner relies principally upon the contention that a price war existed in the base period years among the firms, including petitioner, which collected and processed waste paper in Cleveland. Regulations 112, section 35.722-3 (b), recognizes that a ruinous price war may be a temporary economic circumstance unusual in the case of a taxpayer 1319 and may constitute a basis for relief under section 722 (b) (2). But active competition is a normal factor in business and can not be considered temporary or unusual. Lamar Creamery Co., 8 T.C. 928">8 T. C. 928, 939; Monarch Cap Screw & Manufacturing Co., 5 T.C. 1220">5 T. C. 1220, 1230. And the evidence as a whole fails to show that the conditions under which the waste paper industry operated in Cleveland during the base period were either temporary or unusual.The waste paper industry differs from most other businesses in that competition in it lies primarily in the prices which are paid to the sources of waste paper, such as department stores, office buildings, printing houses, and various industries. This is because high handling costs limit the sources of supply to those which accumulate168 large amounts of waste paper over a relatively short period of time. A firm entering the waste paper business in Cleveland from 1925 through 1939 could succeed only by developing adequate sources of waste paper. Only by offering higher prices for waste paper could a new concern take away from the established businesses the accounts of suppliers of waste paper. Similarly, an existing concern desirous of increasing its share of the market could do so only by increasing the prices which it was willing to offer the suppliers.It may very well be that the policy adopted by National forced petitioner to pay prices for waste paper in excess of prices which might otherwise have obtained. But the raising of petitioner's costs by the activities of National was not the result of a price war; it was the result of the intense competition instigated by National among the waste paper dealers in Cleveland. Cf. Harlan Bourbon & Wine Co., 14 T.C. 97">14 T. C. 97. National's reasons for fomenting this competition are unimportant. The evidence does not show that National, through the payment of excessively high prices for waste paper, had embarked on a policy of destroying the169 industry in Cleveland because of certain real or imagined wrongs suffered by its president and general manager. National was interested in making a profit. It was also desirous of increasing its share of the market at the expense of its competitors. In furtherance of this policy, it embarked on a program of intense price competition. But once it had succeeded in taking away an account from one of its competitors through the payment of higher prices, it would shortly thereafter reduce the price to a point where it could make a profit on it. The net effect of National's policy, however, was to antagonize its regular sources of supply, who were not paid the higher prices offered potential customers, and the number of tons of waste paper handled by National decreased steadily during the base period. During those same years, the number of tons handled by petitioner increased.1320 Petitioner contends that the alleged price war had been in effect since 1929. 2 It is difficult to see how conditions under which an industry, or a segment of an industry, has been operating for 11 years can be characterized as temporary and unusual. And unless the economic circumstances under 170 which the petitioner operated were temporary and unusual, it is not entitled to relief under section 722 (b) (2). The price practices among the waste paper dealers in Cleveland were part of the economic climate in which petitioner operated from 1929 until 1940. The evidence shows that the intensively severe price competition was a regular and expected occurrence in Cleveland during those years; that it was not temporary and unusual.*171 We can not conclude from the evidence that the petitioner has established that its average base period net income is an inadequate standard of normal earnings because its business was depressed during the base period years due to a temporary economic circumstance, unusual in its case, namely, a ruinous price war. It is held, therefore, that respondent was correct in refusing to allow petitioner's claim for relief under section 722 (b) (2).Decision will be entered for the respondent. Footnotes1. The lower prices paid for waste paper by the mills in the base period years account for the fact that the estimated average net profit on brokerage sales increased only 12.68 per cent over that of the years 1925 through 1928, although there was an increase of 58.24 per cent in the brokerage tons handled in the base period over 1925 through 1928. In any comparison between the base period and the years 1925 through 1928, it is significant to note that the percentage of brokerage sales to total sales increased 41.20 per cent in the base period over 1925 through 1928, from 28.42 per cent of net sales to 40.13 per cent. However, the average sale price per ton, upon which an estimated net profit of 2 1/2 per cent was made for both periods, decreased 28.79 per cent, from $ 15.35 per ton to $ 10.93 per ton.↩2. The exact date at which National began the keen price competition is not clear from the evidence. Petitioner claims that the alleged price war was instigated by the president of National out of malice arising from his conviction of violation of the Interstate Commerce Act, for which he believed his competitors responsible. If this was the motivating factor, it is interesting to note that National's president was not indicted until March 1932, and not convicted until November 1932. And a comparison of petitioner's activities from 1929 through 1932 with its activities in the base period shows that its operations were much more profitable during the base period years. Petitioner had a net loss of $ 3,636.94 in 1929, a net income of $ 1,348.54 in 1930, a net loss of $ 13,226.74 in 1931, and a net loss of $ 15,198.22 in 1932. In the base period years, petitioner had a net income of $ 7,722.86 in 1936, a net income of $ 9,886.30 in 1937, a net loss of $ 3,059.20 in 1938, and a net loss of $ 1,372.16 in 1939.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621329/	JAMES M. DURRETT, JR. AND NORMA L. DURRETT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentDurrettDocket No. 8786-90United States Tax CourtT.C. Memo 1992-682; 1992 Tax Ct. Memo LEXIS 724; 64 T.C.M. (CCH) 1401; November 30, 1992, Filed 724 Decision will be entered for respondent. For Petitioners: Kendall O. Schlenker. For Respondent: Thomas F. Eagan. COUVILLIONCOUVILLIONMEMORANDUM OPINION COUVILLION, Special Trial Judge: This case was heard pursuant to section 7443A(b)(3) 1 and Rules 180, 181, and 182. Respondent determined a deficiency in petitioners' 1986 Federal income tax in the amount of $ 3,300.52 and additions to tax under section 6653(a)(1)(A) of $ 165.03 and section 6653(a)(1)(B) of 50 percent of the interest payable on that portion of the underpayment attributable to negligence or disregard of rules or regulations. The issues for decision are: (1) Whether $ 18,231 received by James M. Durrett, Jr. (petitioner), from the University of New Mexico during 1986 in settlement of a grievance claim is excludable from petitioner's gross income under section 104(a)(2), and (2)725 whether petitioners are liable for the additions to tax. Some of the facts were stipulated and are found accordingly. The stipulation and attached exhibits are incorporated by reference. Petitioners, husband and wife, resided in Albuquerque, New Mexico, at the time they filed their petition. In July 1983, after having practiced law for over 20 years, petitioner was appointed assistant university counsel for the University of New Mexico (the University). Petitioner, as an in-house attorney, represented and advised the University's Board of Regents, administration, faculty, and staff and assisted the university counsel, D. Peter Rask (Mr. Rask). Petitioner's employment was governed by the University's Personnel Policies & Practice Manual and by its Staff Employee Handbook. Since there was no written employment contract between petitioner and the University, these documents served as the contractual basis of petitioner's relationship with the University. In accordance with University policy, after successfully completing a 6-month probationary period, petitioner became a regular university employee on January 11, 1984. Policy 215 in the Personnel Policies & Practice Manual stated726 that the University retained the right "to suspend, demote, discharge, or take other disciplinary action against employees for proper cause" and "to relieve employees from duties because of lack of work or for other legitimate reasons". The standards and procedures to be followed by University officials in the discipline or discharge of regular employees were also set out in that manual. These procedures differed from those applicable to probationary employees who could "be terminated at any time prior to completion of the probationary period". Petitioner's job performance was routinely evaluated at the end of his probationary period and thereafter in November 1984 and July 1985 by Mr. Rask. The evaluator rated an employee's performance on a scale of 1 to 5, based on various factors. Petitioner received favorable ratings on all three evaluations. On January 1, 1985, the University Board of Regents appointed a new president of the University, who in turn appointed a Mr. Goldberg as university counsel. Mr. Goldberg replaced Mr. Rask, who left the University several months later. In November 1985, Mr. Goldberg orally requested petitioner's resignation as assistant University 727 counsel for the reason that Mr. Goldberg was not pleased with petitioner's performance. At trial, petitioner testified to his reaction at the time: Well, fine, Joe. We never discussed anything other than he wanted my resignation. And he said, Well, when are you going to give it to me? And I said, Well, I don't know. As soon as I can find another job. I will start looking. And I said, I have been kind of looking because things have been a little shaky around here. I knew there was trouble between the Board of Regents and the president. But I will continue looking and as soon as I can find something, I will leave. On December 19, 1985, Mr. Goldberg again insisted that petitioner set a date for his resignation, which Mr. Goldberg required be no later than January 31, 1986. On December 20, 1985, petitioner sent a memorandum to Mr. Goldberg advising that he was actively seeking other employment, that he would "cooperate in every way possible", but that he was unable to "set an arbitrary date" such as January 31, 1986, for his resignation. Petitioner felt it would take him at least 6 months to a year to find comparable employment. Petitioner testified that, sometime during 728 the following two weeks while on annual and holiday leave, he placed a call to the president of the Board of Regents, Jerry Apodaca, seeking advice about his employment situation. Petitioner told Mr. Apodaca that he did not want to resign because he liked his job, but that he also did not want to cause a lot of trouble. The advice petitioner received prompted a second memorandum to Mr. Goldberg on January 2, 1986, seeking written reasons for requesting petitioner's resignation. The following day, Mr. Goldberg replied with a lengthy, detailed letter describing particular incidents and areas in which he felt petitioner's work was deficient. It was also made clear to petitioner that action was being taken to terminate his employment with the University effective January 20, 1986. Mr. Goldberg stated in this letter that petitioner was entitled, under the University's personnel policies, to a hearing on the termination action and that a meeting could be arranged to give petitioner an opportunity to rebut and discuss the matter. Neither this letter nor any criticism of petitioner's performance was ever made public. On January 8, 1986, petitioner filed a grievance memorandum "pursuant729 to Policy 220 of the Personnel Policies and Practices Manual" with the University's director of personnel. Petitioner's grievance was the "wrongful termination" of his employment. Petitioner prepared the grievance himself and intended it to form the complaint upon which his remedy from the University would be based. The remainder of the memorandum read: The facts upon which this grievance is based are as follows: a. On January 3, 1986, I was handed a letter from University Counsel Joseph Goldberg stating that my employment would be terminated on January 20, 1986. A copy of this letter is attached. b. The statements contained in the January 3, 1986 letter are incorrect or explainable and I was not given an opportunity to discuss or explain any of the matters prior to delivery of the termination notice. The facts stated above constitute a discharge without proper cause in violation of University policy set out in Policy 215 and Policy 225 of the Personnel Policies and Practices Manual. The remedy sought is reinstatement of my position with full back-pay and benefits in the event that any working time is lost as a result of this termination. Petitioner met with Mr. Goldberg730 on January 13, 1986, and verbally responded to the allegations previously made. A conference was scheduled for January 16, 1986, to be attended by petitioner, Mr. Goldberg, and the director of personnel in order to address petitioner's grievance. Immediately before the conference, Mr. Goldberg handed petitioner a letter stating that he would not withdraw the action to terminate petitioner's employment. At the conference, a settlement was reached between the parties which resulted in a lump-sum payment to petitioner in the amount of $ 18,231. A "Memo of Understanding for Settlement of Grievance" was prepared by the University's employee relations manager on February 3, 1986, and signed by Mr. Goldberg and petitioner. The following stipulations constituted the entire agreement between the parties: (1) Petitioner's termination was changed to resignation effective January 20, 1986. (2) All communications regarding petitioner's termination were removed from his personnel file and held in a confidential grievance file. (3) University counsel was instructed to forward all employment inquiries to Mr. Rask. (4) Petitioner received the lump-sum amount as "full financial settlement 731 and no payment of any other benefits" would be made. (5) Petitioner would not pursue the grievance on any other format and the matter would be considered closed. The University issued a check to petitioner on February 14, 1986, for $ 18,231. This amount was equal to one-half of petitioner's annual compensation with the University. Petitioner thereafter received a Form 1099-MISC from the University reporting this amount as nonemployee compensation for 1986. In the preparation of his 1986 income tax return, petitioner did not include the $ 18,231 in income. Based on the information return filed by the University, respondent determined that the $ 18,231 constituted taxable income. The determinations by respondent in a notice of deficiency are presumed correct, and the burden of proof is on the taxpayer to prove that the determinations are in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). Respondent contends that the $ 18,231 settlement petitioner received from the University was intended to settle a claim involving the breach of an employment contract and was paid in exchange for petitioner's resignation. Thus, the amount is includable732 in gross income. Petitioner contends that the payment was for claims more "tort-like than contract-like", and that, therefore, the payment is excludable under section 104(a)(2). Section 61(a) states that, except as otherwise provided, gross income means "all income from whatever source derived". Section 104(a)(2) provides otherwise, in that it excludes from gross income damages received on account of personal injuries or sickness. The Internal Revenue Code of 1954 does not explain what a taxpayer must show in order to prove that the damages were received "on account of personal injuries". Stocks v. Commissioner, 98 T.C. 1">98 T.C. 1, 8-9 (1992); Seay v. Commissioner, 58 T.C. 32">58 T.C. 32, 36 (1972). However, it is well established the term "personal injuries" in section 104(a)(2) includes nonphysical as well as physical injuries. See United States v. Burke, 504 U.S. , 112 S. Ct. 1867, 1871-1872 n.6 (1992); Threlkeld v. Commissioner, 848 F.2d 81">848 F.2d 81, 84 (6th Cir. 1988), affg. 87 T.C. 1294">87 T.C. 1294, 1308 (1986); Bent v. Commissioner, 87 T.C. 236">87 T.C. 236, 244 (1986),733 affd. 835 F.2d 67">835 F.2d 67, 69-71 (3d Cir. 1987). Section 1.104-1(c), Income Tax Regs., provides that "The term 'damages received (whether by suit or agreement)' means an amount received (other than workmen's compensation) through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of such prosecution." Therefore, section 104(a)(2) excludes only damages received on account of the prosecution or settlement of tort or tort-type claims, not damages received on account of the prosecution or settlement of economic rights arising out of a contract. Downey v. Commissioner, 97 T.C. 150">97 T.C. 150, 160 (1991); Metzger v. Commissioner, 88 T.C. 834">88 T.C. 834, 848-850 (1987), affd. without published opinion 845 F.2d 1013">845 F.2d 1013 (3d Cir. 1988). Section 104(a)(2) provides for the exclusion of damages received through a settlement agreement, as well as through a suit. Metzger v. Commissioner, supra at 847. In this case, petitioner received $ 18,231 through a settlement agreement. Where a settlement agreement734 exists, determining the exclusion for tax purposes depends on the nature of the claim that was the actual basis for settlement rather than the validity of the claim. Stocks v. Commissioner, supra at 10. The settlement agreement between petitioner and the University contains no express language that the payment in question was made on account of a personal injury or tort or tort-type rights. The exact language of the agreement read: 4. Mr. Durrett will receive a sum of $ 18,231.00. This will constitute full financial settlement and no payment of any other benefits will be made. 5. Mr. Durrett will not pursue this grievance on any other format and this matter will be considered closed. At the beginning of the agreement, the document was captioned "Re: J. M. Durrett, Jr., Unjust Termination." If the settlement agreement lacks express language stating what the settlement amount was paid to settle, then the most important factor in determining any exclusion under section 104(a)(2) is the "intent of the payor" as to the purpose in making the payment. Knuckles v. Commissioner, 349 F.2d 610">349 F.2d 610, 612 (10th Cir. 1965),735 affg. T.C. Memo. 1964-33; Metzger v. Commissioner, supra at 847-848; Glynn v. Commissioner, 76 T.C. 116">76 T.C. 116, 120 (1981), affd. without published opinion 676 F.2d 682">676 F.2d 682 (1st Cir. 1982). Such an intent is factually grounded and must be discerned from an inquiry into all the facts and circumstances surrounding the actual payment. Seay v. Commissioner, supra at 37; Madson v. Commissioner, T.C. Memo 1988-325">T.C. Memo. 1988-325. Petitioner at all times claimed that Mr. Goldberg's actions in terminating his employment were taken without proper cause and without following the proper procedures set out in the University's Personnel Policies & Practices Manual. In Forrester v. Parker, 606 P.2d 191 (N.M. 1980), the New Mexico Supreme Court held that, based on the words and conduct of the parties, the personnel policy guide constituted an implied employment contract governing the employment relationship. Neither petitioner nor respondent disputed the existence of such a contract between petitioner 736 and the University. Petitioner admitted that the grievance he filed did not allege any personal injury, that he did not seek any pecuniary amount in damages, and that he only sought continued employment with the University. In fact, his grievance memorandum stated expressly "The remedy sought is reinstatement of my position with full back-pay and benefits in the event that any working time is lost as a result of this termination." These factors are all indicative of a claim contractual in nature. Glynn v. Commissioner, supra; Nussbaum v. Commissioner, T.C. Memo. 1982-725; Boudar v. E.G. & G., Inc., 742 P.2d 491">742 P.2d 491 (N.M. 1987). Nevertheless, petitioner argues that his grievance did not state all of his possible claims against the University, and that there were additional "tort or tort-type" claims. For example, petitioner argues that any action by him against the University "would have been based" upon a "mixed theory of recovery in tort and contract" and "would also have been based on" a constitutional violation of petitioner's right to due process. Petitioner also cited a number of737 cases addressing the validity of these, and other, possible claims. The Court finds that these arguments are misplaced. The question that ultimately must be answered is what claims did the payer intend to settle at the time the payment was made and not what claims petitioner might have brought in a hypothetical legal action. In a case where the intent of the payer had to be discerned, Stocks v. Commissioner, supra, this Court concluded that the payment received by an employee in settlement of a dispute with her employer was intended to settle a potential breach of contract claim as well as a potential racial discrimination claim; 2 thus, the damage award was allocated accordingly. That case is distinguishable from this case because the employee in the Stocks case did not use the administrative grievance process but had filed two civil rights complaints with the U. S. Equal Employment Opportunity Commission. Therefore, the taxpayer's employer had knowledge of those claims and, in fact, testified that the settlement would not have been the same unless those civil rights claims were released.738 The Court finds no evidence in this case that the University intended to settle any claim of petitioner based upon "tort or tort-type" rights or personal injury claims, such as emotional distress or harm to reputation, or that the University had knowledge of any such claims that petitioner intended to pursue. The language on the face of the grievance and settlement documents sets forth a claim contractual in nature, and petitioner's testimony does not persuade the Court to find otherwise. The settlement was not made pursuant to any past or pending legal action. It appears that the settlement was intended to compensate petitioner only for lost wages, namely, one-half of his annual salary from the University. There is no evidence that petitioner, in negotiating the termination settlement, asserted any claim or argument based upon tort or tort-type rights, or received any part of the settlement as compensation for such a claim. Therefore, the Court finds that petitioners failed to meet their burden of proof. Respondent is sustained on this issue. See United States v. Burke, supra.Respondent also determined petitioners were liable for the additions739 to tax for negligence under section 6653(a)(1)(A) and (B) for 1986. Section 6653(a)(1)(A) provides that, if any part of an underpayment of income tax is due to negligence or disregard of rules or regulations, there shall be added to the tax an amount equal to the sum of 5 percent of the underpayment. Under section 6653(a)(1)(B), an additional amount is due equal to 50 percent of the interest payable under section 6601 with respect to the portion of such underpayment which is attributable to negligence or disregard of rules or regulations. Negligence is the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). The Commissioner's determination is presumptively correct and will be upheld unless the taxpayers are able to rebut the presumption by showing they used due care. See Reily v. Commissioner, 53 T.C. 8 (1969). Under section 6653(g), if any amount is shown on an information return, and the payee or other person with respect to whom the return is made fails to properly show such amount on his or her return, 740 any portion of an underpayment attributable to such failure shall be treated as due to negligence in the absence of clear and convincing evidence to the contrary. In the preparation of his 1986 income tax return, petitioner failed to report the $ 18,231 which was properly includable in gross income. Petitioner received from the University of New Mexico Form 1099-MISC reporting the total amount as nonemployee compensation and knew this information had been reported to respondent. Petitioner testified that, prior to his conference with the University which resulted in the settlement, he consulted with attorneys who specialized in employment and civil rights law. He was advised that a recovery for violation of his civil rights would not constitute taxable income. These attorneys also expressed their opinion that it appeared to them that petitioner had a civil rights claim. However, these attorneys did not represent petitioner in the settlement with the University nor did petitioner consult with these attorneys after the settlement was completed. Petitioner sought no other legal advice. As noted earlier, the record is barren of any claim or semblance of a claim by petitioner for741 personal injuries, including a claim for violation of petitioner's civil rights. Petitioner's belief that he had a valid civil rights claim, even though no such claim was ever asserted, was the basis upon which he failed to report the $ 18,231 on his income tax return. Such a belief, standing alone, does not prove by clear and convincing evidence that petitioner used due care in the preparation of his return. Therefore, the Court must hold for respondent on the additions to tax issue. Decision will be entered for respondent.Footnotes1. All section references are to the Internal Revenue Code in effect for the year at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Injuries resulting from racial discrimination are personal injuries for purposes of sec. 104(a)(2). See Stocks v. Commissioner, 98 T.C. 1">98 T.C. 1, 9↩ (1992).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621331/	FRANKLIN MILLER HANDLY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Handly v. CommissionerDocket Nos. 66810, 67671, 74406.United States Board of Tax Appeals30 B.T.A. 1271; 1934 BTA LEXIS 1201; July 24, 1934, Promulgated 1201 The income of a trust created in Tennessee by a mother for the education and support of each of her minor children and distributed to their father, one of the trustees, for that purpose, held not within her gross income, notwithstanding the settlor's right to revoke as to principal in a future year. J. Harry Price, Esq., and W. T. Kennerly, Esq., for the petitioner. John D, Kiley, Esq., for the respondent. STERNHAGEN 1271 Respondent determined deficiencies of $12,639.10, $10,472.69, and $6,308,93 in petitioner's income taxes for 1929, 1930, and 1931, by including in gross income the income of five trusts which petitioner contends is taxable to others who are the beneficiaries. FINDINGS OF FACT. Petitioner is a resident of Knoxville, Tennessee. She and her husband, Oscar Handly, Sr., have five children, who in 1925 were minors and resided with them. Petitioner was then the owner of 2,500 shares of stock in the Anderson-Dulin-Varnell Co. (now called 1272 Miller's, Inc.), a corporation successfully engaged iv the operation of a department store in Knoxville. On September 1, 1925, petitioner transferred to the Fidelity1202 Trust Co. of Knoxville, Tennessee, and to Oscar Handly, Sr., as trustees, five blocks of 400 shares each of her said stock, one block in trust for each of her five children, under five identical trust instruments. These instruments provide that: The entire income, profits, increments and earnings from the properties conveyed hereunder shall be applied for the use and benefit and for the education, maintenance and support of [the beneficiary]. Said income, profits, earnings, dividends and increments shall be held and re-invested as directed by the Settlor and the Settlor shall have the right to direct the expenditure of all or any part of said income, earnings and profits for the education, maintenance and support of said child as she may determine at any time, and the Trustees and Settlor shall and are hereby expressly relieved from accounting to the said beneficiary, his heirs, executors, administrators or assigns, or to anyone else, for said expenditures but such expenditures shall be made only for the use and benefit of said child. * * * It was further provided that upon the settlor's death or disability, the expenditure of the income be entrusted to Oscar Handly, Sr., 1203 for the child's benefit, and upon his death to the child's guardian. Subject to certain conditions, not here material, the beneficiary was to receive the principal upon reaching the age of thirty-five. Should a beneficiary die before receiving the principal, leaving no issue or widow surviving, the principal was to be equally distributed to his surviving brothers and sisters, or if a widow survived, then the income was to go to her during widowhood, and the principal thereafter distributed as above, or if widow and issue survived, then the benefits of the trust should inure to them in a specified manner. The settlor reserved the right to change the securities in trust for others of equal value, to direct the investment of income in securities, and to exercise the voting rights of trust stock. The sixth paragraph of the instruments is as follows: The Settlor reserves the right to revoke the trust herein created as to the original securities transferred hereunder or their equivalent in value, if converted, on January 1, 1936, or any time thereafter, but such power of revocation shall not exist in the Settlor prior to January 1, 1936. In the event of revocation, the title to1204 the original properties conveyed hereunder, or if converted, the title to their equivalent in value shall be reconveyed and restored to the Settlor. Provided, however, that the trust herein created is not revocable as to the income, profits, or increments and earnings realized by the Trustees from the securities conveyed hereunder. Since the creation of these trusts the Fidelity Trust Co., trustee, has retained possession of the principal, collected and disbursed the income, and kept all records thereof. On October 21, 1926, the trustees purchased 1,500 more shares of the Anderson-Dulin-Varnell Co. for $330,000, paying interest on a deferred portion of the price. 1273 This purchase was made on the settlor's instructions, with income collected for the trusts, to each of which 300 of the newly acquired shares were added. All income other than that so reinvested has been paid to Oscar Handly, Sr., who has invested it for the beneficiaries. On January 2, 1934, the Hamilton National Bank of Knoxville was substituted as cotrustee for the Fidelity Trust Co.The aggregate income of the five trusts for 1929, 1930, and 1931 from the 2,000 shares originally contributed and1205 the 1,500 shares subsequently acquired was as follows: 1929$85,750193068,600193151,625The trustees have reported all income received and disbursed by them as fiduciaries, and each beneficiary has reported all income received by his guardian from the trusts and from investments made by their father, as natural guardian, with income received from the trusts, and they have paid all Federal income taxes thereon. Respondent has added the following amounts to petitioner's gross income as representing the aggregate income of the five trusts: 1929$85,750193068,600193151,625OPINION. STERNHAGEN: The respondent has treated the trust income as taxable to the settlor under Revenue Act of 1928, section 167.1 It is, however, hard to see this without confusing the mother and the children. She was not a beneficiary of the trust during any of the years before us, nor, during those years, could any part of the trust income be legally distributed to her individually, nor could it be held or accumulated for future distribution to her. It could only be and was only distributed to Oscar Handly for the named beneficiaries. The fact that they1206 were minors under guardianship is consistent with their being separate individual taxpayers, . While, as respondent says, the settlor, being the mother of the beneficiaries, is with the father a joint natural guardian and jointly 1274 charged with their care and education (Tennessee Laws of 1923, ch. 41), it is at least doubtful whether her obligation imposes on her a burden as prompt or as1207 absolute as on the father, ; , and hence whether, short of necessity, the trust operated to relieve her of any natural onus. We think this falls far short of being a substantial economic benefit to her, comparable with that in ; cf. . Whatever power Congress may have, as supported by that decision, to tax such income to the settlor, the language of section 167 does not purport to exercise it. It is also plain that the settlor had not, during the taxable years in question, the power to revest in herself any part of the corpus, and hence, that section 166 2 is not applicable. . 1208 Reviewed by the Board. Judgment will be entered under Rule 50.SEAWELL, ADAMS, and TURNER dissent. MURDOCK MURDOCK, concurring: I fully approve of the above opinion except for the reference to the case of Edmund O. Schweitzer,30 B.T.A. 155">30 B.T.A. 155. The present case and dissenting opinion in the Schweitzer case demonstrate that the latter case was incorrectly decided. The reasoning in the Schweitzer case was contrary to the Commissioner's rulings and regulations (C.B. 3, p. 116, S.O. 14), and to prior decisions of the Board. Irene O'D. Ferrer,20 B.T.A. 811">20 B.T.A. 811; S. A. Lynch,23 B.T.A. 435">23 B.T.A. 435; Lilian K. Blake,23 B.T.A. 554">23 B.T.A. 554; John H. Stevens,24 B.T.A. 52">24 B.T.A. 52; Francis J. Stokes,28 B.T.A. 1243">28 B.T.A. 1243. Cf. Frank P. Welch,12 B.T.A. 800">12 B.T.A. 800; Sidney R. Bliss,26 B.T.A. 962">26 B.T.A. 962; Edson v. Lucas, 40 Fed.(2d) 398. Where the statute provides that the income of a trust is taxable to the "beneficiaries" the word was intended to have the meaning which it always has in the law of trusts. It does not include one only indirectly benefited*1209 from income distributed for the benefit of those named in the trust instrument. The latter are the "beneficiaries." Cf. concurring opinion Iola Wise Stetson,27 B.T.A. 173">27 B.T.A. 173. The only exceptions to this rule are by specific legislative provisions. Burnet v. Wells,289 U.S. 670">289 U.S. 670; Langley v. Commissioner, 61 Fed.(2d) 796; Mabel A. Ashforth et al., Executors,26 B.T.A. 1188">26 B.T.A. 1188. I think the Schweitzer case should be overruled. LEECH agrees with this concurring opinion. Footnotes1. SEC. 167. INCOME FOR BENEFIT OF GRANTOR. Where any part of the income of a trust may, in the discretion of the grantor of the trust, either alone or in conjunction with any person not a beneficiary of the trust, be distributed to the grantor or be held or accumulated for future distribution to him, or where any part of the income of a trust is or may be applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23(n), relating to the so-called "charitable contribution" deduction), such part of the income of the trust shall be included in computing the net income of the grantor. ↩2. SEC. 166. REVOCABLE TRUSTS. Where the grantor of a trust has, at any time during the taxable year, either alone or in conjunction with any person not a beneficiary of the trust, the power to revest in himself title to any part of the corpus of the trust, then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621332/	FLINT, GOERING & CO., LTD., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Flint, Goering & Co. v. CommissionerDocket No. 20078.United States Board of Tax Appeals19 B.T.A. 421; 1930 BTA LEXIS 2404; March 26, 1930, Promulgated 2404 The petitioner was a limited partnership and in the year 1919 it distributed its assets to its members with the understanding that the income received by the members from such assets should be deposited with the partnership to take care of future liabilities, if any. At the close of 1922 the amounts thus deposited aggregated the sum of $37,557.99. Held that such amounts deposited with the petitioner by its members did not constitute income to it. William C. Alexander, Jr., Esq., for the petitioner. Eugene Meacham, Esq., for the respondent. SMITH 421 This proceeding is for the redetermination of an alleged deficiency in income tax for the year 1922 amounting to $4,694.75. The petitioner alleges that the respondent erred in including in income for the year 1922 the amount of $37,557.99. 422 FINDINGS OF FACT. The petitioner was a limited partnership association with an office in Philadelphia, Pa. Prior to the year 1919 it was engaged in business as ship brokers and as such carried on business in the city of Philadelphia up to the year 1919, since which time it has not been engaged in business. Due to the termination of2405 the World War, the petitioner in the year 1919 determined to discontinue its business as ship brokers. It also determined to liquidate its assets, inasmuch as its members desired to enter other fields of business activity. In pursuance of such determinations the known liabilities of the petitioner were paid during the year 1919 and the partnership assets, which consisted of bonds and cash, were distributed to its members as their several interests therein appeared. At the time of the distribution certain questions relating to the liability of the petitioner to income tax for prior years had not been settled. In view of this situation, the assets distributed to the members of the partnership were turned over to them with the understanding that the income received by them from such assets would be deposited to the credit of the petitioner to take care of any liabilities which might arise. Accordingly, the three members from time to time deposited their individual checks in a bank to the credit of the petitioner. Such deposits were allowed to accumulate until the close of the year 1922. In the meantime, however, the securities which had been distributed to the three members were2406 sold or hypothecated by them without restriction, no accounting being made to the petitioner of such disposition. After the close of the year 1922, the amounts deposited to the credit of the petitioner were distributed to its three members. The petitioner filed returns as a personal service corporation for the years 1918, 1919, 1920, and 1921. Its return for the year 1922 was prepared as a partnership return, but on a corporation form reporting the amount of $37,557.99, which was included by the respondent in computing petitioner's net income. This amount of $37,557.99 represented an accumulation over several years of the sums deposited to petitioner's credit by its three members. In determining the income-tax liability of George Flint, one of the members of the partnership, for the year 1919, the respondent considered the petitioner as having been liquidated in that year, Subsequently, the respondent determined that the petitioner should be classified as a personal service corporation. The alleged deficiency for the year 1922 was predicated upon respondent's determination that the petitioner is taxable as a corporation. 423 OPINION. SMITH: The issue before*2407 us is whether the amount of $37,557.99 constituted income to the petitioner for the year 1922. From the record in this proceeding we are convinced that when the partnership decided to discontinue business in 1919 and to distribute its assets, it thought best to make some provision to take care of unknown or prospective liabilities. Consequently, the partnership assets were distributed to its members with the understanding that the income derived by them from such assets should be deposited with the partnership to take care of any such liabilities. This view of the matter, in our opinion, characterizes the amounts deposited in the bank to the credit of the petitioner not as income of the petitioner, but as property of the depositors, liable to be used by the petitioner only in the event that it should be needed to meet liabilities. The petitioner had not taxable income in 1922. Judgment will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621333/	GERRIT VANDERPOL AND HENRIETTA VANDERPOL AND VAN'S TRACTOR, INC., Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentVander Pol v. CommissionerDocket No. 18729-84.United States Tax CourtT.C. Memo 1987-555; 1987 Tax Ct. Memo LEXIS 547; 54 T.C.M. (CCH) 1021; T.C.M. (RIA) 87555; November 4, 1987; As amended November 25, 1987 John L. Burghardt, for the petitioners. Donna J. Rice, for the respondent. WRIGHTMEMORANDUM FINDINGS OF FACT AND OPINION WRIGHT, Judge: By separate notices of deficiency dated March 15, 1984, respondent determined deficiencies in petitioners' Federal income tax as follows: PetitionerTaxable YearDeficiencyVan's Tractor, Inc.1977$ 25,401197836,588197933,471Gerrit and HenriettaVanderPol1977$ 9,433197811,814197916,157548 After concessions, the sole issue for decision is whether the amounts paid by Van's Tractor, Inc., to its officer-shareholder Gerrit VanderPol, during the taxable years 1977, 1978 and 1979, constitute reasonable compensation within the meaning of section 162(a)(1). 1FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by reference. Petitioner Van's Tractor, Inc. (hereinafter referred to as the corporation), was organized under the laws of California. The corporation maintained its corporate headquarters and principal place of business in Modesto, California, at the time the petition was filed. During the taxable years in issue, the corporation, an accrual basis taxpayer, was engaged on the sales and service of farm equipment and machinery. On its corporate income tax returns for fiscal years 1977, 1978 and 1979, the corporation549 claimed deductions in the amounts of $ 54,161, $ 76,225 and $ 72,762, respectively, for compensation paid to officers under section 162. Petitioners Gerrit and Henrietta VanderPol (hereinafter referred to as VanderPol or the VanderPols) resided in Modesto, California, at the time they filed their petition. The VanderPols, cash basis taxpayers, filed joint income tax returns for the calendar years 1977, 1978 and 1979. They claimed the benefit of the maximum tax on earned income under section 1348 for all amounts received as compensation from the corporation. All of the 700 shares of the corporation's outstanding stock are owned by the VanderPols. In 1965, the year the corporation was organized, the VanderPols made an initial contribution of capital in the amount of $ 35,000. Since then there have been no contributions to capital. The officers and directors at all times since incorporation have been Gerrit VanderPol as president and Henrietta VanderPol as secretary/treasurer. VanderPol was born and raised on a farm in Washington, where he became familiar with farming techniques and equipment. His first job was selling farm equipment for International Harvester. In 1947, 550 he opened a farm equipment dealership with his brother in Washington. Fourteen years later he sold his share to his brother and moved to Modesto, California, where he invested the proceeds in another farm equipment dealership. This business, a sole proprietorship which subsequently incorporated as Vann's Tractor, Inc., was engaged in selling used tractors. Van's Tractor, Inc., was successful almost immediately, chiefly because VanderPol purchased used tractors directly from Great Britain. Using this purchasing procedure, VanderPol took advantage of certain foreign tax provisions, and saved roughly 50 percent of the cost per tractor. He also provided a six-month 100 percent warranty on the used tractors, which was highly unusual. In 1971, the corporation bought a Massey-Ferguson dealership in Modesto, California, expanding the original product lines of Van's Tractor. VanderPol ceased importing used tractors when the tax advantages which lowered the cost of used tractors in Great Britain were eliminated. In 1975, the corporation purchased the assets of Valley Tractor, a John Deere dealership. Valley Tractor had two sales locations, one in Modesto, California, and one in Patterson, 551 California (hereinafter referred to as John Deere Modesto and John Deere Patterson). These two stores continued to do business under the name of Valley Tractor, although they were owned by the corporation, Van's Tractor, Inc. As evidenced by the figures below, the corporation was successful and enjoyed a consistent level of profitability. Net profit asFiscalGrossBookNetBeginninga percentageYearSalesIncomeProfitsNet Worthof Net Worth1976$ 6,311,634$ 178,615$ 358,204$ 543,24065.94%19776,211,578108,642190,483721,85526.39%19787,420,896105,034266,832828,63432.20%197910,755,917191,242243,637944,77725.79%Although VanderPol was the general manager for all three locations, each operation was distinct and maintained separate books, employees, bank accounts and franchises. By 1979, the corporation held the following franchises: John Deere, Patterson: Agricultural Dealer Franchise, Consumer Products Dealer Franchise, Agricultural Dealer Security Agreement, Agricultural Dealer Leasing Agreement, Consumer Products Dealer Leasing552 Agreement; John Deere, Modesto: Consumer Products Dealer Agreement, Agricultural Leasing Agreement; Massey-Ferguson: Dealers Sales and Service Agreement. Each of these franchises was obtained through VanderPol's skillful negotiations and each brought more business to the corporation. In 1979, VanderPol was awarded the John Deere engine distributorship, which authorizes him to sell John Deere equipment to other dealers. The distributorship was one of three in California and was awarded after a lengthy and competitive selection process. At all three locations the corporation's principal business was the sale and service of the franchise line equipment. However, all three locations also sold more complementary lines of equipment than other dealerships in the area. The corporation continually expanded the number of product lines throughout the years in issue. Due to the generally favorable weather conditions and the long growing season, the region was able to sustain numerous different kinds of agricultural operations, which, in turn, required a wide range of farming equipment. 2 Many of the crops required round-the-clock care, placing heavy demands on agricultural equipment. 553 To meet these demands the corporation provided service and maintenance 24-hours a day. The continuous nature of the servicing needs meant that the corporation had to keep a large inventory of parts in stock. VanderPol initiated a sophisticated ordering system. Unlike other farm equipment dealership owners who estimated future needs by looking exclusively to past sales records, VanderPol conducted thorough research into a number of different factors which would have impact on the upcoming market. He read farm magazines and government reports to aid him in ordering new equipment and parts. He also watched fluctuations in market conditions for chief crops to assist him in determining what his future ordering needs would be. The parties agree that Vanderpol worked very hard. He worked an average of 12 to 16 hours per day, frequently staying late to do office work. He tried to visit every sales location each day but was not always able to do so. VanderPol was ultimately responsible for every facet of his business. As a general manager he supervised all aspects of the business554 at all three locations. 3VanderPol was responsible for ordering, purchasing and managing inventory. If specific equipment was necessary he would often travel to obtain it. Occasionally VanderPol would make mechanical alterations to available equipment to create a product better suited for a particular agricultural need. He approved sales, 4 discounts and larger trades of equipment. He supervised personnel and monitored the parts and service departments as well as the sales staff at each of the three locations. He implemented an advertising program. He organized community farm activities, such as an annual tractor pull exhibition. He also participated in both the Future Farmers of America and the 4-H Program. VanderPol placed great emphasis on customer service. VanderPol would occasionally make trips out into the farming community to listen to the farmers' needs and concerns, as well as to555 cultivate goodwill. Pursuant to his purchasing contract for the John Deere franchise, VanderPol was required to erect a new plant. He contributed to the building plan and designed an innovative service bay which made it easier for the employees to repair the equipment. VanderPol established individual credit policies for his businesses. These have helped to protect the corporation from financial distress at a time when other farm equipment dealers were experiencing an unusually high loan failure rate. Indeed, in its 35 years of doing business, the corporation has repossessed equipment, as a result of default, only 6 times. VanderPol has never taken a vacation, although he has traveled extensively on business, investigating new sources of supply and product lines from around the world. These trips were exclusively business-related. He has never been accompanied by his wife on any of his business trips. Pursuant to the556 banks' financing requirements, VanderPol had to personally guarantee each loan the banks made to the corporation. Similarly, VanderPol personally guaranteed all the leases held by the corporation. VanderPol was also the sole owner of two other businesses. He owned Vanco Leasing Company, an in-house leasing business, which handled mostly farm equipment and related items. VanderPol estimated that he spent about 2 hours a week on Vanco business. He also owned Gervans, a wholesale company which distributed sprayers and other equipment to distributors. This business only required 4 to 6 hours of VanderPol's time per week. Each of these businesses had its own employees and VanderPol's involvement was exclusively managerial. Neither of these businesses had their own separate physical plants. Vanco was located in the Massey-Ferguson dealership in Modesto, while Gervans was situated at John Deere, Modesto. VanderPol was paid under a combination salary and bonus scheme. As a salary he received $ 60,000 from the Massey-Ferguson dealership in Modesto. He received combined salary from the two John Deere dealerships in the amount of $ 72,000 in 1977 and $ 92,059 in 1978 and $ 104,110557 in 1979. The John Deere dealerships also paid him a bonus. VanderPol received the following amounts of compensation during the years in issue: Massey-FergusonJohn DeereYearSalarySalaryBonusTotal1977$ 60,000 $ 72,000$ 59,669$ 191,669197860,00092,05990,000242,059197960,000104,110106,640270,750The bonus was computed under a formula which had been in effect since before 1976. The formula allocated to VanderPol 20 percent of the net profit as shown on the books of the two John Deere locations together. The figure used to determine the bonus amount equalled taxable income before certain adjustments were made by the return preparer. 5 The bonus payments were each authorized by the Board of Directors in the corporate minutes. 558 The corporation had a profit sharing plan for the employees, and a bonus payment scheme related to sales and service. The Massey-Ferguson employees received cash bonuses while contributions were made to the profit sharing plan for the John Deere employees. VanderPol never participated in the plan, although he was entitled to do so. VanderPol chose a profit sharing plan because it was flexible and sensitive to the needs of the business. Contributions were made at a maximum level of 15 percent of the employee's salary. 6 The contribution to the profit sharing plan was computed after the bonus payable to the officer-shareholder was subtracted. The total compensation scheme for the corporation's employees was: Officer'sPercentAllPercentYearTotal SalesSalaryof SalesEmployeesof Sales 7(includingbonus)19766,311,634.00221,453.003.51%842,651.008.3%19776,211,578.00191,669.003.09%836,938.0013.47%19787,420,896.00242,059.003.26%959,259.0012.93%197910,755,917.00270,750.002.52%934,490.008.69%559 The corporation has never paid dividends. Retained earnings were reinvested in the business. Because the equipment that the corporation sold was generally very expensive, the seller frequently provided substantial financing. The bulk of retained earnings went to carrying charges on the accounts receivable. Retained earnings were560 also used to purchase spare parts and equipment. VanderPol believed it was necessary to keep a large inventory of parts on hand at all times. Furthermore, Vanderpol was advised by his accountant, Darrell Kaiser (hereinafter referred to as Kaiser) not to pay dividends. This advice was based on two premises. Kaiser's first concern was that the payment of dividends might prevent the corporation from repaying the large amount of debt it was carrying and perhaps from acquiring new debt. The second consideration was the loan agreement between the corporation and its chief lender, Lloyd's Bank. The terms of that agreement prevented the corporation from paying dividends or raising salaries without permission of the lender. Although the corporation never declared dividends, it did increase salaries annually without authorization from the bank. OPINION The principal issue for decision is whether the amounts paid in 1977, 1978 and 1978 to VanderPol by the corporation are deductible under section 162(a) as reasonable compensation for services rendered. If we hold that the section 162(a) deductions were proper then it necessarily follows that the individual petitioners may treat such561 amounts as personal service income within the meaning of section 1348. 8Section 162(a)(1) provides a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. This includes a "reasonable allowance for services actually rendered." Section 1.162-7(a), Income Tax Regs., requires that the compensation be reasonable in amount and that the payment be for actual services rendered. 9 The regulations further explain that a reasonable amount is one which would result from an arm's-length bargain between employer562 and employee. Finally, reasonable compensation is limited to the amount that would ordinarily be paid by an enterprise under like circumstances. Sec. 1.162-7(b), Income Tax Regs.In the instant case, respondent maintains that the compensation paid563 by the corporation to its officer-shareholder in the years 1977, 1978, and 1979 was excessive and unreasonable. In the alternative, respondent contends that even if the compensation was reasonable in amount, the payments constituted disguised distributions of earnings and profits with respect to stock. Petitioner takes the position that the payments made by the corporation to the officer-shareholder in the years in issue comprised reasonable compensation for services actually performed and not disguised dividends. Respondent's determination is presumptively correct, and petitioners have the burden of proving otherwise, Botany Worsted Mills v. United States,278 U.S. 282">278 U.S. 282 (1929); Rule 142(a), Tax Court Rules of Practice and Procedure.The burden is on petitioner to show that it is entitled to deductions from compensation paid to officers in excess of the amounts allowed by respondent. Laure v. Commissioner70 T.C. 1087">70 T.C. 1087 (1978), affd. in part, revd. in part 653 F.2d 253">653 F.2d 253 (6th Cir. 1981). If petitioners successfully prove error, the Court must564 then determine what was reasonable compensation under the particular facts and circumstances. Pepsi-Cola Bottling Co. of Salina, Inc. v. Commissioner,61 T.C. 564">61 T.C. 564, 568 (1974), affd. 528 F.2d 176">528 F.2d 176 (10th Cir. 1975). The issue of reasonable compensation is a factual question and must be decided on the basis of all the facts in each particular case. Home Interiors & Gifts, Inc. v. Commissioner,73 T.C. 1142">73 T.C. 1142 (1980); Pepsi-Cola Bottling Co. of Salina, Inc. v. Commissioner, supra;Botany Worsted Mills v. United States, supra;Rule 142(a). Where controlling officer-shareholders set the levels of compensation that they will receive as employees, as in the case before us, we must use close scrutiny to determine whether the purported compensation is a disguised dividend. Trinity Quarries, Inc. v. United States,679 F.2d 205">679 F.2d 205 (11th Cir. 1982); Nor-Cal Adjusters v. Commissioner,503 F.2d 359">503 F.2d 359 (9th Cir. 1974), affg. a Memorandum Opinion of this Court; Levinson & Klein, Inc. v. Commissioner,67 T.C. 694">67 T.C. 694 (1977).565 Many factors are relevant in determining whether compensation is reasonable and no single factor is dispositive. 10 As this case is appealable to the Ninth Circuit we are required to follow that court's applicable law. Golsen v. Commissioner,54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940">404 U.S. 940 (1971). In Elliotts, Inc. v. Commissioner,716 F.2d 1241">716 F.2d 1241 (9th Cir. 1983), revg. and remanding a Memorandum Opinion of this Court, the court of appeals articulated an analytical structure for this inquiry. Specifically, the Ninth Circuit used a facts and circumstances test comprised of five broad categories. Therefore, for purposes of our analysis here, we shall use similar criteria and organizational framework. Role in CompanyThe566 first category among the Elliotts, Inc. factors is the role of the employee in the company, particularly whether the employee was instrumental to the corporation's success in part or in whole. Based on the record before us, it is apparent that VanderPol was indispensable to the corporation and was singlehandedly responsible for the success the corporation enjoyed. 11 VanderPol managed and supervised the sales and service staffs for three different locations, relying on knowledge of a wide range of equipment, parts and service. He also explored new markets and new products through tireless research and investigation, which other dealers in the area did not do. VanderPol made all the management decisions from strictly routine choices to broad policy goals. He worked an average of 12 to 16 hours a day, without a vacation. External ComparisonsThe second consideration requires us to compare the financial well being of the corporation with the industry as a whole. This includes a comparison of the employee's compensation to those paid by similar companies for similar services. While evidence567 introduced to show industry comparables is relevant, the failure to show an exact industry comparable is not in itself dispositive. Home Interiors & Gift, Inc. v. Commissioner, supra.Neither petitioner nor respondent introduced expert testimony at trial. 12 One of petitioner's witnesses was Jerry Schuller (hereinafter referred to as Schuller), a rival John Deere dealer. Schuller testified that for his two John Deere dealerships, one with gross sales of 2.8 million dollars and the other with gross sales of 1.5 million dollars, he paid the general managers an average of $ 85,000 each per year in compensation. 13568 Respondent introduced Marvin Davis (hereinafter referred to as Davis), a competitor, with three farm equipment dealerships in the neighboring area. 14 The gross sales from the three dealerships Davis owned rivalled the sales of the corporation in the instant case equalling approximately $ 8,000,000 in 1977, $ 10,000,000 in 1978 and $ 11,000,000 to $ 12,000,000 in 1979. During 1979, Davis and his partner each received compensation totalling approximately $ 80,000 to $ 100,000. Both Schuller and Davis testified that the compensation paid by the corporation to VanderPol was reasonable. This opinion was echoed by Barry Bunte (hereinafter referred to as Bunte), the executive vice president of the Far West National Farm and Power Equipment Dealers Association, 15 who testified for respondent. 569 Respondent called Thomas Samuelson (hereinafter referred to as Samuelson) a vice president of Lloyd's Bank. Lloyd's Bank has made several sizable loans to the corporation. Samuelson is experienced at evaluating the financial viability of farm equipment dealerships. After considering the sales, debt and net worth of the corporation Samuelson stated that the compensation paid by the corporation to VanderPol was reasonable. Indeed, the only witness who stated with any conviction that the compensation was unreasonable was respondent's auditing agent. 16 In light of the conformity of opinion held by persons who, although not experts, have experience in the industry, we find this evidence to be credible. Character and Condition of CompanyThis third factor includes an examination of the company's size as indicated by its sales, net income or capital income, the complexities of the business and the prevailing economic conditions. 17Elliotts, Inc. v. Commissioner, supra.570 The corporation was apparently a leader in the farm equipment sales industry and operated at a high level of efficiency and profitability. The corporation's sales area encompassed up to five times the market area and contained up to three times the sales potential as its competitors. Indeed, respondent's own witness, Bunte, found that the corporation's sales were so large as to make them beyond comparison with other farm equipment dealerships in the California area. The corporation's success was due in part to the franchise rights which VanderPol obtained under favorable terms after long and arduous negotiations. VanderPol's unique management style contributed to the corporation's success. Unlike other dealers, VanderPol travelled the world looking for new farm equipment or procedures which could be marketed in the corporation's sales area. This was particularly complicated because the corporation's sales area produced so many different kinds of crops. The corporation's sales frequently required financing. VanderPol devised credit policies for in-house financing and made recourse arrangements for outside financing. The corporation experienced only six defaults on payment, 571 leading to repossession, during all its years in business. Due to VanderPol's insightful business acumen and use of innovative marketing techniques the corporation became a leader among California farm equipment dealerships.Conflict of interestThe fourth factor under the Elliotts, Inc. analysis is whether there was a conflict of interest between the company and the employee. To determine this the Ninth Circuit looks for the existence of an arm's-length bargain or, if there is none, at whether a hypothetical independent investor would consider the compensation reasonable. Under the first prong of the inquiry it is unlikely that VanderPol could establish that there was arm's-length bargain with the corporation. It is futile for a controlling shareholder to attempt to characterize his relationship with the corporation as disinterested. Even an arrangement which appears fair and equal would be suspect if it arose between an employee and the corporation he controls. 18572 Another investigative criterion under the arm's-length bargain inquiry is a corporation's dividend history. Pacific Grains, Inc. v. Commissioner,399 F.2d 603">399 F.2d 603 (9th Cir. 1968), affg. a Memorandum Opinion of this Court. The corporation in the instant case has never paid dividends. Rather, earnings and profits were reinvested into the corporation to accomplish two business objectives. First, the corporation maintained an unusually high level of inventory at all three locations to insure speedy service. Secondly, the funds supported the extensive credit that the corporation routinely offered on the sale of large farm equipment. Furthermore, the financing agreement that the corporation had with its creditor, Lloyd's Bank, precluded the declaration and distribution of dividends without permission. Kaiser, petitioner's accountant and advisor, had warned him that he might endanger his relationship with this important creditor if dividends were paid. 19 We note, however, that the mere absence of dividend distributions does not require a conclusion that the amount of compensation is unreasonably high or contains hidden dividend distributions. Elliotts, Inc. v. Commissioner, supra at 1247.573 Because it is impossible for VanderPol to demonstrate that his salary was the result of an arm's-length bargain, our inquiry turns to the second prong of the analysis, the question of the hypothetical independent investor. The Ninth Circuit explained this in the following way: If the bulk of the corporation's earnings are being paid out in the form of compensation, so that the corporate profits, after payment of the compensation, did not represent a reasonable return on the shareholder's equity in the corporation, then an independent shareholder would probably not approve of the compensation arrangement. If, however, that is not the case and the company's earnings on equity remain at a level that would satisfy an independent investor, there is a strong indication that management is providing compensable services and that profits are not being siphoned out of the company disguised as salary. [Footnote references omitted.]Elliotts, Inc. v. Commissioner, supra at 1247. Where the net worth of the corporation574 has increased, a hypothetical investor would not begrudge the salaries necessary to achieve it. With an initial capital outlay of $ 35,000 the corporation's gross sales equalled $ 451,989 in 1966. By 1979 gross sales had grown to $ 10,755,917, an increase of 237.96 percent. These are factors which would indicate to an investor that the corporation was accruing in value. An important criterion for estimating the financial well-being of a corporation from the perspective of an independent hypothetical investor is the rate of return on equity. The Ninth Circuit in Elliotts, Inc. defined this as the relationship between net profits and equity. 716 F.2d at 1247. In Elliotts, Inc. the Ninth Circuit determined that 20 percent would be an acceptable rate of return for an independent hypothetical investor. However, on remand, we determined that rates for return on equity from other corporations similarly situated required us to set the level of return on equity at a higher figure. For John Deere dealerships with sales between $ 3 and $ 4 million the rate of return averaged 50.51 percent (48 T.C.M. (CCH) 1245">48 T.C.M. 1245, 1250, 53 P-H Memo T.C. par. 84,516 at 2092)575 and for similarly situated dealerships this would be the figure expected by a hypothetical independent investor. On brief, both petitioner and respondent submitted figures for return on equity. 20 With the evidence submitted to us at the trial and the information presented to us on brief, it is impossible to determine what the actual rate of return on equity was for the corporation during the years in issue. Moreover, in the instant case, there is evidence that there are no similarly situated John Deere dealerships from which the corporation's gross sales to those in Elliotts, Inc., because the corporation's gross sales are far greater. Thus, we find that a rate of return on equity of 50.51 percent cannot be applied to the facts before us. Internal ConsistencyThe fifth and final factor under the Elliotts, Inc. analysis considers whether the payments schedule576 is related exclusively to the performance of services to the corporation. Bonuses, while not inherently suspect, are strenuously scrutinized. Mayson Mfg. Co. v. Commissioner, supra.Bonuses which are consistently designated in amounts which reflect the percentage of the recipient's stock holdings, however, are suspect. Elliott's Inc. v. Commissioner, supra at 1247. The bonus schedule ought to be predetermined and authorized by the Board of Directors. The bonus should not be computed and awarded after a perusal of the year's profits. Nor-Cal Adjustors [Text Deleted by Court Emendation] v. Commissioner, supra.In the instant case the bonus was consistently awarded under a predetermined formula. The record shows that 20 percent of the net profits, as shown on the internal corporate books from the two John Deere locations, was authorized as a bonus every year. The formula had been applied in the same way since before 1976. The evidence presented makes it abundantly clear that the bonus formula was consistently and unerringly applied during the years577 in issue. Finally, it is appropriate to pay one employee more than others when he performs several jobs. Elliotts, Inc. v. Commissioner, supra at 1246. See Hammond Lead Products, Inc. v. Commissioner,425 F.2d 31">425 F.2d 31 (7th Cir. 1970), affg. a Memorandum Opinion of this Court. In this case petitioner was the chief executive officer for three dealerships at different locations.ConclusionAccordingly, after a very careful analysis of all the facts and circumstances and thoughtful weighing of those circumstances, together with due consideration of the weight to be accorded to the oral testimony, we hold that the payments made to VanderPol as salary and bonus constituted reasonable compensation within the meaning of section 162(a). Therefore, the amounts are deductible to the corporation under section 162 as payments made for compensation and correspondingly, the individual petitioners are entitled to treat such compensation as personal service income within the meaning of section 1348. To reflect the concessions by petitioners, as well as the foregoing, Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Service Code of 1954, as amended and in effect during the years in issue, and all Rule references, unless otherwise noted, are to the Tax Court Rules of Practice and Procedure. ↩2. The area produced from 19 to 26 different crops, many requiring specialized farm equipment. ↩3. During the years in issue the corporation had about 55 employees. The two John Deere stores shared a sales manager, Irving Gilgert, while the Massey-Ferguson store had its own sales manager, Vern VanderPol, VanderPol's son. The three stores also shared a common bookkeeper. ↩4. Because the salesmen were paid by commission their predictions of a customer's financial resources were occasionally unduly optimistic and credit would be extended too generously. VanderPol felt it necessary to check every large credit transaction. ↩5. The following chart shows how the bonuses were computed: ↩197719781979Taxable Income - (From corporate$ 158,305$ 266,105$ 214,329income tax returns)Add BackLIFO Inventory Adjustment-40,697111,831Bonus to employees27,33224,80056,200Bonus to VanderPol59,66890,000106,640Profit Sharing36,00027,79425,000Massey-Ferguson Dealershipelimination17,03525,40419,200Base for Calculation298,340450,000533,000Percentage20%20%20%Bonus59,66890,000106,6406. Bonuses were paid to the Massey-Ferguson employees in the amounts of $ 27,332 in 1977, $ 24,800 in 1978 and $ 56,200 in 1979. Contributions to the John Deere employees' profit sharing plan were made in the amounts of $ 36,000 in 1977, $ 27,794 in 1978 and $ 25,000 in 1979. ↩7. As requested by the parties, we have taken judicial notice of the facts relied upon in Elliotts, Inc. v. Commissioner,T.C. Memo 1980-282">T.C. Memo. 1980-282, revd. and remanded 716 F.2d 1241">716 F.2d 1241 (9th Cir. 1983). Those facts include a chart showing total compensation in the amounts below. However, the data from the Elliotts case is not controlling here because that corporation had sales less than half of those in the instant case. This evidence, then, is relevant but not particularly compelling. See discussion, infra, at pages 22-23. ↩FiscalCompensationPercentTotal EmployeePercent ofYearSalesPaid to Officerof SalesCompensationSales19763,467,758150,0014.33%280,2698.08%19773,558,513119,1493.35%262,8497.39%19783,052,20958,5181.92%185,6616.08%8. Personal service income as used in section 1348(b)(1) means "wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits" as defined in section 911(b)↩. 9. Historically, courts tend to focus only on the reasonableness of the compensation. See, e.g., Pacific Grains, Inc. v. Commissioner,399 F.2d 603">399 F.2d 603 (9th Cir. 1968), affg. a Memorandum Opinion of this Court, unless the Commissioner presents evidence that the payments were disguised dividends. Klamath Medical Service Bureau v. Commissioner,29 T.C. 339">29 T.C. 339, 348-349 (1957), affd. 261 F.2d 842">261 F.2d 842 (9th Cir. 1958). See Elliotts, Inc. v. Commissioner,716 F.2d 1241">716 F.2d 1241 (9th Cir. 1983), revg. and remanding a Memorandum Opinion of this Court. The Ninth Circuit will not presume an element of a disguised dividend from the bare fact that a profitable corporation does not pay dividends. See also Golsen v. Commissioner,54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940">404 U.S. 940↩ (1971). 10. For a comprehensive list of the factors frequently used to determine reasonable compensation, see Pepsi-Cola Bottling Co. of Salina, Inc. v. Commissioner,61 T.C. 564">61 T.C. 564, 567-568 (1974), affd. 528 F.2d 176">528 F.2d 176 (10th Cir. 1975), quoting Mayson Mfg. Co. v. Commissioner,178 F.2d 115">178 F.2d 115↩ (6th Cir. 1949).11. VanderPol's importance to the corporation was conceded by respondent.↩12. Pursuant to stipulation, the parties introduced three surveys into evidence. These were the Dealer Comparative Management Reviews for 1977, 1978 and 1979, and were prepared using data from certain John Deere dealers. However, the information contained in these reports is not helpful to us in evaluating the worth of the corporation in the instant case. The dealerships in the survey were apparently smaller and less profitable because the gross sales figure indicating high performance in the survey was one-fourth to three-fourths of the gross sales figure of the corporation before us. Thus, those dealerships are not comparable to Van's Tractor, Inc. ↩13. In 1977, Schuller paid salaries in the amount of $ 79,000, in 1978 he paid salaries in the amount of $ 85,100, and in 1979 he paid salaries in the amount of $ 89,125 each. ↩14. Marvin Davis built a successful Massey-Ferguson dealership 8-1/2 miles down the road from Van's Tractor. ↩15. Pursuant to stipulation, the parties introduced the 1977, 1978 and 1979 Cost of Doing Business Studies prepared by the National Farm & Power Equipment Dealers Association. The information is not applicable to the instant case, however, because the sales volume and business complexity of the corporation are considerably greater than the sales volume and business complexity of the dealerships in the studies. ↩16. A rival John Deere dealership with much lower sales figures said only that VanderPol's salary seemed "a little high."↩17. During the years in issue the general market conditions were apparently fair although they have subsequently worsened appreciably. ↩18. The factor of control cuts both ways. A controlling shareholder is in a good position to award himself an unreasonably large salary. Conversely, the fact that the employee is also the owner might cause him to forego reasonable compensation during lean years, putting the needs and welfare of the business first. See Allison Corp. v. Commissioner,T.C. Memo. 1977-166; Skyland Oldsmobile, Inc. v. Commissioner,T.C. Memo. 1972-17↩. 19. The same financing agreement also precluded an increase in salaries without prior approval but this restriction was not observed by the corporation. ↩20. According to petitioner, the corporation's return on equity was 58.94 percent in 1977; 56.57 percent in 1978 and 53.95 percent in 1979. Respondent put forward alternative figures representing return on equity in the amounts of 19.1 percent in 1977; 28.2 percent in 1978 and 18.9 percent in 1979.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621334/	Appeal of THE SNEATH GLASS COMPANY.Sneath Glass Co. v. CommissionerDocket No. 346.United States Board of Tax Appeals1 B.T.A. 736; 1925 BTA LEXIS 2823; March 9, 1925, decided Submitted December 15, 1924. 2823 1. A corporate taxpayer, which acquires patents under a written agreement to pay for them a reasonable sum each year based upon the profits therefrom, and at the same time increases its capital stock without any reference in its records to the patents and distributes the increased stock pro rata to its shareholders, is not entitled to include in its statutory invested capital any amount representing the estimated value of the patents; nor is it entitled to deduct from gross income for the years 1917, 1918, and 1919, any amount representing depreciation on the estimated value of the patents. 2. A taxpayer, which has consistently charged to expense over a series of years the cost of the manufacture or purchase of molds and patterns having a life of from a few days to three to five years, is not entitled to amend its books of account, charge the cost of such molds and patterns to capital account, include the depreciated cost thereof in invested capital, and deduct depreciation from its gross income for the years 1917, 1918, and 1919, in respect of the cost of them. Lawrence A. Baker and Thomas R. Rutter, Esqs., for the taxpayer. John D. Foley, Esq. (Nelson2824 T. Hartson, Solicitor of Internal Revenue) for the Commissioner. SMITH 736 Before GRAUPNER, LITTLETON, and SMITH. This is an appeal from a determination by the Commissioner of a deficiency in income and profits taxes for the calendar years 1917, 1918, and 1919, in the amounts of $20,379.40, $24,232.39, and $17,024.84, respectively, aggregating $61,636.63. These alleged deficiencies are based upon an increase of net income for these years on account of the disallowance of the deduction of certain amounts for depreciation of patterns and on account of a reduction in the claimed invested capital. From the testimony and documentary evidence presented, the board makes the following FINDINGS OF FACT. 1. The taxpayer is an Indiana corporation, with its principal place of business at Hartford City, Ind. For some time prior to January 2, 1917, its capital stock was $200,000. The corporation was originally a family affair. A. C. Crimmel, his father, and three other individuals each owned one-fifth of the stock. Later some of these individuals died, and the stock went to their heirs, but the corporation remained in fact a close corporation. In 1917 there2825 were 737 about 15 stockholders. A. C. Crimmel was vice president and treasurer and owned the largest number of shares. In 1894 the taxpayer started making different articles, until, in 1914 or 1915, it started in the manufacture of glassware for kitchen cabinets. Prior to that time practically everything in connection with such cabinets was made of wood and tin. It was found that many things kept better in glass. The taxpayer had been manufacturing many different items of kitchen-cabinet equipment out of glass for many months before it began the manufacture of glass sugar bins. The latter were still made of tin in 1916. In 1916 the taxpayer got up a pattern on a glass sugar bin which was much superior to a tin sugar bin. 2. Prior to January 22, 1917, A. C. Crimmel was the owner of four patents, to wit: 59, dated November 10, 1914. 79, dated October 26, 1915. Design No. 48060, dated November 2, 1915. 86, dated April 11, 1916. These patents were used by the taxpayer and products were manufactured thereunder prior to January 22, 1917. 3. On January 22, 1917, these patents were assigned to the taxpayer2826 by an instrument in writing, under the terms of which the taxpayer covenanted and agreed that it would - make, manufacture, market and sell all and each of said patent articles that it can procure a market therefor, and further hereby agrees that the said Sneath Glass Company, will pay to the said Alvie C. Crimmel, during the life of each of said Letters Patent, annually such reasonable sum as the board of directors of the said Sneath Glass Company may determine to be fair and equitable therefor, based upon the volume of sales of each and all of said articles made, manufactured and sold by it, taking into consideration the cost of production, manufacturing and marketing same, and the profit to said company therefrom; and it is further understood and agreed that should the siad Sneath Glass Company sell or assign the right to make or manufacture any or all of said articles to any other persons, firms or corporations, or transfer, sell or dispose of said Letters Patent, then and in that event the said Sneath Glass Company, hereby agrees to pay to the said Alvie C. Crimmel, such reasonable sums, as may be determined upon by the Board of Directors of the Sneath Glass Company, based upon2827 the amount received by it therefor. 4. At a meeting of the stockholders of the corporation on January 22, 1917, the following resolution was adopted: Be it resolved by the stockholders of The Sneath Glass Company, duly organized under and [by] virtue of the laws of the State of Indiana, in regular annual meeting assembled: That the capital stock of the said The Sneath Glass Company be increased in the sum of two hundred thousand ($200,000) dollars; that is from the sum of two hundred thousand ($200,000) dollars (its present capital stock) to the sum of four hundred thousand ($400,000) dollars. That all of said increase of capital stock be issued and disposed of as common stock, and divided into shares of the same amount and par value, as the value of the shares provided for by the original Articles of Incorporation. That upon the passage and adoption of this resolution that a verified certified copy of the record and proceeding of this meeting, so far as the same pertains to the increase of the capital stock of said company shall be prepared and certified to by the president and secretary of The Sneath Glass Company, which said certificate shall contain and show the2828 total amount of the capital stock of The Sneath Glass Company, issued and outstanding as of this date, together with the amount of capital stock voted in favor of this resolution, and together with the amount of capital stock voted in favor of this resolution, and the increase of the capital stock as in this resolution provided. 61359 - 26 - 47 738 The president then declared that the total shares of capital stock of The Sneath Glass Company, issued and outstanding on this date being 2,000 shares, and that 2,000 shares having been duly and regularly voted in favor of the foregoing resolution and of increasing the capital stock of said company from $200,000 to $400,000, that said resolution was duly and regularly passed and adopted and said capital stock increased from said sum of $200,000 to the sum of $400,000, to be divided into shares of the same par value each, as the shares of stock provided for by the original articles of incorporation. It was then regularly moved by A. C. Crimmel and seconded by R. D. Sneath that the shares of stock, representing the $200,000 of increase of capital stock of the Sneath Glass Company be issued and delivered to the stockholders2829 of said company, who were stockholders of record on the 22d day of January, 1917, such portion to be issued to each stockholder, as the number of shares held by such stockholder bears to the total number of shares of the capital stock, issued and outstanding on said day. Which said motion was duly and regularly adopted and carried. 5. Approximately, in terms of gross sales, the manufacture of the patent appliances amounted to one-half of the total business of the taxpayer for the years 1917, 1918, and 1919. 6. The books of account of the taxpayer were kept in a very crude manner. While the taxpayer was a corporation in name, it in reality was run as a partnership or as a family concern; it never really had an audit; no one was put under bond; and there was never any question as to how it was or should be operated. 7. The net income of the taxpayer for the years 1911 to 1913, and from 1915 to 1919, was as follows: 1911$21,038.22191232,137.00191349,347.54191557,993.351916111,751.09191797,321.17191899,068.21191977,460.648. The Commissioner, in determining the value of 96 shares of stock of The Sneath Glass Co. held by the2830 father of A. C. Crimmel, deceased, October 10, 1917, fixed the value at $100 per share, total $9,600. The taxpayer made a capital stock tax return for the fiscal year ended June 30, 1918, and placed a value of $400,000 upon the taxpayer's capital stock. 9. The Commissioner allowed no deduction for depreciation of the value of patents in the taxpayer's returns for the years 1917, 1918, and 1919. 10. Between May 6, 1911, and December 31, 1917, the taxpayer expended $18,032.76 for the manufacture or purchase of molds and patterns. No part of this amount was charged to capital account. In the computation of invested capital for the years 1917, 1918, and 1919, the Commissioner allowed nothing for the cost of such molds and patterns. Some of the molds and patterns would last one day and some three, four, or five years. 11. The Commissioner addressed to the taxpayer a letter of deficiency, dated August 9, 1924, which disclosed a total deficiency in tax for the years 1917, 1918, and 1919 of $61,636.63. Approximately $9,000 of that deficiency is admitted by the taxpayer to be owing. 739 DECISION. The Determination of the Commissioner is approved. OPINION. 2831 SMITH: This appea is from deficiencies in income and profits taxes for the years 1917, 1918, and 1919, and presents for determination the questions: (1) whether the taxpayer is entitled to include in invested capital the depreciated cost of patents assigned to it on January 22, 1917; (2) whether it is entitled to deduct from gross income for each of the taxable years mentioned any amount representing depreciation on such patents; (3) whether it is entitled to include in invested capital the depreciated cost of molds and patterns, the cost of which was charged to expense when acquired; and (4) whether it is entitled to deduct from gross income depreciation in respect of such cost. Th pertinent facts with respect to the acquisition of patents are set forth in the findings of fact. The taxpayer was and is engaged in the manufacture of various articles of glassware. In 1914 or 1915 it started in the manufacture of glassware for kitchen cabinets. In the development of this line of manufacture, A. C. Crimmel, who was the principal stockholder, general manager, and a director of the taxpayer, took out certain patents on a glass sugar bin, distributing cap, and bracket. In 1916 or2832 the early part of 1917 "it was talked over among the directors that the Sneath Glass Co. should own these patents, because if anything would happen I would leave the company, take my patents along, and it (the business) would go to somebody else. When the last patents were issued (April 22, 1916), I decided to give the patents to the Sneath Glass Co." (Testimony of A. C. Crimmel.) The patents were assigned to the taxpayer on January 22, 1917, under an agreement, the next to the last paragraph of which is quoted in the findings of fact. At a meeting of the stockholders of the corporation on January 22, 1917, an increase in the capital stock from $200,000 to $400,000 was voted, and it was provided that the shares of stock representing the $200,000 increase should be issued and delivered to the stockholders, the number of shares to be issued to each being equal to the number of shares then held by such stockholder. No notation was made in the books of the corporation or in the minutes of the stockholders' meetings which would indicate in any way that the additional shares of stock were issued by reason of the acquisition of patents. In the light of the facts stated above, the2833 Commissioner holds that the evidence does not warrant a conclusion that the patents were paid in to the corporation for shares of stock. It is his contention that the patents were assigned to the corporation under an agreement by which the corporation obligated itself to pay to Crimmel a reasonable amount for the use thereof. On behalf of the taxpayer, it is contended that the patents had great value and that they were in reality paid in to the corporation 740 for shares of stock authorized to be issued on January 22, 1917, or that the patents were paid in to the surplus account, thereby creating a surplus of $200,000, which should be added to invested capital. In our opinion the evidence does not show that the patents were paid in to the Sneath Glass Co., at January 22, 1917, for shares of stock in that company. Not only is there no book record which would indicate that fact, but the contract which was entered into between the taxpayer and Crimmel argues against such a contention. Apparently the directors of the company desired that the company should own the patents, and Crimmel, who was the principal stockholder and who controlled the policies of the corporation, 2834 was willing to assign them to it upon condition that it would agree to pay him such an amount for the use of the patents as the board of directors of the corporation should determine was fair and equitable. It is argued on behalf of the taxpayer that this contract was without force or effect, so far as Crimmel was concerned, and that the promise of compensation to him was only illusory. We do not think that this view is tenable. Crimmel practically controlled the affairs of the corporation. The agreement was a sufficient consideration for the assignment of the patents. The fact that the taxpayer paid nothing under the agreement or that Crimmel waived his claim to receive compensation does not alter the essential character of the agreement. The alternative proposition of the taxpayer is that if the patents were not paid in to the corporation for shares of its capital stock they were, nevertheless, paid in; that they had great value; and that the corporation is entitled to a paid-in surplus in respect to such value. The evidence with respect to the value of the patents is the value of the shares of stock of the corporation after the issuance of the $200,000 capital stock on2835 January 22, 1917. The taxpayer submits that the fact that the taxpayer filed a Federal capital stock tax return in July, 1917, showing that the fair value of the 4,000 shares then outstanding was $400,000, and the further fact that the estatetax division of the Bureau of Internal Revenue found that the value of 96 shares of the capital stock in October, 1917, was $9,600, are proof that the value after January 22, 1917, was $100 per share. It also submits that the fact that the Commissioner found that the invested capital of the corporation for 1917 was only $185,455.60 is proof that the value of the assets of the corporation at December 31, 1916, was not in excess of $200,000. It is therefore argued that the value of the assets was increased to the extent $200of,000 by the assignment at January 22, 1917, of the patents above referred to. We are of the opinion that the evidence does not establish the fact that the patents assigned to the corporation under the agreement of January 22, 1917, had a value to the corporation of $200,000. The fact that the Commissioner found that the taxpayer was entitled to an invested capital for 1917 of $185,455.60 is not conclusive as to the value2836 of the capital stock of the corporation at January 1, 1917. From the findings of fact, it will be noted that the year 1916 was the most prosperous year that the corporation ever had (at least to 1920), the net income for the year being $111,751.09, or practically twice as much as it had been in 1913 or in 1915. The testimony of Crimmel was to the effect that the sugar bin was still manufactured out of tin 741 in 1916. Therefore it must be assumed that the profits of the year 1916 were not in large part attributable to the manufacture of glass sugar bins. Whatever may have been the facts with respect to the value of the patents if they had been assigned outright to the taxpayer, we do not think that the evidence establishes that they had a value to the corporation under the agreement ofJanuary 22, 1917. The profits of the years 1917, 1918, and 1919 were apparently due in part to the fact that the taxpayer was never required to pay anything for the use of the patents during those years. This fact could not have been foreseen by the taxpayer at January 22, 1917. The second contention of the taxpayer is that it should be entitled to deduct from gross income for the years2837 1918 and 1919 a reasonable amount representing depreciation of the cost to the taxpayer of the patents in question. We are of the opinion, however, that the evidence does not establish that they cost the taxpayer anything and, accordingly, that it has not established its claim to a deduction for depreciation in respect of them. The taxpayer contends that prior to 1917 it had expended $18,032.76 for the manufacture or purchase of molds and patterns, and that no part of this amount was included by the Commissioner in invested capital for the years 1917, 1918, and 1919. The evidence shows that some of these molds and patterns last from a day or two to five years; that the corporation has always charged to expense the cost of the manufacture or purchase of them; and that no capital account has ever been maintained in respect of them. We are of the opinion that it was entirely proper for the taxpayer to charge these items as expenses when the molds and patterns were acquired. Conservative accounting would warrant such action. The Commissioner has never raised any question as to the correctness of such treatment. We are therefore of the opinion that the taxpayer is not entitled2838 to include in invested capital any amount representing the estimated cost of the molds and patterns acquired in past years, and that it is not entitled to any deduction from gross income for the years 1917, 1918, and 1919, in respect of depreciation upon the estimated cost of them. On consideration by the Board, STERNHAGEN dissents.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621335/	A. EISENBERG, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Eisenberg v. CommissionerDocket No. 12938.United States Board of Tax Appeals11 B.T.A. 574; 1928 BTA LEXIS 3773; April 13, 1928, Promulgated 3773 A vendee paying in 1921 an excise tax imposed by section 902, Title IX, of the Revenue Act of 1918, upon the purchase of paintings, is not entitled to deduct from gross income in his income-tax return for 1921 the amount of the tax paid. John E. McClure, Esq., for the petitioner. John Marshall, Esq., for the respondent. SMITH 574 This is a proceeding for the redetermination of a deficiency in income tax for the year 1921 in the amount of $3,711.04. The respondent has increased the petitioner's net income by the amount of $7,215.45, which amount the petitioner paid as an excise tax under section 902 of the Revenue Act of 1918 upon the purchase of certain paintings during the year and which he claims constitutes a legal deduction from gross income for the taxable year under the provisions of section 214(a)(3) of the Revenue Act of 1921. FINDINGS OF FACT. The petitioner is a resident of Baltimore, Md. During the year 1921 he purchased certain oil paintings and paid at the time of purchase as a tax thereon $7,215.45 levied under section 902 of the Revenue Act of 1918, the purchases all having been made prior to June 30, 1921. He claimed3774 the tax paid as a deduction from gross income in his income-tax return for 1921. The deduction was disallowed by the respondent in the determination of the deficiency. 575 OPINION. SMITH: Sections 902 and 903 of the Revenue Act of 1918 provide: Sec. 902. That there shall be levied, assessed, collected, and paid upon sculpture, paintings, statuary, art porcelains, and bronzes, sold by any person other than the artist, a tax equivalent to 10 per centum of the price for which so sold. This section shall not apply to the sale of any such article to an educational institution or public art museum. Sec. 903. That every person liable for any tax imposed by section 900, 902, or 906, shall make monthly returns under oath in duplicate and pay the taxes imposed by such sections to the collector for the district in which is located the principal palce of business. Such returns shall contain such information and be made at such times and in such manner as the Commissioner, with the approval of the Secretary, may by regulations prescribe. The tax shall, without assessment by the Commissioner or notice from the collector, be due and payable to the collector at the time3775 so fixed for filing the return. If the tax is not paid when due, there shall be added as part of the tax a penalty of 5 per centum, together with interest at the rate of 1 per centum for each full month, from the time when the tax became due. It is apparent that the taxes paid by the petitioner were imposed on slaes by the dealer and are payable by him. They are not imposed upon the purchaser. See Colgate & Co. v.United States, (Ct. Cls.), decided February 20, 1928. What the petitioner did in this case was simply to reimburse the dealer for an excise tax payable by him. Section 214(a)(3) of the Revenue Act of 1921 permits an individual to deduct from gross income certain taxes paid. But the taxes deductible are taxes imposed upon and paid by the taxpayer. Cf. ; National Bank of Commerce in ; ; 3776 ; . Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621336/	ARMSTRONG WORLD INDUSTRIES, INC. AND AFFILIATED COMPANIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentArmstrong World Industries, Inc. v. CommissionerDocket No. 853-89United States Tax CourtT.C. Memo 1991-326; 1991 Tax Ct. Memo LEXIS 375; 62 T.C.M. (CCH) 148; T.C.M. (RIA) 91326; July 16, 1991, Filed 375 Decision will be entered under Rule 155. A. Carl Kaseman, III, Stephen R. Mysliwiec, and James G. Rafferty, for the petitioner. Eugene J. Wien and Judy Jacobs Miller, for the respondent. COHEN, Judge. COHENMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined a deficiency of $ 5,032,135 in petitioner's Federal income tax for 1981. The issues for decision are (1) whether petitioner's transactions with Conrail complied with the requirements of section 168(f)(8) with respect to safe harbor leasing, thus entitling petitioner to certain investment tax credits and depreciation deductions for the leased property, and (2) whether petitioner is entitled to use the Replacement-Retirement-Betterment 1-year recovery period for property placed in service in 1981. Unless otherwise indicated, all section references are to the Internal Revenue Code as amended and in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. FINDINGS OF FACT Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. Armstrong World Industries, Inc. (petitioner), was376 incorporated under the laws of the Commonwealth of Pennsylvania, with its principal office located in Lancaster, Pennsylvania. In 1981, petitioner used the accrual method of accounting and a calendar year basis for Federal income tax and financial accounting purposes. During 1981, petitioner was taxed under subchapter C of the Internal Revenue Code and was not a personal holding company under section 542. For 1981, petitioner filed a consolidated corporate Federal income tax return. The Consolidated Rail Corporation (Conrail) was incorporated in 1974 and began operations in 1976 primarily to receive and to operate railroad properties belonging to six insolvent railroads. Conrail was at all relevant times taxed under subchapter C of the Internal Revenue Code. Conrail sustained substantial net operating losses from its inception through 1981. Conrail was a common carrier railroad operating in interstate commerce and was required to maintain its books and records according to the Interstate Commerce Commission (ICC) Uniform System of Accounts prescribed for class 1 rail carriers. Conrail used the accrual method of accounting for financial reporting, ICC reporting, and Federal377 income tax reporting purposes. The Safe Harbor Leasing Transactions Between Petitioner and ConrailConrail solicited formal bids, through investment bankers and others, for the sale and leaseback of the property that is the subject of the safe harbor leasing transactions in issue. Petitioner was the highest bidder. Petitioner and Conrail entered into nine agreements for the sale and leaseback of railroad property with a total basis of approximately $ 96 million. In each agreement, the parties elected to have the provisions of section 168(f)(8) apply. Three of the agreements were dated "as of December 17, 1981," and six of the agreements were dated "as of December 31, 1981." Of the nine agreement documents entered into between Conrail and Armstrong for the sale and leaseback of numerous properties, three agreements related to replacement and betterment to track structure, three related to additions and improvements (A&I), and three related to equipment reconstruction costs. Each of the three A&I agreements entered into between Conrail and Armstrong that pertain to the properties in dispute defined "Item of Property" as "each of the items of property described in Exhibit378 A hereto." Exhibit A of the agreement "dated as of December 17, 1981," for $ 14,512,260 defined "Item of Property" as "All of the Additions and Improvements in respect of the Property described in the Supplement to this Exhibit A, and the supporting documents thereto, placed in service between October 1, 1981 and October 31, 1981, both inclusive." Exhibit A of the agreement "dated as of December 31, 1981," for $ 3,053,144, defined "Item of Property" as "All of the Additions and Improvements in respect of the Property described in the Supplement to this Exhibit A, and the supporting documents thereto, placed in service between November 1, 1981 and November 31, 1981, both inclusive." Exhibit A of the agreement "dated as of December 31, 1981," for $ 16,500,000, defined "Item of Property" as "All of the Additions and Improvements in respect of the Property described in the Supplement to this Exhibit A, and the supporting documents thereto, placed in service between November 1, 1981 and December 31, 1981, both inclusive." Schedules and supplements identifying the accounts and properties comprising the agreed dollar amounts for the leased properties were prepared. The Supplement to exhibit379 A for the three A&I agreements described the leased properties only by authority for expenditure (AFE) numbers and did not show any breakdown of the component properties included in each AFE number. Those schedules and supplements were not physically attached to the leases. The Supplement to exhibit A of the agreement "dated as of December 31, 1981" for $ 16,500,000 was not completed by Conrail or provided to Armstrong until, at the earliest, January 19, 1982, when supporting documents were prepared. On December 17, 1981, and December 31, 1981, petitioner, by wire transfer, made payments to Conrail in the respective amounts of $ 19,006,523.86 and $ 15,738,726.14. Under the terms of the agreements, petitioner agreed to make deemed, semi-annual payments of principal and interest, and Conrail agreed to make deemed rental payments to petitioner in the same amounts. Under the agreements, no money actually changed hands with respect to the deemed rental or deemed principal and interest payments. Petitioner and Conrail timely filed Forms 6793, "Safe Harbor Lease Information Return," with respect to the properties that were the subject of the agreements. On those forms, the safe harbor380 lease properties were described as "additions and improvements" or "replacements and betterments to track structure." The subject properties were not specifically identified on those forms. The Orrville-to-Colsan Traffic Control SystemIn the late 1970s, Conrail experienced considerable congestion and delays in the movement of traffic on the Pittsburgh-to-Chicago main rail line between Orrville and Colsan, Ohio. The main rail line from Orrville to Colsan consisted of two parallel tracks, extending 76 miles, each able to operate trains in only one direction. The delays were caused by the heavy volume of traffic and by the outmoded system of controlling train traffic along that route. During that time, the various interlockings (connections between main tracks and sidings) along the route were controlled by human operators stationed in control towers. An operator was required to be in the control tower at all times to watch for oncoming trains, to flash the appropriate signals to the trains, and to manipulate the track at the interlocking to ensure that each train was routed onto the appropriate main track or siding. After passage of a train, the operator would normally381 signal towers further down the track that a train would be approaching their location. An equipment housing near the signals contained batteries and electrical relays that transmitted commands from the tower operator to the signal equipment and track routing equipment. The instructions as to how to align a track for each train were given to each operator verbally by a human dispatcher at a distant location. On April 12, 1977, to eliminate the delays on the main line, the Board of Directors of Conrail approved the Orrville-to-Colsan Traffic Control System. One or more AFE numbers were assigned to a project by Conrail's accounting department in order to monitor costs. The Orrville-to-Colsan project was described on an AFE form used by Conrail and dated October 27, 1977, as follows: (1) Install a traffic control signaling system (TCS) on the Pittsburgh-Chicago main line between Orrville and Colsan, Ohio, and on the Cleveland-Indianapolis main line between Crestline and Galion, Ohio; (2) downgrade the parallel Akron-Galion main line; (3) convert to remote control 17 interlockings; (4) improve connections at Crestline, Ohio, from the Pittsburgh-Chicago main line to the Cleveland-Indianapolis382 main line; and (5) construct a connection at Mansfield, Ohio, from the Pittsburgh-Chicago main line to the Brady Lake-Galion main line. The AFE form included AFE Nos. HC94, HC95, HC96, HC97, HC98, and HC99, totaling $ 11,469,000. Gross investment cost as used on an AFE was a prospective estimate of all expenditures to be incurred under the AFE, including removal costs, used (fit) material costs, and costs of non-section 38 property. The gross investment costs contemplated by a revised AFE form dated June 6, 1980, categorized by each AFE number, were as follows: AFE NumberDescription of WorkGross Investment CostHC94TCS on Pitts.-Chic. line$ 10,015,000HC95TCS Crestline-GalionMP 75.5-79.0790,000HC98TCS Crestline-GalionMP 75.5-79.0111,000HC97TCS Crestline-Galion655,000HC96TCS Akron-Galion1,307,000HC99TCS Crestline-GalionColumbus Office Machine22,000TOTAL $ 12,900,000The installation of the TCS served to permit two-way movement of trains on each of the parallel tracks. The TCS was constructed in segments. In the construction process, the extent of a given segment or segments would be determined and construction would proceed on such383 segment or segments. When new signals, connections to Youngstown, Ohio, wiring, and necessary track work were completed in a segment, such segment would be "cut over," i.e., turned over by construction personnel to local crews for actual train operation. The trains and track switches on the completed segment were operated by remote control by the dispatcher at Youngstown. As each additional geographic segment was completed, it would be connected permanently to previously completed segments, temporary wiring to unreconstructed segments would be installed, and the newly completed segment would also be controlled from Youngstown. The following is the schedule of actual cutover dates on which each geographic segment was turned over to local train crews for actual train operations: 1. Lucas & Ross3/7/792. Mans. & W. Mans.11/15/793. Horn12/4/794. E. Crest3/13/795. W. Yard9/10/806. E. Colsan9/8/807. Colsan9/8/808. Mohican10/21/809. Big Run5/21/8110.Crest. & W. Crest.5/27/8111.Orrville10/26/81A computer was installed at Youngstown to govern the entire Orrville-to-Colsan TCS. The computer was able to throw switches, change signals384 by remote control, and perform the decision-making process for train routing and prioritizing of trains. The computer was installed in 1980. The final TCS segment was cut over on October 26, 1981. Until the final TCS was cut over, the computer was not able to make prioritizing decisions along the entire route. The Orrville-to-Colsan project involved, in addition to the installation of a TCS, various track changes at each interlocking along the route to permit higher speed movements and certain other changes, such as adding a siding so that low-priority trains could be held to one side to allow priority traffic to pass. Rail Classification YardsThe function of a rail classification yard is to receive incoming trains, to re-sort the cars of the incoming trains into new outgoing trains, and to send the new trains out of the yard. In a rail classification yard, among other things, (1) incoming trains are disassembled, (2) cars are sorted by destination, and (3) cars are reassembled into new trains. A rail yard typically is found near the intersection of two or more major rail lines. In physical terms, a rail yard usually includes receiving tracks for incoming trains, classification385 tracks, and departure tracks. Trains entering a rail yard from any of the lines served by the yard are first routed to the receiving tracks, on which trains are lined up for uncoupling and sorting. In a hump yard, this sorting function is performed when a yard engine pushes a train up to the crest of the hump, a man-made hill. Cars are uncoupled at the crest and then descend into the classification yard, where they automatically are switched onto the appropriate track to meet and couple with previously sorted cars. As each car descends, it is braked automatically by retarders built into the track. Groups of outbound cars are then taken to the departure yard for assembly into new trains before leaving the yard. Cars released by the retarders at a speed that is too fast or too slow can disrupt significantly the safe and efficient functioning of a rail classification yard. Cars that travel too fast cause hard couplings and can cause derailments and damage to the cars and lading. Cars traveling too slowly may stall, i.e., not clear the switches into the receiving track, thereby obstructing further sorting activities on its own track and other tracks. The automation of switches386 in a railroad yard with a retarder control system increases the efficiency of the yard by eliminating the need for an operator to disrupt train movement in order to throw the retarder switch. Allentown YardPrior to 1978, Conrail had two separate yards at Allentown, Pennsylvania. An eastbound yard was located on the northern side of the tracks with a self-contained set of receiving, classification, and departure tracks designed to serve only eastbound traffic. A westbound yard contained a similar but separate set of tracks to serve only westbound traffic. Those yards were in a deteriorated condition, and their configuration was not suited to the altered traffic volume and movements faced by Conrail. On June 13, 1978, the Board of Directors of Conrail approved a request for investment authority (RIA) No. 1978-24, and thereafter in 1978, the Board of Directors also approved an AFE form including AFE Nos. HN07 and HN08, totaling $ 13,051,000, to "remove the Eastbound yard, level the hump, then construct a new receiving and departure yard, with main tracks relocated around the south side of the yard. The Westbound classification yard is to be expanded with a new retarder 387 and 8-track group on the south side." The anticipated gross investment costs identified under each AFE number were as follows: AFEDescription of WorkGross Investment CostHN07Allentown yard improvements$ 13,000,200HN08Allentown yard improvements50,800Total $ 13,051,000An automatic switching feature was installed by SAB Harmon Industries, Inc. (Harmon), in September 1980. The first test of the full system, i.e., the automatic switching feature and the speed control feature, was performed in January 1981. There were several ongoing problems with both the automatic switching portion and the speed control portion of the system. Those problems were brought to the attention of Harmon representatives. Harmon took corrective action to resolve the problems with the system. The last changes with respect to the software and hardware relating to the system were made in November 1981. In November 1981, Harmon personnel went to Allentown to make two changes to the system. One change was made to enable the relays to operate fewer times thereby making the retarders close fewer times. The second change was made to compensate for the temperature so that, when the388 weather was cold, the cars would be released a little faster and, when the weather was hot, the cars would be released a little slower. The changes made to the system in November 1981 were design changes. They were not in the original specifications for the system. Although the system experienced problems after Harmon's last visit in November 1981, the problems were in the nature of normal maintenance, i.e., component rather than system failures. The Allentown yard continued to operate during the course of construction, and portions of the yard were used both before and after they were involved in the construction work. The Oak Island YardPrior to the creation of Conrail, the northern New Jersey area surrounding the Oak Island yard was served by three separate railroads, each of which maintained its own classification yard. Upon the formation of Conrail and subsequent consolidation of service, it was no longer efficient to continue to operate all of the various yards. Accordingly, Conrail decided to consolidate the adjacent Garden and Oak Island yards into one yard, to close the other yards in the area, and to expand and modernize the new Oak Island yard. The benefits389 of the project included having a single yard with the capacity and operating efficiency to handle the resulting increased traffic flow. On January 4, 1980, Conrail's Board of Directors approved an AFE form consisting of work identified by AFE Nos. TD25 through TD33 to improve the Oak Island yard. The AFE form identified anticipated gross investment costs of $ 10,687,443. The underlying RIA (No. 1978-36) was approved by Conrail's Board of Directors on September 12, 1978, and authorized an investment of $ 13.6 million. The Oak Island project was described as follows in the AFE form: 1. Track Connection at Nave2. Buildings and Utilities. A New Main Yard Office is required, to house the general office, superintendent's office, field terminal, crew locker and welfare facilities, maintenance areas, and yardmaster's tower. Also to be constructed are an East Yard office and a caboose servicing facility. 3. Communications and Signal Facilities. These facilities include Route Selection control equipment; operating consoles; and talkback speakers. Also included are changes in signals and electric traction facilities associated with new track connections in the390 terminal at "CY" and "PIKE." 4. Track Changes. This construction includes new connections and track changes required for consolidation in the Oak Island area. Included are: (a) crossovers at "Upper Bay"; (b) crossover in the Greenville Branch; (c) crossovers at "WA2;" (d) installation of setoff track; (e) track changes at east (pullout) end of Oak Island; (f) track changes in the Westbound Receiving Yard and Garden Yard; (g) locomotive escape track. 5. Yard Retirements. Track and crossovers are listed to be retired at the following yards: Waverly, Bayline, Oak Island, Elizabethport, and Brills. The gross investment costs identified under AFE Nos. TD25 rough TD32 were broken down on the AFE form as follows: Gross InvestmentAFE NumberDescription of WorkCostTD25Part A--Expansion andModification of Oak Island Yard$ 1,875,522 TD2Part A--Expansion andModification of Oak Island Yard4,860,781TD2Part A--Expansion andModification of Oak Island Yard182,134 Part A--Total$ 6,918,437 TD28-31Part B--Nave Connection$ 3,238,810 TD32Part C--Waverly Yard Retirements$ 151,520 TD25Part C--Bay Line Yard Retirements108,160TD26Part C--Oak Island Yard Retirements11,836TD33Part C--Elizabethport YardRetirements173,520TD27Part C--Brills Yard Retirements85,160Part C--Total$ 530,196 Parts A, B, & C--Total$ 10,687,443391 AFE Nos. TD28 through TD31 covered construction of the connection at Nave. The function of the Nave connection was described in the AFE as follows: The present route for trains moving in the terminal area between Oak Island and Croxton yards requires two reverse movements plus travel over the highly congested P&H Branch, resulting in excessive yard crew and locomotive cost. It is proposed to build a track connection at control point "NAVE" in Jersey City, connecting the National Docks Branch and Croxton yard. This connection will establish a direct route between the Oak Island Classification and departure tracks at Croxton yard, completing the integration of all North Jersey Terminal yards into the Oak Island consolidation plan. An automatic retarder control and route selection system was installed at the hump at Oak Island that was nearly identical to the system that was installed at the Allentown yard. That system was designed and installed by Harmon in July 1981. After the system at Oak Island was installed, the system experienced numerous operational problems. As a result, various changes were made to the system. Many of those changes required Harmon personnel 392 to make various hardware and software modifications. Those changes were completed on September 10, 1981. The last changes made by Harmon to the system took place in November 1981. On that date, a change was made to the console module. That change was necessary to eliminate paper jams in the console typewriter or printer. The Oak Island yard continued to operate during the course of construction, and portions of that yard were used both before and after they were involved in the construction work. The Olean Yard and TCSOlean, New York, is located in southwest New York in an area known as the southern tier. Olean is a heavily traveled north-south route of the former Penn Central railroad that crosses the former Erie-Lackawanna line. The old Olean yard was located on the north-south line, in the southwest quadrant of that crossing. In the late 1970s, New York was seeking to purchase the land occupied by the old Olean yard for use in building a highway. The State agreed to pay Conrail $ 3,506,000 for the land and for construction of a TCS. The agreement between Conrail and the State of New York provided the following with respect to title to the materials: The materials393 used for the purpose of accomplishing the work set forth in the Wellsville Siding Work Schedule (Appendix 1A) and the Signal and Communications Work Schedule (Appendix 1B) shall be the property of the State and title thereto shall be vested in the State for the useful life of said materials. For the purposes of this Agreement, the useful life of the materials shall not exceed the term of this Agreement. At the end of the useful life of said materials, or at an earlier date as otherwise set forth in the Special Provisions of attached Appendix 3, title shall be vested in the Railroad.The Wellsville siding project consisted of the installation of a passing siding and two automatic switches or control points at the entrances to the siding near Wellsville, New York. The siding was located approximately 22 miles east of the easternmost part of the TCS between Cuba Junction and Salamanca. Appendix 1 to the agreement between Conrail and the State of New York provided the following description of the work to be performed on the Olean-Wellsville project: This project consists of four parts, each to be funded in whole or in part, in different manners. All four parts are elements394 of the project and must be accomplished, but only Parts 3 [relating to the construction of the Wellsville siding] and 4 [construction of the TCS between Cuba Junction and Salamanca] are funded by the State under this Agreement.On June 20, 1979, the Board of Directors of Conrail approved RIA No. 1979-15, and on October 19, 1981, the Board also approved an AFE form for AFE Nos. TC08, TC09, TC10, TD53, TD51, and TE14, authorizing a gross investment of $ 11,144,500 to: (1) Construct a new yard at Olean; (2) construct new wye track in the northwest and southwest quadrants; and (3) remove one main track and install a TCS on the remaining track from Cuba Junction, New York, to Salamanca, New York. The trackage removed as part of the installation of the TCS on the east-west line was used to construct a new Olean yard. The anticipated gross investment costs identified under each AFE number were as follows: Gross InvestmentAFE NumberDescription of WorkCostsTC08Part A--Construct new yard$ 6,172,400 TC08Part B--Construct trackconnection at X Tower973,200TC09Part C--Construct new yard1,004,800TC09Part D--Construct trackconnection at X Tower475,400TC09Part E--Remove 1 main track CubaJunction to Salamanca & TCS2,002,400TC10Part E--Remove 1 main track CubaJunction to Salamanca & TCS110,500TD53Part F--Salamanca yard--removetracks & turntables144,300TD51Part G--Install & rearrange signalequip. related to track connectionat X Tower12,700TE14Part H--Install & rearrange signalequip. in leased bldg. at Youngstownrelated to TCS141,700TC08Part I--Rearrange industry tracksoff RR right-of-way at X Tower107,100TOTAL $ 11,144,500395 Prior to the time the project was initiated, trains that wanted to use the Olean yard, whether arriving from Buffalo or Williamsport or Harrisburg, had to stop and operate hand switches in order to get in and out of the yard. The automation of the switches was essential to the operation of the Olean yard. The new Olean yard was completed in 1982. The TCS from Cuba Junction to Olean was cut over on May 21, 1980. The West Olean-to-East Salamanca portion was cut over on April 8, 1981. The TCS from West Olean to Olean was cut over on December 17, 1981. The TCS work done after December 1981 involved the rearrangement and construction of Control Point West Cuba and the installation of the TCS from Control Point West Cuba to East Salamanca in the western-most segment of the system. The TCS from Cuba Junction to Salamanca was completed in March 1982. The construction and installation of the control point at Scio, New York, took place in 1982. Control Point Scio, however, was the control point at the western entrance of the Wellsville siding. The work at Control Point Scio did not affect the functioning of the Olean yard. Switch heaters, also known as snow melters, were installed396 at the interlockings at East Salamanca and Control Point West Cuba and at Control Point Wellsville and Control Point Scio. Flashers at the crossings along the east-west line were relocated in 1982. There was also miscellaneous cleanup work done in 1982 with respect to the Olean project. Replacement Track PropertiesOn December 31, 1980, and at all prior times, Conrail used the Replacement-Retirement-Betterment (RRB) method of depreciation under section 167(r) for its track properties. Petitioner never used the RRB method of depreciation. Conrail used a system known as Depreciation Accounting for Track Structure (DATS) for recording the costs of programmed track rehabilitation. The DATS program track work consisted of a review of a certain portion of Conrail's track system each year to replace or rehabilitate old or worn materials. There were basically five types of planned projects or categories of work to be undertaken during any year: (1) Rail and surfacing or tie and surfacing categories; (2) tie only or bridge deck categories; (3) surface only category; (4) interlock category; and (5) rail, field weld, crossing diamond, or retarder categories. Each DATS job was 397 assigned a specific work order number. Charges for labor or material relating to that specific rehabilitation project flowed into Conrail's integrated accounting system by reference to the work order number. By using the work order number for the job, which might involve as little as a couple of thousand dollars of costs, Conrail was able to identify the particular work and materials involved in the job and its precise location. Individual time cards of Conrail employees performing the reconstruction work were coded to reflect the specific job involved. Materials used were charged out of Conrail's inventory using forms that were coded to reflect the job and to indicate whether the material was new or used. Conrail excluded costs attributable to used property from the RRB replacement property included under the leases. The track property installed by Conrail during the months of October, November, and December 1981 included $ 50,973,247 of RRB replacement property. Pursuant to three agreements, Conrail sold $ 50,973,247 of RRB replacement property to petitioner. The term of each of the agreements was 21 years without option or reservation for renewal. There were no extensions398 of the agreements. At the time of the execution of the safe harbor lease agreements, Conrail had a cost basis of $ 50,973,247 in the RRB replacement property included under such lease agreements. For Federal income tax purposes, petitioner had a basis in this RRB replacement property of no greater than $ 50,973,247. Further, the replacement and betterment track properties transferred pursuant to the three agreements were considered placed in service by Conrail within 3 months prior to the agreement dates. Petitioner, as the lessor, used a 5-year recovery period for both the RRB replacement property and betterments installed by Conrail during October, November, and December 1981 and transferred pursuant to the three agreements. The class lives for the component properties that were constructed as part of the four A&I projects at issue and that were included under the lease documents were either 14 or 30 years. The lease term of the subject properties was no greater than 150 percent of the class lives. Railroad track properties and grading were the only component properties included under the lease documents that did not have assigned class lives. The useful economic life of399 grading is 121 years. The useful economic life of track properties is no less than 24 years. The term of the Armstrong/Conrail lease documents was no greater than 90 percent of the useful economic lives of the track and grading properties included thereunder. At the time the properties were placed in service under the agreements and at all times thereafter, petitioner maintained an investment in each of the properties in an amount not less than 10 percent of the adjusted basis of such properties. Conrail used all of the properties included under the safe harbor lease agreements at issue in this case in its trade or business. Conrail's RecordsUpon completion of a project, the project support division of Conrail prepared a completion report on Form CE-355. Those reports contained spaces for a brief description of the project and the dates on which a project was started, completed, and placed in service. Certain of those forms were altered, before being sent to the Internal Revenue Service or offered in evidence in Court, for purposes of placed-in-service dates with respect to the safe harbor leasing transactions between Conrail and petitioner. Placed-in-service dates400 on certain of those forms were crossed out or whited out and replaced with other dates. An internal Conrail memorandum with respect to closing out the accounting costs on the Olean yard stated: It should be noted that the "Completion Report" dated October 13, 1981 was a "tentative" one, and was issued only at the request of the Accounting Department, in order for them to satisfy regulations governing their investment tax credit package. * * Another internal Conrail memorandum on the Olean yard improvement project stated: Based on our general handling of CE-355's, I can only say that this particular completion report was initiated to satisfy regulations governing tax benefit sales, as the capital work done on this project in 1982 was scheduled to be done in 1982 and is appropriately charged to capital.The Forms CE-355 offered in evidence in this case were not reliable evidence of either Conrail's regular system of accounting or actual dates on which properties were placed in service. Notice of DeficiencyThe depreciation deductions and investment tax credits disallowed by respondent relate to approximately $ 29,775,950 of additions and improvements401 purchased by petitioner from Conrail and leased back to Conrail under three of the nine agreements. The notice of deficiency described the amounts in dispute as follows: Section 38"As of" DateTotal LeasedAt IssueProperty12/17/81$ 14,512,260TC09 Olean$ 2,730,980 HC94 Orrville-10,086,334Colsan 12/31/8116,500,000TC08 Olean3,747,672TD25 Oak Island1,333,702HN Allentown8,976,31312/31/813,053,144TD26 Oak Island2,900,944Total at Issue$ 29,775,945In the Explanation of Items attached to the notice of deficiency, respondent stated: It is determined that you failed to establish that the depreciation deductions claimed on your return, with respect to certain purported sales/leasebacks of railroad properties between Conrail, and you, in the amount of $ 4,466,392.00, are deductible under the "safe harbor" lease provisions of Section 168 or are otherwise deductible under any other provision of the Internal Revenue Code. It is determined that you failed to establish that the investment tax credits claimed on your return, with respect to certain purported sales/leasebacks of railroad properties between Conrail, and you, in the 402 amount of $ 2,977,595.00, is allowable under any provision of the Internal Revenue Code.On January 12, 1989, petitioner timely filed its petition in this case challenging the deficiency determined by respondent. In addition, petitioner claimed an overpayment of Federal income tax in an amount in excess of $ 20 million for 1981. That overpayment claim relates to depreciation deductions over a 5-year period with respect to $ 50,973,247 of replacement track properties purchased by petitioner from Conrail and leased back to Conrail under three of the nine agreements. OPINION Safe Harbor Leasing--ConceptuallyThe safe harbor leasing provisions were enacted in 1981 as part of the Economic Recovery Tax Act of 1981, Pub. L. 97-34, 95 Stat. 172. The rationale for the enactment of the safe harbor leasing provisions, as stated by the Senate Finance Committee report, was as follows: The committee recognizes that some businesses may not be able to use completely the increased cost recovery allowances and the increased investment credits available for recovery property under ACRS [accelerated cost recovery system]. ACRS will provide the greatest benefit to the economy if ACRS403 deductions and investment tax credits are more easily distributed throughout the corporate sector. Under present law, three-party financing leases ("leverage" leases) are now widely used to transfer tax benefits to users of property who do not have sufficient tax liability to absorb those benefits. The committee has decided to facilitate the transfer of ACRS benefits through these types of transactions. Under current administrative practice, however, lease characterization is subject to specific IRS guidelines. Moreover, court decisions have not prescribed clear guidelines as to the appropriate tax characterizations of financing leases. Since the committee has decided that lease characterization should be more available, the committee bill establishes an exception to current judicial and administrative guidelines dealing with leasing transactions. * * * The committee bill creates a safe harbor that guarantees that a transaction will be characterized as a lease for the purposes of allowing investment credits and capital cost recovery allowances to the nominal lessor. Lessors will be able to receive cost recovery allowances and investment tax credits with respect to404 qualified leased property, while it is expected that lessees will receive a very significant portion of the benefits of these tax advantages through reduced rental charges for the property (in the case of finance leases) or cash payments and/or reduced rental charges in the case of sale-leaseback transactions. [S. Rept. No. 97-144 (1981), 2 C.B. 412">1981-2 C.B. 412, 432; emphasis supplied.]The safe harbor leasing provisions are further explained in the General Explanation of the Economic Recovery Tax Act of 1981, dated December 31, 1981, prepared by the Staff of the Joint Committee on Taxation: The new provision is a significant change overriding several fundamental principles of tax law. Traditionally, the substance of a transaction rather than its form controls the tax consequences of a transaction. In addition, a transaction generally will not be given effect for tax purposes unless it serves some business purpose aside from reducing taxes. Because the leasing provision was intended to be only a transferability provision, many of the transactions that will be characterized as a lease under the safe harbor will have no business purpose (other than to transfer405 tax benefits). When the substance of the transaction is examined, the transaction may not bear any resemblance to a lease. [Staff of the J. Comm. on Taxation, General Explanation of the Economic Recovery Act, at 104 (J. Comm. Print 1981); emphasis supplied.]The passages quoted above are indicative of the liberal nature of the safe harbor leasing provisions. Those provisions were enacted by Congress to "encourage particular conduct and achieve certain policy goals." Fox v. Commissioner, 82 T.C. 1001">82 T.C. 1001, 1025 (1984). Further, the safe harbor leasing provisions were intended to facilitate the transfer of tax benefits to those companies that were able to utilize those benefits and simultaneously spur new investment by those companies. See Papago Tribal Utility Authority v. Federal Energy Regulatory Commission, 773 F.2d 1056">773 F.2d 1056, 1065 (9th Cir. 1985); Greene v. Commissioner, 88 T.C. 376">88 T.C. 376, 382 (1987). The safe harbor leasing provisions were repealed by section 209 of the Tax Equity and Financial Responsibility Act of 1982, Pub. L. 97-248, 96 Stat. 324, 442. Section 168(f)(8)Section 168(f)(8) was the operative provision406 for safe harbor leasing activity. Section 168(f)(8)(A) generally provided that, if the parties to a lease of qualified leased property agree to have that section apply, the agreement is treated as a lease of the property, the lessor is treated as the owner of the property, and the lessee is treated as the lessee of the property. Section 168(f)(8)(B) set forth certain requirements, concerning the lessor and the lease term, that were to be met in order to satisfy section 168(f)(8). The parties agree that those requirements are satisfied in this case. The controversy here involves the requirements of section 168(f)(8)(D), which defined qualified leased property as follows: (D) Qualified leased property defined. -- For purposes of subparagraph (A), the term "qualified leased property" means recovery property (other than a qualified rehabilitated building within the meaning of section 48(g)(1)) which is -- (i) new section 38 property (as defined in section 48(b)) of the lessor which is leased within 3 months after such property was placed in service and which, if acquired by the lessee, would have been new section 38 property of the lessee, (ii) property -- (I) which was new407 section 38 property of the lessee, (II) which was leased within 3 months after such property was placed in service by the lessee, and (III) with respect to which the adjusted basis of the lessor does not exceed the adjusted basis of the lessee at the time of the lease, or * * * For purposes of this title (other than this subparagraph), any property described in clause (i) or (ii) to which subparagraph (A) applies shall be deemed originally placed in service not earlier than the date such property is used under the lease. In the case of property placed in service after December 31, 1980, and before the date of the enactment of this subparagraph, this subparagraph shall be applied by substituting "the date of the enactment of this subparagraph" for "such property was placed in service."The parties agree that the properties in issue were new property for investment tax credit purposes, that is, the original use of the properties commenced with the lessee, Conrail. Qualified Lease PropertyPetitioner's PositionPetitioner contends that the rail properties included under the Armstrong/Conrail safe harbor leases were leased in 1981 within 3 months of the time 408 they were placed in service by Conrail; that the leased properties were placed in service as a single integrated unit; and that the other requirements of section 168(f) have all been satisfied. Respondent's PositionRespondent contends that the Armstrong/Conrail safe harbor leasing transactions did not meet the requirements of section 168(f)(8). Respondent argues that the rail properties were not leased within 3 months of the time they were placed in service; a portion of the leased property was not recovery property because it was financed by the State of New York; petitioner's adjusted bases in the leased properties exceeded the adjusted bases of Conrail in those properties; and certain portions of the leased properties were not leased in 1981 because they were not identified in the safe harbor lease contract when it was executed. The focus of this dispute is on whether the leases between Armstrong and Conrail applied to property placed in service during the required time frame. Resolution of the dispute requires analysis of the authorities and the evidence regarding when the subject property was placed in service for depreciation and investment tax credit purposes. 409 Applicable AuthoritiesPetitioner argues that "each of Conrail's rail projects constitutes a 'facility' permitted to be placed in service as a facility for safe harbor leasing purposes." Section 5c.168(f)(8)-6(b)(2)(i), Temporary Income Tax Regs., 46 Fed. Reg. 51911 (Oct. 23, 1981), provided what is referred to as the facility rule. That rule is that, "If an entire facility is leased under one lease, property which is part of the facility will not be considered placed in service under this rule until the entire facility is placed in service." In many ways, determination of whether a project is a facility involves the same analysis, set forth below, as to whether a project is a single integrated unit. Respondent contends, however, that the facility rule is inapplicable because petitioner did not lease each entire project under a single lease. Petitioner admits that "costs attributable to the Oak Island Project were included under both the first and second December 31 documents; and, finally, the costs attributable to the Olean Project were split between the December 17 document and the second December 31 document." Petitioner did not lease each project under410 a single lease and may not invoke the facility rule of the temporary regulation. Petitioner also argues that, "under ordinary placement in service principles applicable to complex properties, each of Conrail's rail projects constitutes an integrated unit of property required to be placed in service as a single property." Petitioner contends that all of the components constructed as part of the rail yard projects were necessary to the safe and efficient operation of the whole and thus functioned together as a single unit. Petitioner relies on Hawaiian Independent Refinery v. United States, 697 F.2d 1063 (Fed. Cir. 1983); Public Service Co. of New Mexico v. United States, 431 F.2d 980">431 F.2d 980 (10th Cir. 1970); Consumers Power Co. v. Commissioner, 89 T.C. 710 (1987); Noell v. Commissioner, 66 T.C. 718">66 T.C. 718 (1976); LTV Corp. v. Commissioner, 63 T.C. 39">63 T.C. 39 (1974); Madison Newspapers v. Commissioner, 47 T.C. 630">47 T.C. 630 (1967); Oglethorpe Power Corp. v. Commissioner, T.C. Memo 1990-505">T.C. Memo 1990-505; and Siskiyou Communications, Inc. v. Commissioner, T.C. Memo 1990-429">T.C. Memo 1990-429,411 for the proposition that the safe harbor lease properties should be viewed as single integrated units. In Hawaiian Independent Refinery v. United States, 697 F.2d 1063 (Fed. Cir. 1983), the Court of Appeals for the Federal Circuit addressed the placed-in-service issue with respect to an oil refinery complex. The complex consisted of the refinery facility, an offshore tanker-mooring facility located 2 miles from the refinery but connected to the refinery by a pipeline, and two other pipelines used to transport finished products from the refinery to storage facilities. The court concluded, among other things, that the two off-site refinery properties could not be considered separate from the refinery itself for purposes of the investment tax credit. Rather, the court stated that the entire refinery complex was to be treated as a single asset. The court concluded: The trial judge, noting that nothing in the statutes or regulations deals specifically with what is a single property for purposes of section 50, IRC, reasoned that the tanker-mooring facility is used to transport raw materials to the refinery and the products pipelines connect the refinery with 412 HIRI's [Hawaiian Independent Refinery] storage facilities, so that the two offsite components, "in conjunction with the refinery itself, functionally form a single property," construction of which began when construction was begun on the refinery component. We regard this as a reasonable approach, particularly since the refinery complex was conceived, designed, and constructed as a unit, the three components being placed in operation concurrently. * * [697 F.2d at 1069; emphasis supplied.]The Court of Appeals for the Tenth Circuit, in Public Service Co. of New Mexico v. United States, 431 F.2d 980">431 F.2d 980 (10th Cir. 1970), considered whether component assets of an electrical power plant could be placed in service prior to the time that the entire plant was placed in service. The component assets included a turbine generator, a cooling tower, a transformer, a main power plant building, and a steam generating unit. The court concluded that the various assets were placed in service when the entire plant became operational because: No one of these * * * [component assets] would serve any useful purpose to * * * [Public Service Co.] but all413 of them properly fitted together by the contractor, together with the building, constituted a complete unit which was operational and served the purpose intended by * * [Public Service Co.]. It was the complete operational unit that * * * [the contractor] agreed to construct from the many components and deliver to * * * [Public Service Co.] as an electrical power generating plant. [431 F.2d at 984.]Consumers Power Co. v. Commissioner, 89 T.C. 710">89 T.C. 710 (1987), involved the placed-in-service issue with respect to a pumped storage hydroelectric plant. In a pumped storage hydroelectric plant, water is pumped from a lower reservoir, during periods when electrical power demand is low, up to a higher elevation storage reservoir. When supplemental power is needed, water is released, turning hydraulic turbine generators and producing electrical power. In November 1972, the plant began pumping water into the upper reservoir, the generating mode was first synchronized with the transmission system, and power was produced. The plant produced electrical power ranging from 18 percent to 89 percent of capacity, and electrical power was sold to customers414 through December 1972. The unit was shut down temporarily in December 1972, and testing was suspended. Preoperational testing continued on the unit through January 1973, when the repairs were completed and the taxpayer accepted the unit from the general contractor. We there concluded: Not until January 17, 1973, after * * [the unit] successfully had completed all phases of preoperational testing, thereby demonstrating that it was available for service on a regular basis, was the unit in a state of readiness and availability for its specifically assigned function within the meaning of sections 1.46-3(d)(1)(ii) and 1.167(a)-11(e)(1)(i), Income Tax Regs. [Consumers Power Co. v. Commissioner, 89 T.C. at 724.]Further, with respect to whether the plant and the reservoir should be regarded as single property for depreciation and investment tax credit purposes, we stated: In our opinion, based on the foregoing, the Ludington Plant must be viewed as one integrated unit because the physical plant and the reservoir operate simultaneously and as a unit in order to produce electrical power. [89 T.C. at 726.]In Noell v. Commissioner, 66 T.C. 718">66 T.C. 718 (1976),415 we addressed whether a taxpayer was entitled to an investment tax credit for an airplane runway. Prior to the time the runway was completed, airplanes landed on a grass strip. Some airplanes used the runway after a rock base was laid, but the roughness of the rock surface made it unsatisfactory for permanent use. Further, due to the wetness of the underlying black soil, the rock surface was usable only under good weather conditions. The determinative issue was "when the landing strip was placed in a state of availability for a specific function in petitioner's trade or business." 66 T.C. at 728. We concluded: The runway was not "in a condition or state of readiness" in 1967. The rock surface on which some planes landed in 1967 was clearly only a stage in the construction of the facility. This surface was quite unsatisfactory and pilots risked damaging their aircraft by landing on it. Moreover, the rock surface could not be used on a permanent basis, since the landing area easily could be ruined by the weather. In fact, the runway here had been ruined three times before petitioner finally put the pavement down. In short, the facility was simply not available416 for full service until the runway was paved in 1968. We therefore hold that the landing facilities were not placed in service until that year. [66 T.C. at 729.]LTV Corp. v. Commissioner, 63 T.C. 39">63 T.C. 39 (1974), involved a contract to lease computer equipment. Pursuant to the contract, the computer equipment was to be installed by the seller on or before December 31, 1961. The computer was on the taxpayer's premises prior to the installation date. Installation of the computer, however, was not completed until after December 31, 1961. We there concluded that the taxpayer was entitled to an investment tax credit in 1962 because "the what in this case is an installed and operating computer; one that is available for use by the * * * [taxpayer] for the purpose for which it was purchased." 63 T.C. at 46. We further stated that "IBM [the seller] felt its obligation was not completed until there was a mutual agreement between IBM and the customer [the taxpayer therein] that the machine was operational and ready to perform the functions for which it was intended." 63 T.C. at 48. In Madison Newspapers, Inc. v. Commissioner, 47 T.C. 630 (1967),417 this Court addressed whether certain units of a printing press were new section 38 property for purposes of the investment tax credit. Components of the units had been delivered to the taxpayer prior to installation. Respondent there argued "that * * [the taxpayer] had control over the units prior to * * * [the year the credit was claimed], as evidenced by the fact that * * * [the taxpayer], directly or indirectly, paid the salaries of all those connected with the installation of the units and allegedly could have, at any time, dismissed any of those so working." 47 T.C. at 634. The taxpayer argued that it did not have control over the units until they were ready for commercial operation and acceptance, that a contractor had ultimate responsibility for the installation, and that it contracted for installed units, not component parts. We there concluded that the taxpayer's physical possession of the units was not determinative. Rather, the taxpayer had contracted for installed units, not an uninstalled assortment of components, and those units were not in existence for investment tax credit purposes until they were installed. 47 T.C. at 637.418 In Oglethorpe Power Corp. v. Commissioner, T.C. Memo 1990-505">T.C. Memo 1990-505, this Court concluded that a coal-fired electrical generating plant was leased within the required 3-month window under section 168(f)(8)(D)(iii). The electrical generating plant was part of the Georgia Integrated Transmission System (the system), an integrated system of electrical transmission lines and substations. After initial separate component testing was completed, the unit was synchronized with the system. The period between initial synchronization and commercial operation is referred to as the test period. During that period, the components of the unit are integrated into a coordinated system, problems are resolved, and the unit is then moved to commercial readiness. Respondent argued that the unit was placed in service when the unit was first synchronized with the system. The taxpayer argued that "the testing of * * [the unit], as a fully integrated unit, had not begun at the time of initial synchronization, and that the test period which followed synchronization revealed a series of major defects which made it impossible for the unit to serve its intended 419 purpose until the defects were corrected." Oglethorpe Power Corp. v. Commissioner, T.C. Memo 1990-505">T.C. Memo 1990-505, 1990 Tax Ct. Memo LEXIS 558">1990 Tax Ct. Memo LEXIS 558, 60 T.C.M. (CCH) 850">60 T.C.M. (CCH) 850, 858-859, T.C.M. (RIA) 90505 at 2470. The opinion in Oglethorpe Power Corp. discussed the purpose of the safe harbor leasing provisions and the placed-in-service requirement contained in section 168(f)(8)(D)(ii). In determining the placed-in-service dates, the Court analyzed the provisions of sections 1.167(a)-11(e)(1)(i) and 1.46-3(d)(1)(ii), Income Tax Regs., and section 5c.168(f)(8)-6(b)(2), Temporary Income Tax Regs., 46 Fed. Reg. 51911 (Oct. 23, 1981). Section 1.167(a)-11(e)(1)(i), Income Tax Regs., provides: The term "first placed in service" refers to the time the property is first placed in service by the taxpayer, not to the first time the property is placed in service. Property is first placed in service when first placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, in the production of income, in a tax-exempt activity, or in a personal activity. * * [Emphasis supplied.]Similarly, section420 1.46-3(d)(1)(ii), Income Tax Regs., relating to the investment tax credit, provides: (d) Placed in service. (1) For purposes of the credit allowed by section 38, property shall be considered placed in service in * * * * * (ii) The taxable year in which the property is placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, in the production of income, in a tax exempt activity, or in a personal activity. [Emphasis supplied.]Section 5c.168(f)(8)-6(b)(2), Temporary Income Tax Regs., 46 Fed. Reg. 51911 (Oct. 23, 1981), provides: (2) Placed in service. (1) Property shall be considered as placed in service at the time the property is placed in a condition or state of readiness and availability for a specifically assigned function. * * * Based upon the similar language contained in the foregoing sections, we concluded in Oglethorpe Power Corp. that, for safe harbor leasing purposes, a property is placed in service when first "placed in a condition of or state of readiness and availability for a specifically assigned function." T.C. Memo 1990-505">T.C. Memo 1990-505, 1990 Tax Ct. Memo LEXIS 558">1990 Tax Ct. Memo LEXIS 558, 60 T.C.M. (CCH) 850">60 T.C.M. (CCH) 850, 859, T.C.M. (RIA) 90505 at 90-2470 (1990).421 We found that the components of the unit were tested separately to the extent possible to eliminate problems that could be detected prior to synchronization with the system. We concluded, however, that testing of an electrical generating plant unit within the system could not be performed until the unit was synchronized with the system and that the major defects that were found to exist could not have been discovered without that testing. The unit was prevented from achieving generating levels near its rated capacity until those defects were remedied. Therefore, we concluded, the unit was not placed in service until the preoperational system testing was completed and the unit was achieving a consistent output near its rated capacity. The reasoning in Oglethorpe is persuasive. Nevertheless, it does not aid petitioner when applied to the facts in this case. Respondent notes that "in none of the cases cited by petitioner where a court found that component properties constituted a single integrated property had such property been used, other than in preoperational testing prior to the time it was placed in service." Respondent contends that, contrary to the safe harbor lease422 properties in the present case, the properties in those cases were of no use to their owners until they were integrated with other components comprising a single integrated unit. We agree with respondent that "it is rare for a court to find that property is placed in service after it has been used." Property will be found to have been placed in service to the extent that it has been used for its specifically assigned function, as explained below. The applicable authorities are consistent in their analysis of placed in service where the completion of a component is integral to the availability and readiness of a project as a whole for its specifically assigned function. In that instance, part of a project is not considered placed in service until the whole project is placed in service. In our view of the evidence, the safe harbor leases here involved projects consisting of subprojects; therefore a similar analysis is appropriate. Thus we must decide whether the subprojects were integral to the whole project and, if not, when the subprojects were completed and used for their specifically assigned function. The EvidenceThe placed-in-service determination is significant 423 in the present case because safe harbor lease property must be qualified leased property under section 168(f)(8)(D) -- leased within 3 months of the time it was placed in service (the window). Three of the safe harbor leases were dated as of December 17, 1981, and six were dated as of December 31, 1981. The opening dates for the window therefore are September 16, 1981, and September 30, 1981. Petitioner argues that "Conrail's regular procedure of placing self constructed properties in service on an entire project or integrated subproject basis constitutes a permissible method of tax accounting" and that that procedure was used with respect to the safe harbor lease properties in the present case. Petitioner argues that the placed-in-service dates under that procedure are conclusive. At trial, petitioner offered documents and the testimony of Conrail accounting and supervisory personnel regarding the procedure used by Conrail for determining when a project was placed in service, including copies of Conrail internal project completion reports (Forms CE-355). Some of the Forms CE-355 offered by petitioner were not admitted in evidence because we concluded that alterations of those424 documents and other evidence of the manner in which dates were chosen undermined their reliability. Despite our rulings during trial, petitioner relies in its briefs on the Forms CE-355, asserting that "Conrail merely tailored some of the paperwork to fit the requirements of the safe harbor leasing program." We reiterate that the evidence of alteration of the Forms CE-355 undermines their reliability for purposes of this case, regardless of whether such forms were used consistently for other purposes. The trial testimony of current and former Conrail personnel was in substantial part based on the Forms CE-355 and otherwise was not persuasive. We conclude that the contemporaneous writings, including the internal Conrail memoranda described in our findings, and the inferences to be drawn from deliberate alterations are entitled to greater weight. Many of the controlling facts, however, have been stipulated or are undisputed. We have accepted the testimony of Conrail's employees as to the functions of specific properties. 1. Orrville-to-Colsan ProjectThe Orrville-to-Colsan project consisted of construction of a new signal and rail TCS along a 76-mile corridor. That 425 project was conceived and designed as entailing the installation of signaling units along a 76-mile stretch of track. The construction of the system proceeded in segments. After a segment was completed, it was cut over for use by Conrail. A computer was installed in 1980 to govern the entire TCS when completed. The first 10 segments of the Orrville-to-Colsan project were cut over before June 1981 and were used by local crews for train operation prior to September 1981. The final segment was cut over on October 26, 1981. The use of a segment after it was cut over manifests the independent character of the segment in relation to the other segments. The individual segments were not necessary to the whole but, rather, were subprojects. Accordingly, only the final segment is within the 3-month window. Although the computer was installed in 1980, the computer was not ready to perform its specifically assigned function until the final segment was cut over on October 26, 1981; the computer was therefore placed in service within the 3-month window. 2. Allentown YardThe Allentown yard project involved the construction of a new rail yard on the site of two previously separate426 yards. The automatic hump control operation was a significant portion of the Allentown project. That operation allowed for uncoupling of cars, sorting of those cars by destination, and automatic reforming of those cars into new trains. The automatic hump control operation components, the automatic route switching and the retarder control, were installed and tested and were operating in January 1981. Software and operational changes were subsequently made and completed in November 1981. Those software changes were design changes; they were not in the original plans. The operation was available and ready to perform its specifically assigned function in January 1981, and it was therefore placed in service at that time and not during the relevant 3-month period. See section 1.46-3(d)(2)(iii), Income Tax Regs.3. The Oak Island ProjectThe Oak Island project involved the installation of an automatic hump control operation similar to the one installed in Allentown. The Oak Island operation was completed in July 1981. Final adjustments to the Oak Island operation were made through September 10, 1981. In November 1981, an adjustment to the computer printer was made. That427 adjustment did not affect the specific function of the unit but, rather, entailed the elimination of a paper jam. Accordingly, the project was placed in service on September 10, 1981, and not within the 3-month window. See section 1.46-3(d)(2)(iii), Income Tax Regs.4. The Olean Yard and TCSThe Olean yard and TCS project consisted of constructing a new rail yard near the intersection of two main lines. Also, two-way automatic signaling and switching was installed along a 20-mile stretch of the east-west rail line adjacent to the yard. The new yard was completed in 1980. The TCS was completed in four segments. The TCS between Cuba Junction and Olean was cut over on May 21, 1980; the West Olean-to-East Salamanca portion was cut over on April 8, 1981; the TCS between West Olean and Olean was cut over on December 17, 1981; and the TCS between Cuba Junction and Salamanca was cut over in March 1982. The TCS between West Olean and Olean was the only segment placed in service within the 3-month window. Adjusted Basis of the Leased PropertiesSection 168(f)(8)(D)(ii)(III) requires that the safe harbor lessor's adjusted basis in the qualified leased property not exceed428 the adjusted basis of the lessee in the property at the time of the lease. Petitioner contends that it acquired an adjusted basis in the leased properties no greater than Conrail's actual cost basis. Respondent argues that the cost basis of certain components of the safe harbor lease projects should be reduced to reflect depreciation taken during the years prior to the lease of the properties. Respondent's argument assumes that the properties were placed in service prior to 1981. We have concluded that petitioner is not entitled to any safe harbor leasing benefits for properties that were placed in service outside of the 3-month window in 1981; no taxable period passed from the time the properties were placed in service to the time they were leased. Conrail's cost bases, therefore, were the equivalent of their adjusted bases in the safe harbor lease properties. Property Identified to the ContractRespondent's final argument on the safe harbor leases is that the property that was the subject of the lease agreement dated "as of December 31, 1981" for $ 16,500,000 was not leased in 1981. Respondent argues that, because Conrail had more fourth-quarter benefits than it actually429 sold, its commitment to sell a dollar amount of tax benefits to petitioner was not sufficient to identify particular properties to be transferred. According to respondent, there is, subsumed in section 168(f)(8), a requirement that each leased property to which an election is made be identified before the election can become effective. Respondent contends that title to leased property could not pass from Conrail to Armstrong prior to its identification by Conrail, which did not occur until, at the earliest, January 19, 1982. We have found as a fact that the supplements to exhibit A to the $ 16,500,000 lease dated as of December 31, 1981, were not provided to Armstrong prior to January 19, 1982. This finding was based on the dates of certain supporting documents prepared by a Conrail employee. The documents and the testimony of that Conrail employee impeached testimony that the schedules were attached to the leases when they were executed in 1981. When the Court ordered the original documents produced, the supplements were not attached to the original leases, and those showing a total of $ 16,500,000 were attached to supporting documents dated January 19, 1982. Nonetheless, 430 petitioner contends that respondent raised this issue for the first time on brief, thereby unfairly prejudicing petitioner. The statutory notice broadly determined that petitioner had failed to establish that the deductions and investment tax credits claimed on its return met the safe harbor leasing requirements of section 168, thus encompassing all requirements in section 168(f). Questions about the contents of the documents executed in December 1981 were raised during the stipulation process, in respondent's pretrial memorandum, and at trial. Any prejudice to petitioner results only from impeachment of petitioner's witnesses by petitioner's records belatedly produced. This issue is decided on that evidence and is not affected by allocation of the burden of proof. Petitioner contends that State law requirements that property be identified are not controlling and that specific identification of the safe harbor lease properties does not have to be made until the filing of the information return. Petitioner relies on the following language of section 5c.168(f)(8)-1(c), Temporary Income Tax Regs., 46 Fed. Reg. 51908 (Oct. 23, 1981), for the assertion that property431 is not required to be identified under section 168(f)(8): An agreement that meets the requirements of section 168(f)(8) and sections 5c.168(f)(8)-2 through 5c.168(f)(8)-11 may be treated by the parties as a lease for Federal tax law purposes only. Similarly, a sale by the lessee of the leased property to the lessor in a transaction where the property is leased back under an agreement that meets the requirements of section 168(f)(8) may be treated by the parties as a sale for Federal tax law purposes only. The agreements need not comply with State law requirements concerning transfer of title, recording, etc.Petitioner contends that the above regulation obviates the necessity for identification of the property subject to a safe harbor lease. That section, however, merely dispenses with State law formalities. The issue is whether a binding agreement could occur in 1981 without specification between the parties as to the subject of the agreement. Prior to 1982, the parties to the lease had agreed on the dollar amount of property to be transferred, but they had not identified the property other than as placed in service between November 1 and December 31, 1981. As to432 the specific properties, it was an agreement to agree. Absent identification of the properties prior to the end of the year, the agreement was not susceptible of enforcement and could not take effect. By not challenging leases other than the $ 16,500,000 lease dated December 31, 1981, respondent is implicitly agreeing that the properties were sufficiently identified in the subsequently prepared schedules. He is only challenging the timeliness as to one lease, and, on the evidence, we conclude that he is correct that the identification of the items associated with that lease did not occur in 1981. The parties agree that the $ 16,500,000 lease supplement prepared in 1982 included costs associated with the Oak Island, Allentown, and Olean projects. Although we have concluded that the Allentown and Oak Island projects were not placed in service during the crucial 3-month period, a portion of the Olean project was placed in service on December 17, 1981. This property, however, was not leased to petitioner in 1981. Replacement Track PropertySection 168(f)(3) provides: (3) RRB replacement property. -- (A) In general. -- In the case of RRB replacement property placed in433 service before January 1, 1985, the recovery deduction for the taxable year shall be, in lieu of the amount determined under subsection (b), the amount determined by applying to the unadjusted basis of such property the applicable percentage determined under tables prescribed by the Secretary. * That section further provides that, for property placed in service in 1981, the recovery period is 1 year. The Senate Finance Committee report states that the purpose of the accelerated recovery period is as follows: Under the committee bill, Code section 167(r) permitting the use of the RRB method is repealed as of January 1, 1981. Property placed in service after 1980 that would have been RRB property under present law will be treated as 5-year property under ACRS. During a 4-year transition period (1981-1984), a special transition rule is provided for such property that would have been expensed under RRB (replacements). Costs of property that would have been capitalized under RRB (additions and betterments) are treated the same as other 5-year property under ACRS. Thus, such costs are subject to the same rules that apply for other eligible property placed in service434 after 1980. Replacement property (which would be expensed under RRB) is phased in to ACRS over 5 years. Replacement property placed in service in 1981 will be expensed. * * * [S. Rept. No. 97-174 (1981), 2 C.B. 412">1981-2 C.B. 412, 430.]Petitioner argues that section 168(f)(8)(G) and section 168(f)(10), when read in conjunction with section 1.168-5(a)(1)(ii), Income Tax Regs., provide authority for the proposition that the RRB costs were 100-percent deductible for the year in which they were transferred under the lease. Section 168(f)(8)(G) provides: (G) Regulations. -- The Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this paragraph, including (but not limited to) regulations consistent with such purposes which limit the aggregate amount of (and timing of) deductions and credits in respect of qualified leased property to the aggregate amount (and the timing) allowable without regard to this paragraph.Section 168(f)(10) provides, in relevant part: (10) Transferee bound by transferor's period and method in certain cases. -- (A) In general. -- In the case of recovery property transferred in a transaction described435 in subparagraph (B), the transferee shall be treated as the transferor for purposes of computing the deduction allowable under subsection (a) with respect to so much of the basis in the hands of the transferee as does not exceed the adjusted basis in the hands of the transferor. (B) Transfers covered. -- The transactions described in this subparagraph are -- * * (iii) an acquisition followed by a leaseback to the person from whom the property is acquired.Section 1.168-5(a)(1)(ii), Income Tax Regs., provides: (ii) The provisions of paragraph (a)(1)(i) of this section (relating to a one year recovery period) do not apply to any taxpayer who did not use the RRB method of depreciation under section 167 as of December 31, 1980. In such case, RRB replacement property placed in service by the taxpayer after December 31, 1980, shall be treated as other 5-year recovery property under section 168.Petitioner contends that Conrail both originally placed in service the RRB replacement property in question during 1981 and used the RRB method of depreciation in 1980 (and in previous years). Petitioner therefore contends that Conrail was a taxpayer to which section436 168(f)(3) applied. Petitioner further argues that it purchased the property, leased it back to Conrail, and thus became the owner of the leased property for Federal income tax purposes and was bound by the method used by Conrail, i.e., the RRB method, and, accordingly, was entitled to the benefit of the transitional rule under section 168(f)(10). The purpose of the transitional rule of section 168(f)(3) was to phase into ACRS (accelerated cost recovery system) the property of a taxpayer who had previously used the RRB method under section 167. It does not generally apply to a taxpayer, such as petitioner, who had not used the RRB method. With respect to safe harbor lease transactions, section 5c.168(f)(8)-5(c), Temporary Income Tax Regs., 46 Fed. Reg. 51910 (Oct. 23, 1981), provides: (c) Minimum term. For purposes of this section, the term of the lease must at least equal the period prescribed under section 168(c)(2) for the recovery property class of the leased property. For example, if a piece of leased equipment is in the 5-year recovery property class, the lease agreement must have a minimum term of 5 years. In general, the determination of whether 437 property is 3-year recovery property, 5-year recovery property, etc., in the hands of the lessor will be based on the characterization of the property in the hands of the owner as determined without regard to the section 168(f)(8) lease. Thus, for example, property which is public utility property or RRB replacement property absent the section 168(f)(8) lease will be characterized as such in the hands of the lessor for purposes of section 168(f)(8). However, with respect to RRB replacement property, the transitional rule of section 168(f)(3) shall be inapplicable to the lessor. [Emphasis supplied.]Similarly, section 5c.168(f)(8)-7(e), Temporary Income Tax Regs., 46 Fed. Reg. 51912-51913 (Oct. 23, 1981), provides: (e) ACRS deductions. The deductions that the lessor is allowed under section 168(a) with respect to property subject to a section 168(f)(8) lease shall be determined without regard to the limitation in section 168(f)(10)(B)(iii). The recovery class of qualified leased property in the hands of the lessor shall be determined by the character of the property in the hands of the owner of the property without regard to section 168(f)(8). Any438 elections under section 168(b)(3) by the lessor with respect to the class of recovery property to which the qualified leased property is assigned shall apply to the leased property. However, with respect to RRB replacement property, the transitional rule of section 168(f)(3) shall be inapplicable to the lessor. [Emphasis supplied.]Petitioner argues that the cited temporary regulation sections are merely interpretive and should be granted little deference. Petitioner also contends that those regulations are invalid. Respondent argues that the regulations are consistent with the purpose of section 168(f)(8) and in conformity with the congressional grant of authority to prescribe regulations contained in section 168(f)(8)(G). We agree with respondent. The Supreme Court has articulated the following standard for determining the validity of Treasury regulations: Regulations command our respect, for Congress has delegated to the Secretary of the Treasury, not to this Court, the task "of administering the tax laws of the Nation." United States v. Cartwright, 411 U.S. 546">411 U.S. 546, 550, 36 L. Ed. 2d 528">36 L. Ed. 2d 528, 93 S. Ct. 1713">93 S. Ct. 1713 (1973); accord, United States v. Correll, 389 U.S. 299">389 U.S. 299, 307, 19 L. Ed. 2d 537">19 L. Ed. 2d 537, 88 S. Ct. 445">88 S. Ct. 445 (1967);439 see 26 U.S.C. sec. 7805(a). We therefore must defer to Treasury Regulations that "implement the congressional mandate in some reasonable manner." United States v. Correll, supra at 307; accord, National Muffler Dealers Assn. v. United States, 440 U.S. 472">440 U.S. 472, 476-477, 59 L. Ed. 2d 519">59 L. Ed. 2d 519, 99 S. Ct. 1304">99 S. Ct. 1304 (1979). To put the same principle conversely, Treasury Regulations "must be sustained unless unreasonable and plainly inconsistent with the revenue statutes." Commissioner v. South Texas Lumber Co., 333 U.S. 496">333 U.S. 496, 501, 92 L. Ed. 831">92 L. Ed. 831, 68 S. Ct. 695">68 S. Ct. 695 (1948); accord, Fulman v. United States, 434 U.S. 528">434 U.S. 528, 533, 55 L. Ed. 2d 1">55 L. Ed. 2d 1, 98 S. Ct. 841">98 S. Ct. 841 (1978); Bingler v. Johnson, 394 U.S. 741">394 U.S. 741, 749-751, 22 L. Ed. 2d 695">22 L. Ed. 2d 695, 89 S. Ct. 1439">89 S. Ct. 1439 (1969). * * * [Commissioner v. Portland Cement Co. of Utah, 450 U.S. 156">450 U.S. 156, 169, 67 L. Ed. 2d 140">67 L. Ed. 2d 140, 101 S. Ct. 1037">101 S. Ct. 1037 (1981).]Legislative regulations, that is, those emanating from a specific congressional grant of authority and not merely from the Treasury's general rule-making power under section 7805(a), are entitled to the highest standard of deference. See, e.g., United States v. Vogel Fertilizer Co., 455 U.S. 16">455 U.S. 16, 24, 70 L. Ed. 2d 792">70 L. Ed. 2d 792, 102 S. Ct. 821">102 S. Ct. 821 (1982); Rowan Companies, Inc. v. United States, 452 U.S. 247">452 U.S. 247, 253, 68 L. Ed. 2d 814">68 L. Ed. 2d 814, 101 S. Ct. 2288">101 S. Ct. 2288 (1981).440 Petitioner argues that, notwithstanding the express delegation of authority in section 168(f)(8)(G), quoted above, the temporary regulations are interpretive, are contrary to the "plain language" of section 168(f)(3) and 168(f)(10), and are unreasonable. Petitioner argues that section 168(f)(3)(A) "mandates that Armstrong should claim the one year 100 percent recovery deduction specified under such section." Moreover, according to petitioner, the regulations "contradict the letter and purpose of Code section 168(f)(10)," quoted above. Petitioner also argues that the generally liberal intent and purpose of section 168(f) should override the regulations. Respondent argues that the purpose of section 168(f)(10) was to limit, and not to increase, the cost recovery deductions of certain transferees. Respondent here reasonably relies on the legislative history describing section 168(f)(10) as an anti-churning rule. Petitioner responds that "The transferor/lessee under section 168(f)(10) may transfer only the tax benefits which it would be entitled to claim itself: no more and no less." Petitioner would have us conclude that a provision intended to prevent "step up" of tax benefits441 would mandate that a lessee take advantage of an elective tax benefit. We cannot reach that anomalous result. Considering all of the arguments of the parties, we cannot conclude that the interpretation of the statute in the regulations is unreasonable or invalid. See National Muffler Dealers Assn., Inc. v. United States, 440 U.S. 472">440 U.S. 472, 488, 59 L. Ed. 2d 519">59 L. Ed. 2d 519, 99 S. Ct. 1304">99 S. Ct. 1304 (1979). Petitioner is not, therefore, entitled to use the transitional rule of section 168(f)(3). Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621353/	EPIC METALS CORPORATION AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEpic Metals v. CommissionerDocket No. 2689-79.United States Tax CourtT.C. Memo 1984-322; 1984 Tax Ct. Memo LEXIS 351; 48 T.C.M. (CCH) 357; T.C.M. (RIA) 84322; June 25, 1984. 351 S, a corporation, primarily sold products manufactured by M, a manufacturing corporation. S was the wholly owned subsidiary of M. S reported its income for Federal tax purposes on the cash method of accounting; M reported its income on the accrual method. The Commissioner determined that S was required by secs. 446 and 471, I.R.C. 1954, and the regulations promulgated thereunder to maintain inventories and to use the accrual method of accounting. Held, S is required to maintain inventories and to use the accrual method of accounting since its sales of the products were a material income-producing factor for S, and S has failed to prove that it did not have title to such products. Lester A. Katz,Herbert Alan Dubin, and Gerard J.Mene, for the petitioner. Kathleen E. Whatley, for the respondent. SIMPSONMEMORANDUM OPINION SIMPSON, Judge: The Commissioner determined deficiencies in the petitioner's Federal income tax of $786,165 for the taxable year ended March 31, 1974, and $6,414 for the taxable year ended March 31, 1976. After concessions by the petitioner, the issues for decision are: Whether353 Epic Sales Corporation is required by sections 446 and 471 of the Internal Revenue Code of 19541 and the regulations promulgated thereunder to maintain inventories and to use the accrual method of accounting for income tax purposes, and if not, whether by virtue of the fact that Epic Sales Corporation and Epic Metals Corporation are members of the same consolidated group, the transactions between them constitute nondeferred intercompany transactions which are subject to the income tax reporting provisions of section 1.502-13(b)(2), Income Tax Regs.All of the facts have been stipulated, and those facts are so found. The petitioner, Epic Metals Corporation (EMC) and subsidiaries, had their principal places of business in Rankin, Pa., at the time they filed their petition. On November 29, 1973, EMC formed Epic Sales Corporation (ESC). ESC is a Pennsylvania corporation and a 100-percent subsidiary of EMC. For the years in issue, EMC filed consolidated returns for itself and its wholly owned subsidiaries, including ESC, with the Internal354 Revenue Service, Philadelphia, Pa.EMC and ESC maintain separate accounting records. EMC uses the accrual method of accounting for both bookkeeping and income tax reporting purposes. ESC uses the accrual method of accounting for bookkeeping purposes but uses the cash method of accounting for income tax purposes. EMC is engaged in the manufacture and sale of metal products, primarily metal decking, modular buildings, and roofing systems, which are fabricated to custom specifications for each order from raw metal coils. EMC does not stock socalled standard or stock metal decking as finished goods, and it does not sell custom fabricated metal decking directly to the ultimate user unless it installs the metal decking at the jobsite. EMC employees, who are not part of the ESC sales department, solicit orders for EMC for custom fabricated metal decking that requires installation at the customer's jobsite. ESC derives its income from the sale of custom fabricated metal decking, which it sells without installation. It procures orders for metal decking through its own sales department, commission agents, dealers, and jobbers. It does not solicit orders which require jobsite installation; 355 when it encounters such an order, it refers the order to EMC. ESC places almost all of its orders for metal decking with EMC. However, ESC places orders for metal decking with fabricators other than EMC whenever EMC, for any reason, either chooses not to or is unable to fill an order. EMC fills approximately 95 percent of ESC's orders. ESC never has physical possession of the metal decking, whether the order is placed with EMC or another fabricator. Whether an ESC order is filled by EMC or by another fabricator, the order is always shipped F.O.B. fabricator's place of business. ESC's customer always has the right to select the mode of transportation and the specific carrier to transport the finished product to the jobsite. ESC's sales department consists of approximately 8 full-time sales persons located in Rankin and approximately 7 full-time sales persons located in Florida, Illinois, Michigan, Minnesota, North Carolina, and Ohio. ESC's vice president of sales is not an officer, director, shareholder, or employee of EMC. ESC pays rent at a fair price to EMC for the space it occupies in EMC's building. In addition, EMC charges ESC a yearly management service fee, and it356 charges ESC for a percentage of certain expenses, including those for advertising, utilities, drafting, designing, and credit clearance. ESC and EMC have never had a master contract or any written contract describing the business transactions between them. During the years in issue, the typical transaction between ESC and EMC occurred as follows: ESC solicited an order from its customer or received an invitation to bid from a customer. ESC received and acknowledged the order from its customer. ESC received a sales tax exemption designating it as the vendor. ESC's sales department personnel sent a credit request from to the EMC credit department for approval. EMC charged ESC for the credit check. If the credit check disclosed that credit should not be extended, the order was rejected by ESC. If the order was accepted, ESC's sales department personnel completed an ESC order summary form. This form listed information concerning the order including quantity, pricing information, sales tax information, required shipping date, and sales terms. ESC's personnel forwarded a copy of the ESC order summary to EMC's production scheduling department. EMC's production scheduling department357 used ESC's order summary to enter the order into EMC's computer. EMC then had its own personnel produce all the EMC documentation and paper work necessary to perform the custom fabrication of the metal decking. EMC contacted the ESC customer to confirm or adjust the time of shipment. Once EMC had completed the custom fabrication of the ESC order, EMC, as directed by ESC, loaded the metal decking onto the mode of transportation requested by the ESC customer (customer truck, contract truck, common carrier, or railroad car) for shipment to the ESC customer jobsite. The ESC-ordered custom fabricated metal decking was shipped directly to its customer's jobsite using ESC's shipping papers and bills of lading. EMC notified ESC when the metal decking had been shipped. After an order was custom fabricated but before it had been shipped from EMC's plant (while it was awaiting loading for shipment), the risk of loss or damage to the metal decking was with EMC. The risk of any loss or damage to the metal decking during transit was with the ESC customer under the shipping contract. ESC advanced freight charges for the shipment to its customer, and the freight charges were billed to the ESC358 customer either as part of the purchase price or separately depending on the terms of the particular order. In either case, the ESC customer bore the freight charges and had the right to select the method of shipment and the specific carrier. EMC sent its invoice for the metal decking to ESC, and ESC paid the invoice by making payments to EMC. ESC then sent an invoice to its customer for the metal decking, and the customer paid the ESC invoice by making payment to ESC. ESC bore the credit risk should its customer default on the contract. In his notice of deficiency, the Commissioner determined that the accrual method of accounting used by ESC to keep its books and records should also be used in preparation of the consolidated return since such method clearly reflects income, and that the cash receipts and disbursements method used by ESC in the preparation of the consolidated return does not clearly reflect income. The Commissioner also determined that the use of the accrual method is necessary to clearly reflect the consolidated taxable income of EMC and its subsidiaries. Use of the accrual method of accounting, instead of the cash method, resulted in an increase in the petitioner's359 taxable income for the taxable year ended March 31, 1974, of $1,386,605, and an increase in taxable income for the year ended March 31, 1976, of $238,737. The first issue for decision is whether ESC is required by sections 446 and 471 and the regulations promulgated thereunder to maintain inventories and to use the accrual method of accounting for income tax purposes. Section 446(a) provides the general rule that taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. Section 446(b) provides two exceptions to this general rule. Where no method of accounting has been regularly used by the taxpayer, or where the method used by the taxpayer does not clearly reflect income, the computation of taxable income shall be made under such method as in the opinion of the Commissioner does clearly reflect income. Sec. 446(b). The Commissioner's determination pursuant to his authority under section 446(b) is presumptively correct and must be upheld unless the taxpayer proves that it is clearly erroneous or arbitrary. Lucas v. Structural Steel Co.,281 U.S. 264">281 U.S. 264, 271 (1930); Wilkinson-Beane, Inc. v. Commissioner,420 F.2d 352">420 F.2d 352, 353 n.3 (1st Cir. 1970),360 affg. a Memorandum Opinion of this Court; Brooks-Massey Dodge, Inc. v. Commissioner,60 T.C. 884">60 T.C. 884, 891 (1973). Section 471 provides: Whenever in the opinion of the Secretary the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer on such basis as the Secretary may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income. The regulations promulgated under section 471 require that in every case in which the production, purchase, or sale of merchandise is an income-producing factor, in order to reflect taxable income correctly, inventories at the beginning and end of each taxable year are necessary. Sec. 1.471-1, Income Tax Regs. Such regulations further provide that merchandise should be included in the inventory only if title thereto is vested in the taxpayer. Sec. 1.471-1, Income Tax Regs. If inventories are required, the accrual method of accounting must be used with regard to purchases and sales, unless otherwise authorized. Sec. 1.446-1(c)(2)(i), Income Tax Regs. The Commissioner's discretion361 in matters of accounting methods is very broad. Thor Power Tool Co. v. Commissioner,439 U.S. 522">439 U.S. 522, 533 (1979); Commissioner v. Hansen,360 U.S. 446">360 U.S. 446, 467 (1959). ESC argues that its cash method of accounting clearly reflects income pursuant to section 446. It contends that its accounting method reflects consistent application of generally accepted accounting principles and that its accounting method is one that is used by similarly situated taxpayers in its particular trade or business. It argues that industry practice and trade custom are the crucial elements in the determination of whether or not the cash method of accounting clearly reflects income, and that the Commissioner has unjustifiably ignored industry practice and trade custom in the present case. ESC maintains that if its accounting method satisfies section 446 and the regulations thereunder, we need not consider the applicability of section 471. However, if we should find that section 471 is applicable in the present case, ESC contends that it is not required by section 1.471-1 of the regulations to maintain inventories in order to reflect its income correctly since it is a jobber362 or middleman for willing buyers and sellers of custom fabricated metal decking. It argues that it does not at any time have title to the metal decking which it jobs. Accordingly, ESC contends that if it is not required to maintain inventories, it is not required by section 1.446-1(c)(2)(i) of the regulations to use the accrual method of accounting for income tax purposes. The Commissioner, on the other hand, contends that ESC is a seller of custom fabricated metal decking, that ESC has title to the metal decking which it sells, and that the sales of such decking are an income-producing factor for ESC. Accordingly, the Commissioner argues that ESC is required by section 1.471-1 of the regulations to maintain inventories in order to reflect its income correctly, and that since it is required to maintain inventories, it is required pursuant to section 1.446-1(c)(2)(i) to use the accrual method of accounting for income tax purposes. Where inventories are required, the regulations mandate the use of the accrual method of accounting for purchases and sales. Sec. 1.446-1(c)(2)(i), Income Tax Regs. This principle has been consistently upheld by the courts. See, e.g., Niles Bement Pond Co. v. United States,281 U.S. 357">281 U.S. 357, 360 (1930);363 Wilkinson-Beane, Inc. v. Commissioner,420 F.2d at 354-355; Iverson's Estate v. Commissioner,255 F.2d 1">255 F.2d 1, 2-5 (8th Cir. 1958), affg. 27 T.C. 786">27 T.C. 786 (1957); Caldwell v. Commissioner,202 F.2d 112">202 F.2d 112, 114 (2d Cir. 1953), affg. a Memorandum Opinion of this Court; Ezo Products Co. v. Commissioner,37 T.C. 385">37 T.C. 385, 392 (1961). Thus, we must decide whether ESC must maintain inventories. The parties agree that the sales of custom fabricated metal decking were an income-producing factor for ESC; hence, resolution of the inventory question depends on whether ESC ever had title to the decking. The parties have stipulated, and we have found as a fact, that ESC never had physical possession of the metal decking. However, the regulations under section 471 are clear that title rather than physical possession determines whether merchandise should be included in inventory. Sec. 1.471-1, Income Tax Regs.ESC argues strenuously that it is a jobber, and not a seller, of custom fabricated metal decking, and that, as such, it never acquires title to the metal decking. In support of such contention, ESC points out that it does not364 manufacture goods; that it places orders for metal decking with manufacturers only after it has a firm order for the decking from its customer; that it never invests capital or labor in order to acquire or maintain an inventory of metal decking; that it never has control over or constructive possession of the custom fabricated metal decking; that after the metal decking is fabricated, it is shipped directly to ESC's customer from the manufacturer's plant, F.O.B. manufacturer's plant, and completely bypasses ESC in all respects; that ESC has no control over the manufacture or the method of transportation for the metal decking; that ESC does not bear the risk of loss during shipment, nor does it bear the risk of defects or errors during or arising out of the fabrication of the metal decking; and that the only risk ESC bears is the risk of nonpayment by its customer. ESC also argues that its practices are consistent with industry costom in that other jobbers or middlemen in the custom fabricated metal decking industry also never take title to the metal decking which they provide to their customers. The parties have stipulated that Pennsylvania adopted the Uniform Commercial Code (UCC), 365 effective July 1, 1954, and that Article 2 thereof is applicable to the transactions at issue. ESC, citing Pa. Stat. Ann. Tit. 12A, sec. 2-401(2) (Purdon 1970), argues that under the UCC, absent an explicit agreement to the contrary, title passes to the buyer when the seller completes his performance with respect to the physical delivery of the goods, that is when the seller places the goods with the carrier. ESC asserts that it had no contract or agreement with EMC or any other manufacturer with respect to the passing of title. ESC contends that title passed directly from the manufacturer to the customer at the point of shipment, here the manufacturer's plant. ESC concludes that title bypassed it. The Commissioner argues that ESC's arrangement whereby it never has physical possession of the metal decking is insufficient for it to avoid the requirement that it maintain inventories for tax purposes. He contends that even momentary title is sufficient to require the use of inventories. In support of his contention, the Commissioner cites Middlebrooks v. Commissioner,T.C. Memo. 1975-275, where we held, under the facts, that "While petitioner may have only possessed366 title to the magazines for an 'instant' while the goods were carted through the carrier's front door, as respondent acknowledges, such possession of title was sufficient to require petitioner to inventory the product as his stock-in-trade under respondent's regulations." 34 T.C.M. at 1191, 44 P-H Memo. T.C. par. 75,275 at p. 1164-75. The Commissioner also contends that under applicable provisions of the UCC, title passes from EMC to ESC at the time and place of shipment, and that thereafter, title passes from ESC to its customer virtually immediately. He cites Pa. Stat. Ann. Tit. 12A, sec. 2-401(2)(a) (Purdon 1970), which provides that if the seller is authorized to send the goods to the buyer but does not require him to deliver them at destination, title passes to the buyer at the time and place of shipment. The Commissioner argues that ESC directs EMC to ship the metal decking directly to the customer using ESC's bill of lading and shipping papers, and EMC notifies ESC when the ordered metal decking has been shipped, thus fulfilling the requirements of Pa. Stat. Ann. Tit. 12A, sec. 2-504 (Purdon 1970), "Shipment by Seller." Accordingly, the Commissioner contends title367 passes to ESC under section 2-401(2)(a), and the fact that the metal decking is delivered directly to the customer rather than to ESC does not prevent ESC from receiving title to the decking. Citing Los Angeles Paper Bag Co. v. James Talcott, Inc.,604 F.2d 38">604 F.2d 38, 40 (9th Cir. 1979), he argues that delivery of goods to a third party pursuant to the buyer's instructions causes the buyer's title to pass to the third party. The Commissioner contends that ESC is not selling its services in arranging sales between the other two parties to the transaction, but instead has title to the metal decking and is engaged in selling the metal decking. Although ESC now claims that it never had title to the custom fabricated metal decking sold by it, the record before us does not disclose that such claim was ever made before this litigation, and such claim is wholly inconsistent with the treatment of the transactions by ESC and EMC and by ESC and its customers. ESC, EMC, and the ultimate purchasers of the custom fabricated metal decking all consistently treated the transactions as if title passed from EMC to ESC and then to the ultimate purchaser. ESC treated the transactions between368 itself and EMC for Federal tax purposes as sales of the metal decking by EMC to ESC and the transaction between itself and the ultimate purchaser as a sale by ESC to such purchaser. On the consolidated returns, EMC treated the transaction as a sale and reported the income therefrom. On such returns, ESC treated itself as having purchased metal decking from EMC and claimed a deduction for cost of goods sold. Such treatment is wholly inconsistent with ESC's claim that it was merely a jobber. In addition, ESC was designated the vendor for State sales tax purposes, and in its contracts with its customers, ESC was designated as the seller. In another context, the previously stated: "When negotiating with customers over the terms of sales, petitioners could have insisted on a clear contractual statement of where title was to pass or could have arranged the terms to indicate clearly where the parties intended title to pass." Miami Purchasing Service Corp. v. Commissioner,76 T.C. 818">76 T.C. 818, 830 (1981). What we said in Miami Purchasing Service Corp. is equally applicable in the present case. ESC could have set out in contracts between itself and EMC, and other fabricators,369 exactly when, where, and to whom title to the custom fabricated metal decking was to pass. Had it done so, and had it otherwise acted consistently with such contracts, such provisions would have furnished clear evidence of the parties' intention and governed the passage of title under the UCC. Though ESC did not expressly set forth the terms for the passage of title, we believe that the practices of EMC, ESC, and the ultimate purchaser provide persuasive evidence of their intent to have title pass from EMC to ESC and then to the ultimate purchaser. ESC bears a heavy burden of proof in challenging the Commissioner's determination of the proper method of accounting. Thor Power Tool Co. v. Commissioner,439 U.S. at 533. 2 ESC has clearly failed to meet its heavy burden of proof in challenging the Commissioner's determination; it has failed to prove that it never had title to the metal decking. While ESC only had momentary title, title even for a moment is sufficient to require the use of inventories and the use of the accrual method of accounting. 370 Moreover, the facts of this case illustrate well the reason for requiring the use of inventories and the accrual method of accounting in such a situation. For its taxable year ending on March 31, 1974, EMC treated the costs of custom fabricated metal decking sold to ESC in such year as a cost of goods sold, and since it used the accrual method of accounting, it treated any such sale as an account receivable for such year. However, since ESC used the cash method for tax purposes, it treated all such purchases for which it made payments for such year as cost of goods sold and claimed a deduction for them, but if it did not actually receive payment for such sales until the succeeding year, such payments were not reported until the succeeding year. As a result, it deferred reporting over $1,386,605 of income. If those sales had been made directly by EMC to the ultimate purchaser, such income could not have been deferred, and if ESC is required to use the accrual method, it cannot be deferred. The creation of ESC to handle certain of the sales of the custom fabricated metal decking and its use of the cash method of accounting for tax purposes would result in the deferral of substantial371 income, and such circumstances provide a sound basis for the Commissioner's position that the deferral of such income would be a failure to clearly reflect income within the meaning of section 446(b). ESC relies heavily on Simon v. Commissioner,176 F.2d 230">176 F.2d 230 (2d Cir. 1949), affg. a Memorandum Opinion of this Court, as support for its contention that ESC, as a jobber, is not required to maintain inventories. Simon involved a taxpayer who attempted to change his accounting method from the cash to the accrual method without first obtaining the permission of the Commissioner. In Simon, the taxpayer did not keep on hand any stock of merchandise which could be called an inventory, did not make purchases until he had firm sales contracts, did not have goods delivered to him, but instead had such goods delivered directly to the purchaser from the manufacturer, did not invest any capital in a stock of goods on hand, and did not have any warehouse or storeroom for merchandise, and he argued that under the predecessor regulation to section 1.471-1, Income Tax Regs., the Commissioner's consent was not required to change from an improper to a proper method of accounting.372 The Second Circuit explicitly held that it did not decide whether the Commissioner's consent was unnecessary to change from an illegal to a legal method of accounting. Rather, it held that given the circumstances of the taxpayer's business, there was no need for him to maintain an inventory and that, therefore, he could not rely on the necessity to use an inventory to justify his change of accounting method. ESC argues that Simon is binding precedent on taxpayers and the Commissioner alike and that under the rationale of Simon, the cash method of accounting is the only method permissible for it. In our view, the Second Circuit's opinion in Simon v. Commissioner,supra, is distinguishable. The Second Circuit decided the case on the ground that the taxpayer was properly characterized as a broker or commission merchant since his margin for profits and operating expenses was the 5 percent "commission" or "trade discount" allowed him by the manufacturers. Simon v. Commissioner,176 F.2d at 232. In the present case, ESC does not derive its profit from commissions or trade discounts. Rather, its profit is determined by the difference between373 the price it pays EMC, or another fabricator, for the metal decking and the price at which it sells the metal decking to its customer. Thus, the facts of this case are fundamentally different from those of Simon.Since we have concluded that ESC is required to maintain inventories, it follows that it is required to use the accrual method of accounting. Sec. 1.446-1(c)(2)(i), Income Tax Regs.; Record Wide Distributors, Inc. v. Commissioner,682 F.2d 204">682 F.2d 204, 206 (8th Cir. 1982), affg. a Memorandum Opinion of this Court; Fred H. McGrath & Son, Inc. v. United States,549 F. Supp. 491">549 F. Supp. 491, 493 (S.D. N.Y. 1982); Ezo Products Co. v. Commissioner,37 T.C. at 392. ESC disputes such conclusion and argues that "in numerous cases, the Tax Court has recognized that even the presence of inventory does not necessarily mean that the cash method of accounting does not clearly reflect income." In support of its contention, ESC cites Ezo Products Co. v. Commissioner,supra;Estate of Roe v. Commissioner,36 T.C. 939">36 T.C. 939 (1961); Drazen v. Commissioner,34 T.C. 1070">34 T.C. 1070 (1960); Brookshire v. Commissioner,31 T.C. 1157">31 T.C. 1157 (1959),374 affd. 273 F.2d 638">273 F.2d 638 (4th Cir. 1960). Its reliance on such cases is misplaced. In Ezo Products Co. v. Commissioner,supra at 392, we stated: "In a number of cases we have recognized as petitioner argues that where inventories are so small as to be of no consequence or consist primarily of labor, the presence of inventories is not necessarily sufficient to require a change in petitioner's method of accounting." The present case is readily distinguishable in that the inventories involved are not inconsequential. In holding that ESC must maintain inventories and is required to use the accrual method of accounting, we have considered the petitioner's argument that its method of accounting had been consistently used and its argument that such method was used in its industry. However, such arguments are irrelevant. 3 In view of our holding, it is unnecessary to consider the Commissioner's alternative position concerning the applicability of the consolidated return regulations. 375 Decision will be entered for the respondent.Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect during the years in issue, unless otherwise indicated.↩2. ESC misapprehends its burden of proof when it states: Further, it is Respondent's burden to prove that ESC holds title to the custom fabricated metal decking. It is well-settled Pennsylvania law that proof of title is borne by the one who claims title, and in the case of personalty, the person in possession is presumed to be the owner. The burden is on the person out of possession to prove otherwise. Therefore, the burden is on Respondent to show that title is in the one who does not have possession of the custom fabricated metal decking, i.e., ESC. [Citations omitted.] In the present case, the Commissioner is not "the person out of possession." The burden of proof as to who has title in the present case is on the petitioner. Rule 142(a), Tax Court Rules of Practice and Procedure; Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Duesenberg, Inc. of Delaware v. Commissioner,31 B.T.A. 922">31 B.T.A. 922, 924 (1934), affd. 84 F.2d 921">84 F.2d 921↩ (7th Cir. 1936).3. The present case is clearly distinguishable from the case where a taxpayer has consistently used a particular method of accounting over a long period of time. Cf. Van Pickerill & Sons, Inc. v. United States,445 F.2d 918">445 F.2d 918, 921 (7th Cir. 1971); Magnon v. Commissioner,73 T.C. 980">73 T.C. 980, 1005-1006 (1980); Fort Howard Paper Co. v. Commissioner,49 T.C. 275">49 T.C. 275, 284 (1967). ESC was formed on November 29, 1973, and thus, the Commissioner challenged its accounting method in its first year of operation. See Frank G. Wikstrom & Sons, Inc. v. Commissioner,20 T.C. 359">20 T.C. 359, 362-363 (1953). Nor are we persuaded by the evidence introduced concerning industry practice and trade custom that ESC's cash method of accounting is the method of accounting utilized by similarly situated taxpayers in its trade or business, and that therefore, such method clearly reflects income. Industry practice and trade custom are factors to be considered in determining whether a method of accounting clearly reflects income. See Public Service Co. of N.H. v. Commissioner,78 T.C. 445">78 T.C. 445, 456-457 (1982); Fox Chevrolet, Inc. v. Commissioner,76 T.C. 708">76 T.C. 708, 728 (1981); Magnon v. Commissioner,supra at 1004-1006. However, industry practice is not determinative of whether an accounting method clearly reflects income. Public Service Co. of N.H. v. Commissioner,supra↩ at 455-456.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621354/	CECIL E. AND RUTH P. MAINER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMainer v. CommissionerDocket No. 5597-87.United States Tax CourtT.C. Memo 1988-282; 1988 Tax Ct. Memo LEXIS 304; 55 T.C.M. (CCH) 1168; T.C.M. (RIA) 88282; June 28, 1988. Cecil E. and Ruth P. Mainer, pro se. Scott T. Welch, for the respondent. PARRMEMORANDUM FINDINGS OF FACT AND OPINION PARR, Judge: Respondent determined a deficiency in petitioners' 1983 income tax in the amount of $ 2,872. The issues are: (1) Whether Cecil E. Mainer (hereinafter "petitioner") received income in the amount of $ 9,773 from Ansardi Truck Service (Ansardi) in 1983; and (2) whether petitioners are liable for self-employment tax. 1For convenience, we have combined our findings of fact and opinion. Petitioners have the305 burden of proof. . Rule 142(a). 2Some of the facts have been stipulated and the stipulation is incorporated herein by this reference. Petitioners were married individuals residing in Pearl River, Louisiana, at the time they filed the petition in the above-entitled case. During 1983 petitioner was a truck driver. He worked for five employers during that year. He worked for only one employer at a time, full-time. He was also unemployed for part of the year, and was not in good health. On their joint individual income tax return for 1983 petitioners reported wages of $ 12,318; 3 $ 10,158.63 of this was Cecil Mainer's income, reflected on W-2 Forms as follows: C. G. Smith Co., Inc.$ 547.50Louisiana Scrap Metal Co.2,786.88Industrial Concrete & Supply, Inc.4,300.76Intercontinental Industries, Inc.2,523.49$ 10,158.63Petitioner admits he also worked for Ansardi during 1983306 and did not report any income from that employment. He made several telephone requests for a W-2 Form, but never received one. Petitioner, who has little education, did not keep his own records of the amount received and was unsure what amount to report. We must determine how much money petitioner in fact was paid by Ansardi in 1983, and whether petitioner was liable for self-employment tax on that amount. The resolution of this issue depends upon whether we believe petitioner and Mrs. Mainer on the one hand, or Marie Ansardi, respondent's witness, on the other. We therefore examine their testimony. Petitioners testified as follows. Early in 1983 petitioner worked for Louisiana Scrap Metal Co. His last day there was February 4, 1983. (This date was substantiated by the company.) Petitioner testified he was unemployed for a period between his work at Louisiana Scrap Metal Co. and Ansardi. He did not work for Ansardi more than "3 or 3-1/2 months." He stated he was promised wages of $ 5.50 per hour but was paid only $ 5 per hour. Both petitioners testified that Mr. Mainer was sick with severe headaches during a portion of this time and was unable to work. For this reason307 he did not work more than 45 hours per week. Ms. Ansardi is the wife of the owner of Ansardi Truck Service, and was the bookkeeper in 1983. She testified that petitioner worked there from February 4, 1983 through July 21, 1983. She said he left there because of sickness due to severe headaches. She testified that he was paid a total of $ 9,773 at $ 6 to $ 6.25 per hour, and that Ansardi issued him a Form 1099 in that amount. Ms. Ansardi produced the company's "records," which consisted entirely of pages in a spiral notebook with dates and numbers written all over the pages. Ms. Ansardi testified this represented the dates and number of hours worked each day. Totals, purportedly representing wages paid, were inserted in a different color ink, which Ms. Ansardi acknowledged might have been written in later in connection with this case. Ms. Ansardi stated that the company kept no other records of amounts paid to petitioner and other truck drivers during 1983. She stated that the drivers were paid in cash in an envelope with the hours marked on the envelope. No receipts were requested or obtained from the truck drivers. Ansardi did not withhold any income tax or social security308 taxes from petitioner's wages. All drivers were required to sign a form stating they were independent contractors and were responsible for their own taxes. Petitioner signed an undated form stating his name, date of birth, Louisiana license number, social security number, and address. In addition, the form stated: I Cecil E. Mainer agree to contract my services to Walter R. Ansardi on a job bases [sic]. I understand that I am responsible for reporting my income to the I.R.S. and that I am responsible for paying my own taxes as an individual contractor.Petitioner stated he was told he was signing a form required by the company's insurance provider. We cannot find completely reliable the testimony of either petitioners or of Ms. Ansardi. We think petitioners tried to testify truthfully, but they could not remember many details. Petitioner kept no records of the dates he was employed by Ansardi, the number of hours worked, or the wages he was paid each week. At trial he testified he was promised $ 5.50 but was paid only $ 5 per hour; however, in his petition he states he was paid $ 5.50 per hour. On the other hand, Ms. Ansardi's records are highly suspect. They309 show petitioner working as much as 17 hours per day, during a period when petitioner was in ill health. Ansardi's records are extremely crude and ill kept. Dates are not in sequence. Some entries are marked over or stricken through. Petitioner's name appears on only one page, in which other names of drivers also appear. The other pages purporting to be records of petitioner's time do not bear petitioner's name, but do follow in sequence after a single page bearing petitioner's name. Further, Ansardi's records show petitioner having worked 113 days. Some of these dates appear to be clearly erroneous. For example, Ansardi shows petitioner having worked 13 hours on February 4, the same day which was his last day at Louisiana Scrap Metal Co. Taking all the facts and circumstances into account, we make as close an approximation as possible. . We find that petitioner worked 100 days for Ansardi, averaging 10 hours per day at $ 5.50 per hour, for total wages of $ 5,500 in 1983. Petitioners' joint gross income was therefore $ 17,818. 4310 We further find that Ansardi gave petitioner his work assignments and generally directed his work; therefore, petitioner was Ansardi's employee and not an independent contractor during the time he worked there. Petitioner is thus not liable for self-employment taxes. Decision will be entered under Rule 155.Footnotes1. Ruth Mainer ("Mrs. Mainer") received and reported unemployment compensation of $ 1,955. If we find that petitioners' joint income exceeds the base amount of $ 18,000, Mrs. Mainer's unemployment compensation will automatically become fully taxable. Section 85. ↩2. All Rule references are to the Tax Court Rules of Practice and Procedure; section references are to the Internal Revenue Code as in effect for the years in issue. ↩3. The amounts were rounded. ↩4. Since their income did not exceed the base amount of $ 18,000, Mrs. Mainer's unemployment compensation is therefore not taxable. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621356/	Appeal of MIDDLETON COMPRESS & WAREHOUSE CO.Middleton Compress & Warehouse Co. v. CommissionerDocket No. 1125.United States Board of Tax Appeals1 B.T.A. 1145; 1925 BTA LEXIS 2641; May 20, 1925, decided Submitted March 25, 1925. 2641 A depreciation rate of 4 per cent upon the cost of a combination warehouse and wharf and of 10 per cent upon the cost of an extension of the wharf into deep water, held to be a reasonable allowance for exhaustion, wear and tear. Money actually paid in to the treasury of the corporation with the express understanding that the amount is to be considered in the nature of an increase in the capital of the company, held to be a part of the company's invested capital from the date paid in, although certificates of stock representing the same are not actually issued until a later date. E. Willoughby Middleton, Esq., for the taxpayer. Ellis W. Manning, Esq., for the Commissioner. TRUSSELL 1145 Before JAMES, PHILLIPS, STERNHAGEN, TRAMMELL, and TRUSSELL. This appeal involves income and profits taxes for the fiscal years ended June 30, 1919, and June 30, 1920, in the amounts of $4,446.65 and $618.11, respectively. From the evidence submitted the Board makes the following 1146 FINDINGS OF FACT. The taxpayer is a corporation organized and doing business under the laws of South Carolina, with its place of business at Charleston, 2642 in said State. It is engaged in the business of compressing cotton and concentrating it for the purpose of export. To carry on its business it owns and maintains a certain warehouse and wharf. The original part of this plant was constructed in 1917 and stands partly upon high land and partly upon concrete piers and pile construction in low water, and is subdivided by four brick walls for fire protection. The cost of this part of the plant was $54,551.18, and upon this portion of the property the Commissioner has allowed a depreciation rate of 4 per cent. In 1919 an extension of this property was begun, to be made into deep water and completed in the year 1920. The total cost of the extension, when completed in 1920, was $39,060.16. Upon this portion of the property the Commissioner has allowed a depreciation rate of 10 per cent. The entire construction, excepting the brick fire walls, is composed of wood, and that portion of it which extends over water is supported by concrete piers and piles, some of which are creosoted and some of which have a concrete surface above the low-water line. About three-fourths of the entire construction rests on piles which are exposed to2643 the action of the tides and salt water. The taxpayer claims a rate of depreciation of 10 per cent upon the cost of the entire property. The taxpayer corporation is a creature of, and is entirely owned by, Charles F. Middleton, Charles F. Middleton, Jr., George Abbott Middleton, and the Middleton Company. The latter is a partnership composed of the three Middletons first named, and the Middleton Company furnishes the financial support for all the operations of the taxpayer corporation. In 1919 it was determined that the taxpayer corporation should extend the plant for carrying on its business by acquiring a piece of property adjoining its then existing plant, and this property could be procured at a cost of $60,000. On November 3, 1919, Midleton & Company paid the purchase price of this property with its check, with the understanding of all parties in interest that the amount of this payment should be considered as a subscription to an additional amount of the capital stock of the taxpayer corporation. On November 4, the directors of the taxpayer corporation agreed to hold a meeting for the purpose of considering an increase of its capital stock, and on November 5, at a2644 duly called meeting of the directors, a resolution was adopted authorizing and directing the proper officers to take the necessary steps to procure legal authority to issue additional shares. Such steps as were required by the laws of the State of South Carolina were immediately taken and consummated at the earliest date practicable, and in December, 1919, after having amended its articles of incorporation and thus secured authority to issue additional stock, certificates representing the payment of $60,000 were duly issued to Middleton & Company on December 16, 1919. From the time of the organization of the taxpayer company there was carried upon its books a debit and credit account with Middleton & 1147 Company. When the $60,000 was paid by Middleton & Company it was evidenced by a credit entry in the book of the taxpayer, and when the stock was actually issued the same amount was debited to the account. DECISION. The deficiency should be recomputed in accordance with the following opinion. Final decision will be settled on consent or on fifteen days' notice, pursuant to Rule 50. OPINION. TRUSSELL: The controversy over the amount of depreciation which this2645 taxpayer should be allowed as a deduction from gross income for the years 1919 and 1920 apparently arises from the fact that the company's own books of account separate its depreciable properties into two parts, the original construction being carried on the books as a "construction" account, while the extension into deep water is carried as a "wharf" account; and the taxpayer claims that the estimated life of the entire property should be treated as a unit and should be considered as not to exceed 10 years. It appears, however, from the testimony taken at the hearing that the original structure which was built in the year 1917, is now, in 1925, approximately eight years after its construction, still in good condition; is performing the same service to the company as it originally performed, and, so far as can be determined from the evidence, is good for practical use for some years to come. The claim of a 10 per cent depreciation upon the original construction, therefore, does not seem to be well founded. We are thus led to the conclusion that the rates of 4 per cent upon the original construction and 10 per cent upon the new construction over deep water, together produces a fair2646 rate of depreciation and a reasonable allowance for exhaustion as applied to the entire property, and the Commissioner's decision in reference to this issue should be approved. The evidence furnished in this hearing shows conclusively that when, on or about November 3, 1919, the taxpayer planned to increase its plant, and Middleton & Company advanced the funds for the purpose of purchasing the property desired to be acquired, it was understood and agreed by all parties in interest that the funds so advanced should be an addition to the capital of the taxpayer company, and that immediately thereafter the necessary steps were taken which authorized the issuance of additional capital stock. Such steps were carried to completion at the earliest practicable date and, when proper authority to issue additional stock was procured, stock certificates evidencing the payments of $60,000 were duly issued. It was clearly the purpose of the framers of the Revenue Act of 1918 to provide that all moneys actually paid in to a corporation as a contribution toward the capital of such corporation should be treated as invested capital from the time paid in, and the record of this appeal shows that2647 the $60,000 was paid in on the third day of November, 1919. We are, therefore, of the opinion that it must be treated as an addition to the invested capital of the company on that date.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621357/	J. PAT DILLON AND KATHY M. DILLON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentDillonDocket No. 17247-91United States Tax CourtT.C. Memo 1993-11; 1993 Tax Ct. Memo LEXIS 12; 65 T.C.M. (CCH) 1729; January 11, 1993, Filed 12 Decision will be entered under Rule 155. J. Pat Dillon, pro se. For Respondent: Wesley F. McNamara. GOLDBERGGOLDBERGMEMORANDUM OPINION GOLDBERG, Special Trial Judge: This case was heard pursuant to section 7443A(b)(3) and Rules 180, 181, and 182. All section references are to the Internal Revenue Code in effect for the years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure. Respondent determined deficiencies in petitioners' Federal income tax for tax years 1987 and 1988 in the amounts of $ 5,872 and $ 922, as well as additions to tax for negligence for 1987 in the amount of $ 293.60 and 50 percent of the interest on the portion of the underpayment attributable to negligence, and for 1988 in the amount of $ 46.10. 1Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated13 by this reference. Petitioners resided in Aloha, Oregon, when they filed their petition. After concessions by petitioners, 2 the issues for decision are: (1) Whether the cost of goods sold expense claimed by petitioners on Schedule C attached to their 1987 income tax return should be reduced by $ 9,339; (2) whether commission expenses claimed by petitioners on Schedule C for 1987 should be reduced by $ 8,642; (3) whether petitioners are liable for self-employment tax on the earnings of petitioner Kathy M. Dillon for 1987; and (4) whether petitioners are liable for additions to tax for negligence or intentional disregard of rules or regulations for tax years 1987 and 1988. Petitioners agree that, if this Court sustains respondent's disallowance of Schedule C deductions, Mrs. Dillon will have self-employment income subject to self-employment tax. 14 J. Pat Dillon (hereinafter referred to as petitioner) and Kathy M. Dillon (Mrs. Dillon) were proprietors of a small arts and crafts shop, Country Craftworks, where they sold art supplies, and Mrs. Dillon taught classes for craftspeople. They also sold handcrafted objects on a consignment basis, charging a small monthly rent for displaying each item. Essentially, the shop was operated by Mrs. Dillon. In 1987, Mrs. Dillon had to leave for 4 months to care for her mother, and in her absence employees had to be hired, the business dwindled, and, eventually, it had to be closed. Petitioner and Mrs. Dillon sold some of their inventory and fixtures at distress sale prices. Petitioner kept the books for Country Craftworks on his home computer and prepared joint Federal income tax returns for the years in question. He has retained only three receipts for expenditures. He produced at trial a computer printout made in November 1991 of his business records. He kept these records on an almost daily basis, logging into the computer the amounts of expenditures and receipts and using the computer-generated records to prepare the Schedules C which he attached to the joint Federal tax returns15 which he prepared for 1987 and 1988. The figures on the printout do not entirely agree with the figures on the tax returns because petitioner made minor changes in the records at a later date to reflect an additional small amount of income. However, there are errors in the program so that the calculation of cost of goods sold is clearly incorrect and other items such as depreciation are not properly taken into account. Respondent determined that for 1987 the deduction for cost of goods sold should be reduced by $ 9,339. We sustain respondent's determination on the ground that petitioner has failed to satisfy his burden of proof on this issue. We begin by emphasizing that taxpayers are required to keep sufficient records to enable respondent to determine their correct tax liability. Sec. 6001; . In the absence of adequate books and records, respondent may reconstruct the taxpayer's income through any reasonable method. , affd. without published opinion . Deductions16 are a matter of legislative grace, and taxpayers bear the burden of establishing that they are entitled to any deductions claimed on their return. Rule 142(a); ; ; . Respondent's determination as to the deduction for cost of goods sold involved the assumption that a proper markup in a retail business of this type is 75 percent. Hence respondent determined that petitioners overstated their deduction for cost of goods sold by $ 9,339. Petitioner argues that we should accept his computer printout as evidence of his expenditures for inventory. This we are unable to do. Petitioner has substantiated only three of his inventory purchases, and furthermore, his method of calculating cost of goods sold is so fundamentally confused that the Court cannot make a reasonable redetermination. We sustain respondent's determination as to the adjustment for cost of goods sold. Respondent also disallowed petitioner's entire deduction of $ 8,642 for commissions. 17 Part of the business of Country Craftworks was selling the work of craftspeople, including Mrs. Dillon and her students. The craftspeople were charged a $ 10 fee for the display of their work and were paid a commission when an item was sold. The printout contains an itemized list of payments made to various craftspeople, including Mrs. Dillon, whose share of the commissions was $ 2,734.69. Petitioner conceded at trial that payments to Mrs. Dillon should not have been aggregated with other commissions and subtracted from the receipts of the business. We are persuaded that sale of handcrafted items on a commission basis did form a substantial part of the business, which respondent did not take into account in making her determination of petitioners' Schedule C income. With the exception of the inclusion of Mrs. Dillon's commissions, we find the tally of commissions to be accurate. We have found that the printout represents an essentially contemporaneous record of transactions in petitioner's business. We found its calculations of cost of goods sold to be unreliable because the computer program was misconceived and uninformed by even rudimentary understanding of accounting principles. 18 In the case of the commissions paid to craftspeople, we are able to calculate the correct figure by subtracting the $ 2,734.69 in commissions paid to Mrs. Dillon from the reported amount of $ 8,815.64 to yield the correct deduction of $ 6,080.95. Respondent determined that Mrs. Dillon was liable for self-employment tax on the earnings of Country Craftworks, and petitioner concedes that self-employment tax applies if the income of the business, as redetermined by this Court, is positive. After our redetermination of their Schedule C income, petitioners still have a net loss on Schedule C for tax year 1987. Consequently, self-employment tax does not apply. Respondent also determined that petitioners are liable for additions to tax for the 1987 year under section 6653(a)(1)(A) and (B) and for the 1988 year under section 6653(a)(1) for negligence or intentional disregard of rules or regulations. Negligence under section 6653 means lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. . Petitioner has the burden of proving that respondent's 19 determination of the additions to tax is erroneous. Rule 142(a); . We sustain respondent's determination on this issue. Petitioner assumed the responsibility of preparing a Schedule C for his wife's business but did so in an extremely careless manner and with little comprehension of basic accounting concepts. He also claimed inflated and undocumented automobile and moving expenses. His explanation that he had moved several times does not excuse the unavailability of his records. We find that under the circumstances petitioner has failed to apply due care to the preparation of his tax returns. Decision will be entered under Rule 155. Footnotes1. The applicable sections providing for the additions to tax for negligence are sec. 6653(a)(1)(A) and (B) for 1987 and sec. 6653(a)(1) for 1988.↩2. Petitioners concede that their claimed deductions for employee business expenses should be reduced by $ 13,205 for tax year 1987 and by $ 384 for tax year 1988, and that their claimed moving expense deduction for 1988 should be reduced by $ 5,747.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621358/	APPEAL OF ELIZABETH S. SPRAGUE.Sprague v. CommissionerDocket No. 6740.United States Board of Tax Appeals8 B.T.A. 173; 1927 BTA LEXIS 2923; September 22, 1927, Promulgated 2923 1. Under section 219 of the Revenue Acts of 1918 and 1921, income of the trust for the taxable year which becomes distributable during the taxable year is taxable to the beneficiary, although the beneficiary was unknown until the exercise of a power within the taxable year. 2. Certain trust instruments provided that income should be added to the principal thereof, except that upon written request of the petitioner such income should be paid to her. Held, that such income is taxable to the fiduciary except to the extent to which the power was exercised by the petitioner to request such income be paid to her, and that to such extent the income was distributable and taxable to the petitioner. 3. Although the interest of the beneficiary may be contingent until the trustee makes a determination as to the amount of income which is distributable, after such determination is made and the contingency removed the income becomes distributable and taxable to the beneficiary and not to the fiduciary. Francis V. Barstow, Esq., for the petitioner. J. W. Fisher, Esq., for the Commissioner. PHILLIPS 174 The taxpayer appeals from the determination2924 by the Commissioner of deficiencies of $47.33, $7,907.86, and $48,596.90 in income tax for 1919, 1920, and 1921, respectively. She alleges that the Commissioner has committed error in allocating to her and including in her income, in computing the deficiencies, the income received by the trustees under various indentures of trust and in refusing to determine an overpayment of tax on account of income alleged to have been erroneously reported as received from some of said trusts. FINDINGS OF FACT. The taxpayer is a resident of Boston, Mass.In the determination of the deficiency here in question the Commissioner has included as income to the taxpayer for the respective years income received by trustees under indentures of trust made by her husband, Phineas W. Sprague, as follows: Amount included as incomeTrusteeDate of instrument191919201921The First National Bank of BostonMay 13, 1919$5,257.96Old Colony Trust Co. of BostonOct. 15, 191918,060.93International Trust Co. of BostonJan. 24, 1920$3,057.9519,571.13The First National Bank of BostonFeb. 15, 191942,775.16State Street Trust CoMay 26, 1919$2,298.3811,339.0522,491.66Robert G. Dodge, et alOct. 14, 192026,572.592,298.3814,397.00134,729.432925 By an indenture of trust dated May 13, 1919, executed by said Phineas W. Sprague, husband of the taxpayer, and delivered to the First National Bank of Boston and accepted by that bank on July 14, 1919, said Phineas W. Sprague, having insured the taxpayer's life for $300,000 and the life of his son for $100,000 by endowment policies, transferred to the trustees shares of stock of corporations to hold as a fund upon various trusts, including the following: From the income of the fund the Bank shall pay the annual premiums on all of the said policies, applying the dividends payable upon said policies to increasing the amount of the insurance and adding surplus income, if any, to the principal of the fund. Upon the maturity of the policies the insurance monies and the funds then in the hands of the trustee became a trust fund for the benefit of the settlor's children and their issue with contingent remainders over to the settlor and his wife. The settlor reserved the right to revoke the trust or amend the terms thereof at any time. The settlor amended the trust indenture on September 9, 1920, to omit the provision quoted above and to substitute therefor the following: From the2926 income of the Fund the Bank shall pay the annual premiums on all of the said policies, applying the dividends payable upon said policies to 175 increasing the amount of the insurance, and, unless my wife shall request that the same be paid to her as hereinafter provided, shall add the surplus income, if any, to the principal of the fund. Upon the written request of my wife the Bank shall pay over to her from time to time any of said surplus income when and as the same has been received and found to be unnecessary for the payment of said premiums; or from time to time, upon her written request the Bank may pay over to my said wife from principal an amount equivalent to the aggregate face amount of any such surplus income which has been previously added to the principal of the Premium Trust and not theretofore withdrawn by her under this provision. The settlor further amended the trust indenture on September 10, 1920, making it irrevocable and not subject to amendment. By indenture of trust dated October 15, 1919, executed by said Phineas W. Sprague and delivered to the Old Colony Trust Co., accepted by said company of said date, said Sprague, having insured the taxpayer's2927 life for $100,000 by an endowment policy, transferred to the trust company shares of stock of corporations to hold as a fund upon various trusts, including the following: From the income of the fund the trustee shall pay the annual premiums on the said policy, applying the dividends payable upon said policy to increasing the amount of the insurance, and adding the surplus income, if any, to the principal of the fund. Upon the maturity of the policy the insurance monies and funds then in the hands of the trustee become a trust fund, the principal of which is payable to the wife at certain times or, in the event of her death, the income and principal are payable to the children of the settlor and their issue. The settlor reserved the right to revoke the trust or amend the trust indenture at any time. The settlor amended the trust indenture on September 1, 1920, to omit the provision quoted above and to substitute therefor a provision which is identical in its terms with the provision, quoted above, made on September 9, 1920, with reference to the trust indenture of which the First National Bank of Boston is trustee. The settlor further amended the trust indenture on September 10, 1920, making2928 it irrevocable and not subject to amendment. By indenture of trust dated January 24, 1920, executed by said Phineas W. Sprague and delivered to the International Trust Co. of Boston and accepted by that company on January 28, 1920, said Sprague, having insured the taxpayer's life for $100,000 by an endowment policy, transferred to the trustee shares of stock of corporations to hold as a fund upon various trusts, including the following: From the income of the fund the Bank shall pay the annual premiums on said policy, applying the dividends payable upon said policy to increasing the amount of the insurance, and adding the surplus income if any to the principal of the fund. 176 Upon the maturity of the policy the insurance money and the funds then in the hands of the trustee became a trust fund, the income of which is payable to the taxpayer during her life and after her death to the children of the settlor with provision for payment of the principal to such children and their issue. The settlor reserved the right to revoke or amend the trust at any time. The settlor amended the trust indenture on September 1, 1920, to omit the provision quoted above and to substitute2929 therefor a provision which is identical in its terms with the provision, quoted above, made on September 9, 1920, with reference to the trust indenture of which the First National Bank of Boston is trustee. The said three trusts hereinabove enumerated are hereinafter referred to as the "insurance trusts." By indenture of trust dated February 19, 1919, executed by said Phineas W. Sprague and delivered to the First National Bank of Boston and accepted by that bank on said date, said Sprague transferred certain shares and securities to the trustee to hold upon various trusts including the following: Until and including the 1st February 1925 the trustee shall pay to my wife, Elizabeth Shaw Sprague, from the income of the trust fund such sums as I (or my guardian in case I shall become of unsound mind), shall from time to time request in writing. It was also provided that such income as is not paid to Mrs. Sprague should be added to and become part of the principal of the trust fund. After February 1, 1925, the income is payable to the settlor's children or their issue and at certain times the principal is payable to such children and their issue. The settlor reserved the right2930 to terminate the trust, in which event the settlor is to receive all of the property of the trust. The settlor amended the trust indenture on February 18, 1921, to omit the provision quoted above and to substitute therefor the following: Until and including the 1st of February, 1925, the trustee shall pay to my wife, Elizabeth Shaw Sprague, from the income of the trust fund, such sums as she shall from time to time request in writing. The income of such trust from January 1, 1921, to February 17, 1921, was $11,256.40. By indenture of trust dated May 26, 1919, executed by said Phineas W. Sprague and delivered to the State Street Trust Co. and accepted by that company on said date, said Sprague transferred certain shares of stock to the trustee to hold upon various trusts including the following: Until and including May 1, 1929, to collect invest and reinvest income and to pay to my wife, Elizabeth Shaw Sprague from time to time if she so requests in writing any or all of the income of the trust fund, either in cash or securities 177 or property into which said income may have been invested, and on May 1, 1929 to add to the principal of the trust fund all accumulated2931 income not paid as aforesaid. The income is thereafter to be accumulated until May 1, 1934, and after that date is to be paid to the settlor's children, and after their death the principal is to be dividend among the settlor's issue. The trust instrument contains no provision for amendment or alteration. By indenture of trust dated February 19, 1919, and executed by said Phineas W. Sprague as settlor, and Robert G. Dodge, George Hawley, and George A. Butman, as trustees, said Sprague transferred certain shares of stock to the trustees to hold upon various trusts including the following: Until the expiration of a period of ten years from the date of this instrument the trustees shall pay over the net income of the trust fund to my wife, Elizabeth Shaw Sprague, from time to time as she may request, and if she shall not request them to pay her all of the income the surplus shall be invested and added to the trust fund, subject to her right at any time during said period to require the payment to her of such accumulated income or any part thereof. At the end of the ten-year period the trustees were directed to pay the principal to Mrs. Sprague, the petitioner herein, if living, 2932 and otherwise to divide it among the surviving children of the settlor and Mrs. Sprague. The trust further provided: The provisions of this instrument may be amended by the trustees at any time during my life or the life of my said wife; provided, however, that no amendment shall become effective unless embodied in a written instrument signed by the three trustees for the time being and approved by me if I am living and otherwise by my said wife. On October 19, 1921, this trust instrument was amended to provide that the settlor might terminate it at any time during his life upon written notice, in which event the trust funds, together with all accumulations, were to be transferred and paid over to him. On October 27, 1921, the trust instrument was further amended to provide that if the settlor died within the period of 10 years from the date of its execution, the trustees might terminate the trust and pay the trust funds to the estate of the settlor provided they were of the opinion that such provision will be for the best interests of the family. OPINION. PHILLIPS: The question presented for our determination is whether the income, or any part of the income of the trust2933 funds, is taxable to the petitioner. The provisions of the Revenue Act of 1918, so far as applicable, are as follows: SEC. 219. (a) That the tax imposed by sections 210 and 211 shall apply to the income of estates or of any kind of property held in trust, including - * * 178 (2) Income accumulated in trust for the benefit of unborn or unascertained persons or persons with contingent interests; (3) Income held for future distribution under the terms of the will or trust; and (4) Income which is to be distributed to the beneficiaries periodically, whether or not at regular intervals, and the income collected by a guardian of an infant to be held or distributed as the court may direct. (b) The fiduciary shall be responsible for making the return of income for the estate or trust for which he acts. The net income of the estate or trust shall be computed in the same manner and on the same basis as provided in section 212 * * and in cases under paragraph (4) of subdivision (a) of this section the fiduciary shall include in the return a statement of each beneficiary's distributive share of such net income, whether or not distributed before the close of the taxable2934 year for which the return is made. (c) In cases under paragraph (1), (2), or (3) of subdivision (a) the tax shall be imposed upon the net income of the estate or trust and shall be paid by the fiduciary * . In such cases the estate or trust shall, for the purpose of the normal tax, be allowed the same credits as are allowed to single persons under section 216. (d) In cases under paragraph (4) of subdivision (a) * * the tax shall not be paid by the fiduciary, but there shall be included in computing the net income of each beneficiary his distributive share, whether distributed or not, of the net income of the estate or trust for the taxable years * * . The provisions of subdivision (a) of section 219 of the Revenue Act of 1921 are the same as those of the same subdivision of the 1918 Act. The remaining subdivisions of the 1921 Act, so far as material, are as follows: (b) The fiduciary shall be responsible for making the return of income for the estate or trust for which he acts. The net income of the estate or trust shall be computed in the same manner and on the same basis as provided in section 212 * . In cases in which there is any income of the class described2935 in paragraph (4) of subdivision (a) of this section the fiduciary shall include in the return a statement of the income of the estate or trust which, pursuant to the instrument or order governing the distribution, is distributable to each beneficiary, whether or not distributed before the close of the taxable year for which the return is made. (c) In cases under paragraphs (1), (2), or (3) of subdivision (a) or in any other case within subdivision (a) of this section except paragraph (4) thereof the tax shall be imposed upon the net income of the estate or trust and shall be paid by the fiduciary * * . (d) In cases under paragraph (4) of subdivision (a) * * the tax shall not be paid by the fiduciary, but there shall be included in computing the net income of each beneficiary that part of the income of the estate or trust for its taxable year which, pursuant to the instrument or order governing the distribution, is distributable to such beneficiary, whether distributed or not * * . (e) In the case of an estate or trust the income of which consists both of income of the class described in paragraph (4) of subdivision (a) of this section and other income, the net income of2936 the estate or trust shall be computed and a return thereof made by the fiduciary in accordance with subdivision (b) and the tax shall be imposed, and shall be paid by the fiduciary in accordance with subdivision (c), except that there shall be allowed as an 179 additional deduction in computing the net income of the estate or trust that part of its income of the class described in paragraph (4) of subdivision (a) which, pursuant to the instrument or order governing the distribution, is distributable during its taxable year to the beneficiaries. In cases under this subdivision there shall be included, as provided in subdivision (d) of this section, in computing the net income of each beneficiary, that part of the income of the estate or trust which, pursuant to the instrument or order governing the distribution, is distributable during the taxable year to such beneficiary. The principles to be applied in determining whether income from a trust fund is taxable to the fiduciary or to the beneficiary have been laid down by the Board in the cases of 2937 , and . Those cases arose under the same Acts with which we are here concerned. There we held that income which was properly accumulated was taxable to the fiduciary while income which was properly distributed or distributable was taxable to the beneficiary. It is unnecessary to repeat here the reasons which led us to these conclusions. Substantially the same conclusion was reached by the Circuit Court of Appeals of the Eighth Circuit in , where it is held that the beneficiary and not the fiduciary is taxable upon so much of the income as is severed from the trust estate so that it no longer forms any part thereof. In its opinion the Court said: In each of these Acts, the intent is that annual income to a particular beneficiary from a trust estate shall be taxed to him as a separate unit of taxation where that income is "distributed" to him. "Distribution", as there used, does not necessarily mean passing into the uncontrolled possession or disposition of the beneficiary. It means separation and segregation from the trust2938 fund so that it no longer forms any part or parcel thereof. The test set up by the statute is whether the income passes from the trust estate which produced it and ceases to be subject to the terms and control of that trust. If this trust instrument authorized such incomes to be so separated and segregated and they were so treated in fact, the Commissioner was in error and the trial Court properly overruled the demurrer to this petition and entered judgment for the refund. The Commissioner held that because the petitioner could receive the income of the trust funds by making a written request therefor, the entire income is taxable to her, and determined the deficiency accordingly. This position can not be sustained. The trust instruments all provided that the income should be added to the principal. To this extent such income was accumulated for unascertained persons or persons with contingent interests. There was the further provision that upon written request (by the settlor in one case and by the petitioner in the others) certain portions of the income were to be paid to the petitioner. Any such request constituted the exercise 180 of a power which, to the extent2939 that such power was validly exercised, removed such income from the provision for accumulation and made it distributable. Such distributable income was thereupon severed from the trust property and was taxable to the beneficiary under the provisions of section 219, quoted above. So much as was not distributable pursuant to the exercise of the power given by the trust instrument, remained a portion of the trust property, taxable to the fiduciary. Nor can the petitioner be sustained in her contention that the trusts fall within paragraph (a)(2) of section 219, and that no part of the income is taxable to the beneficiary. At the time the trusts were created and as the income was received from time to time, it may be that the ultimate beneficiary was uncertain but to the extent that the power was exercised within the year, this uncertainty was removed and the beneficiary became known. With respect to the "insurance trusts" petitioner contends that even though the power was exercised to require payment of all the available income, her interest would still be contingent because it was not until surplus income was "found to be unnecessary for the payment of said premiums" that2940 any amount became distributable. Unquestionably the duty to determine whether the retention of surplus income was necessary or unnecessary for that purpose rested upon the trustees, and until that duty was performed there was no distributable income. The determinations of the trustees are factors to be considered before we may arrive at the available income upon which the petitioner may exercise the power granted her to demand payment of such income, but when the trustees have made their determination and the petitioner has exercised the power, her interest is no longer contingent. Reviewed by the Board. Decision will be entered on 20 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621359/	APPEALS OF W. S. BUCK MERCANTILE CO.W. S. Buck Mercantile Co. v. CommissionerDocket Nos. 86, 2007.United States Board of Tax Appeals6 B.T.A. 285; 1927 BTA LEXIS 3556; February 21, 1927, Promulgated 3556 1. Petitioner is engaged in the merchandise business on the installment sales plan. At the close of each operating year it set up on its books an account designated "Reserve for cost to collect bad accounts," and, in its income and profits-tax returns for such years, deducted from its gross income the amounts so added to the reserve as collection expense. Held, that such method of accounting does not clearly reflect income. 2. Evidence of abnormalities in income or invested capital held insufficient to entitle petitioner to relief under the provisions of section 328 of the Revenue Act of 1918. Battle McCardle, Esq., for the petitioner. Briggs G. Simpich, Esq., for the Commissioner. LANSDON 285 These are appeals from determinations by the Commissioner of deficiences in income and profits taxes for the years 1918, 1919, and 1920, in the amounts of $3,206.37, $4,596.73, and $7,690.51, respectively. The issues are: (1) The addition, by the Commissioner, to the net income reported for the years 1918, 1919, and 1920, of the amounts of $7,362.76, $12,027.98, and $17,499.33, respectively, deducted by the petitioner as anticipated cost3557 of collection and losses, in future years, of the outstanding accounts receivable at the close of each year; and (2) whether petitioner is entitled to have its profits taxes for the year 1918 determined in accordance with the provisions of sections 327 and 328 of the Revenue Act of 1918. Except for the issue of special assessment, which applies to the year 1918 only, the facts and issues, except as to the amounts involved, are identical for all years; therefore, by agreement of counsel, the appeals were consolidated and heard together. FINDINGS OF FACT. Petitioner, a Kansas corporation with its principal office at Kansas City, was organized on or about July 11, 1917, for the purpose of taking over that part, known as the Lincoln (Nebraska) branch, of the business theretofore conducted by the Price Mercantile Co. Throughout the years under consideration, it was engaged in the retail sale, on the installment plan, of house furnishings, such as bedspreads, blankets, clocks, lace curtains, rugs, silverware, and table linens. The business policies, as they related to sales, collections, and methods of accounting, were precisely the same as those in effect during the ownership of3558 the business by its immediate predecessor. Generally, petitioner's sales are made through solicitors or agents who canvass industrial centers and country districts, going from 286 home to home, selling direct to the purchaser. The goods are usually carried on trucks by the agents, and delivery is made upon payment by the purchaser of the initial payment and reconveying title to the petitioner by deed of trust, without investigation as to the financial standing of the purchaser. The purchasers are usually of the laboring class, which is more or less transient. Salesmen are employed on a salary and commission basis. The initial payments for each sale, as received, are applied in their entirety by the petitioner to the payment of the salesman's commission until the said commission has been paid in full. The salesman is held responsible for the sale, and accountable for the goods delivered, but after the purchaser makes the first installment payment, the salesman is relieved of any further responsibility for any loss which may occur through failure of the purchaser to meet subsequent installment payments. Should the purchaser default in the first payment, the salesman3559 is required to stand one-half of any loss which may result from the transaction. The average sale seldom exceeds the sum of $25. The initial payment usually is from 5 to 10 per cent of the selling price, the balance being paid in weekly installments. The weekly installments are fixed in such amounts that the account will be paid within six months. Not more than 5 per cent of the total installment payments are made by mail or at the petitioner's offices. The balance of the collections are made by the petitioner's collectors. The latter are employed on a salary and commission basis, the commission being computed at a fixed percentage of the collectible accounts on the collector's books. Frequently collectors find it necessary to make more than one call upon a customer to collect an installment which has become due. It is the accounting practice of the petitioner to charge off, as bad debts, accounts of customers residing within the limits of territory covered by a city collector, after failure to make installment payments for a period of 60 days. In the cases of customers residing in districts covered by rural collectors, the accounts are charged off as bad debts after3560 90 days have elapsed from the date of the last installment payment. If, and when, further collections of installment payments are made upon accounts previously charged off as bad, these accounts are restored on the books. Only the net amount, representing the difference between the total accounts charged off and the total accounts restored, in any year, has been claimed as a deduction for bad debts in income-tax returns. 287 The merchandise sold by the petitioner is subject to rapid and considerable wear and tear. It has been the petitioner's experience that repossessed merchandise is usually in such condition that its because of failure to meet installment payments, the customer's because of failure to meet installment payments, the customer's account is credited with the amount of the unpaid balance of the selling price, and, at the same time, a like amount is charged on the books as the cost of repossessed merchandise. If the repossessed merchandise is still on hand at the close of the year, it is included in the inventory at its original cost. The petitioner's books of account have been maintained in accordance with the accrual method of accounting, and the net3561 income reported in the income-tax returns, for the three years under consideration, has been computed in accordance with that method. At the time of taking over the business, the petitioner, following in principle the accounting practice of the predecessor owner, set up in its books of account an account designated "Reserve for cost to collect and bad accounts," in the amount of $5,061.46, which represented 26 per cent of the book value of the accounts receivable taken over. Thereafter, and during the years under consideration, the petitioner has added annually to this reserve an amount equal to 26 per cent of the increase in the accounts receivable outstanding at the close of the year. The amounts thus added to the reserve each year have been deducted from income in the petitioner's tax returns as collection expense. The amounts so deducted are, for the year 1918, $7,362.76; for the year 1919, $12,027.98; and for the year 1920, $17,499.33. The accounts receivable outstanding at the close of the year 1921 were, in the aggregate, $20,932.38 less than the aggregate outstanding at the close of 1920; hence, the petitioner reduced the reserve by the sum of $5,441.55, or 26 per cent3562 of the decrease, which it included in taxable net income for that year. Upon audit of the petitioner's income and profits-tax returns for the years involved, the Commissioner added the amounts so deducted to gross income for each of the several, respective, taxable years. The purpose for which this reserve account was established was to provide a reserve out of each year's earnings, to take care of (1) the cost of collecting, in a later year, the accounts receivable outstanding at the close of each year, (2) such of those accounts which may in a later year prove to be worthless, and (3) losses which may be sustained in a later year upon the sale, at less than cost, of repossessed merchandise. This accounting practice has been adopted by at least two competitor companies. The following shows the condition of the reserve account at the close of each of the years under consideration, and the manner in which it was built up: /kaccounts receivable) 4,380.74 Amount credited to reserve at time of taking over the business $5,061.46 Amount added to reserve in 1917 (26% of increase of $16,848.98 in accounts receivable) 4,380.74 Amount of reserve at close of 1917 9,442.20 Amount3563 added to reserve in 1918 (26% of increase of $28,182.35 in accounts receivable) 7,362.76 Amount of reserve at close of 1918 16,804.96 Amount added to reserve in 1919 (26% of increase of $46,397.45 in accounts receivable) 12,027.98 Amount of reserve at close of 1919 28,832.94 Amount added to reserve in 1920 (26% of increase of $67,308.12 in accounts receivable) 17,499.33 Amount of reserve at close of 1920 46,332.27 288 The entire collection expense incurred in each of the years under consideration, and the total bad debts charged off on the books during each of those years, have been claimed as deductions in the petitioner's income-tax returns. From the date of organization until at or about October 1, 1919, the business of petitioner company was carried on at the personal residence of its secretary. During that period the petitioner maintained no other place for the transaction of its affairs. The facilities of the secretary's residence, such as light and telephone, were used in the conduct of petitioner's business. During the period stated, no rental was paid to the secretary for the use of his residence and its facilities for office purposes. Until June 1, 1918, the3564 secretary was in the employ of the predecessor owner of the business, notwithstanding which he attended to a considerable part of petitioner's business affairs, matters of office routine, and keeping the books of account. For these services he was paid, during the first five months of the year 1918, compensation at the rate of $120 per month. Prior to the organization of the petitioner, its president had been employed for approximately twenty years by the predecessor owner of the business, as general manager. His compensation, including commissions, was from $10,000 to $12,000. During the first five months of 1918, he devoted his entire time to petitioner's business affairs, and during that period, was paid compensation at the rate of $250 per month. His salary has since been increased to $16,000 per annum. The gross sales shown by the return for the year 1918 amounted to $227,402.18. The total deduction claimed in that return, as compensation of officers, is $8,100. During the year 1918, the total capital stock outstanding was $50,000, and the petitioner's average indebtedness for the last nine months of that year was $59,192.47. 289 OPINION. LANSDON: It3565 should be stated at the outset, that while the petitioner was engaged, during all of the years under consideration, in the sale of merchandise on the installment plan, the appeal raises no question as to its right to compute its net income on the installment basis. The books of account were maintained in accordance with the accrual method of accounting; the net income reported in the returns of the several years under consideration was computed in accordance with that same method; and the petitioner contends that no other method of accounting will clearly reflect its net income. The first issue raised is whether the additions made to the "Reserve for cost to collect and bad debts," in each of the years under consideration, represent unrealized profits which should be excluded from gross income, or, in the alternative, whether the amounts thus set aside to the reserve in each year constitute allowable deductions in computing taxable net income. The petitioner contends that a portion of the annual increase in accounts receivable represents unrealized profits and should be excluded from gross income, because, in a later year, there will be expenses incurred in the collection of these3566 accounts and some of the accounts will prove to be worthless. It submits an alternative contention, that the annual additions to the reserve are allowable deductions from income, under the provisions of section 234(a)(4) of the Revenue Act of 1918, as losses sustained during the taxable year, and not compensated for by insurance, or otherwise. The accrual method of accounting requires that at the end of every accounting period all income which has been earned must be accounted for as income accrued in that period. This is true notwithstanding that the income is not due and will not be collected until some future date. . The increase in the accounts receivable, in any one of the years under consideration, resulted from sales transactions entered into and completed within the year. All of the incidents which entitled or required the petitioner, under the method of accounting employed, to accrue these accounts receivable and the profits represented thereby on its books of account, had taken place before the close of the year. There remained nothing further to be done on the part of the petitioner lawfully to entitle3567 it to receive the full amount of these accounts. The acts of sale and the performance by the petitioner of all of its obligations under the sales contracts, determined the earning of the income. There can hardly be any question that the income represented by the increase in the accounts receivable in each of the years under consideration was earned in those respective years. The statutory definition of gross income, as 290 laid down in section 213(a) of the Revenue Act of 1918, does not differ from the accounting conception of gross income. In a merchandising business, such as that in which the petitioner is engaged, the "gains, profits, and income derived * * * from * * * sales" are represented by the excess of the aggregate selling price over the cost of goods sold. This is a simple and elementary principle of accounting, which is generally understood, and needs no elucidation on the part of this Board. If the income is to be reduced in some manner by the estimated expenses of collecting it at some time in the future and the estimated amount thereof which may not be collected, then, the reduction must take the form of a statutory deduction from income, authority for3568 which must be found under the provisions of section 214(a) or section 234(a) of the Revenue Act of 1918. The estimated amounts, if actually earned, can not be excluded from gross income on the ground that they are unrealized profits. It is apparent from the mere reading of the provisions of section 214(a)(4) of the Revenue Act of 1918, and the corresponding provisions of section 234 applicable to corporate taxpayers, upon which the petitioner relies as authority for its alternative contention that the annual additions to the reserve are proper deductions from gross income as losses, that those sections afford no basis for its contention. Both of the sections referred to provide for the deduction of "Losses sustained during the taxable year," and not of losses which may or may not be sustained in some future year. Nor do we upon examination of the provisions of those entire sections - and they constitute the whole authority for the deduction of business expenses - find any basis for the deduction of these annual additions to the reserve. On the contrary, we find that the deduction to be allowed for bad debts is the total "debts ascertained to be worthless and charged off3569 within the taxable year," and in the case of business expenses "all the ordinary and necessary expenses paid or incurred during the taxable year." There was no ascertainment during the taxable years in question that a portion of the outstanding accounts receivable, at the close of each of those years, were worthless; nor were the expenses incident to the collection of those accounts at some future date, paid or incurred within the taxable years. See . Certain facts were developed by testimony during the hearing which, though not so indicated at the time by counsel, were apparently intended to show that the petitioner was entitled to have its profits taxes for the year 1918 determined under the special relief provisions of the applicable act. Those facts are entirely too meager and insufficient to warrant a conclusion that there existed, during the year 1918, any abnormalities affecting net income or invested 291 capital to such an extent as to work upon the petitioner an exceptional hardship which, if true, would have entitled it, under the provisions of section 327(d) of the Revenue Act of 1918, to have3570 its profits tax liability determined in accordance with section 328 of the Act. Therefore, the relief for which petitioner prays must be denied. Judgment will be entered for the Commissioner.PHILLIPS dissents.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621361/	Henry C. Deneke and Lois Cash, Petitioners, v. Commissioner of Internal Revenue, RespondentDeneke v. CommissionerDocket No. 331-63United States Tax Court42 T.C. 981; 1964 U.S. Tax Ct. LEXIS 52; August 27, 1964, Filed 52 Decision will be entered for the respondent. Petitioners, both employed as salesmen, spent 53 nights during 1959 in a motel in Palestine, Tex. During the rest of the year they traveled throughout adjoining states which were included in their territory. They sent two of their children to a boarding school in Palestine, Tex., and maintained their legal residence there. Held, the petitioners did not have a "home" in Palestine, Tex., and consequently are not entitled to the deductions allowed by section 162(a)(2) of the 1954 Code. Alton King, for the petitioners.John W. Dierker, for the respondent. Hoyt, Judge. HOYT981 The respondent determined a deficiency in petitioners' income tax of $ 1,444.25 for the53 calendar year 1959. The sole issue contested by the petitioners is whether or not certain expenses for meals and lodging were incurred while "away from home" within the meaning of section 162(a)(2) of the 1954 Code.FINDINGS OF FACTAll of the facts have been stipulated and are found accordingly.Petitioners Henry C. Deneke and Lois Cash were husband and wife during the calendar year 1959 with their legal residence at the Dogwood Motel, Palestine, Tex. They filed their joint Federal income tax return with the district director of internal revenue in Dallas, Tex., for the calendar year 1959.During the year 1959 petitioners were employed as salesmen for Silas Dean Organization, Denver, Colo., with a sales territory consisting of the States of Louisiana, Oklahoma, Texas, Arkansas, and New Mexico.The records of the Dogwood Motel, Palestine, Tex., reflect that the petitioners spent 53 nights at the Dogwood Motel for which they paid $ 368 during the year 1959. Forty-two of the nights were spent in single rooms, 10 nights in double rooms, and 1 night in a three-room apartment.Two of the petitioners' dependent children, Thomas and Richard, 11 and 9 years of age, respectively, also resided54 in Palestine, Tex. They attended the St. Mary's Academy of Palestine, Tex., and during 1959 the petitioners paid $ 1,566 for their board, lodging, tuition, and incidental expenses. The school had instructions that in case of an emergency they should call Robert H. Mackie who was the manager of the Dogwood Motel.Petitioner Henry C. Deneke made payments on a note for $ 636 to the East Texas National Bank of Palestine, Tex., during the year 982 1959. The petitioners also paid poll taxes in Anderson County, Tex. The address which they listed with the tax assessor-collector, Anderson County, Tex., was the Dogwood Motel, Palestine, Tex.During the year 1959 the petitioners spent $ 2,495.27 for rooms while away from Palestine, Tex. They also spent $ 1,248 for meals while away from Palestine.OPINIONIn order to be entitled to a deduction under section 162(a)(2) the petitioners must show that (1) the expenses incurred were reasonable and necessary, (2) that they incurred the expenses while "away from home," and (3) that the expenses were incurred in pursuit of business. Commissioner v. Flowers, 326 U.S. 465 (1946). Here in this fully stipulated55 case, the only issue argued by the parties is whether or not the expenses were incurred "away from home."As was noted by the court in the recent case of James v. United States, 308 F. 2d 204 (C.A. 9, 1962), there are two reasons for allowing a deduction for meals and lodging while "away from home." One is to compensate for the duplication of living expenses, and the second is to make allowance for the excessive cost of food and shelter while traveling.In the present case the petitioners had no permanent home in Palestine, Tex. Consequently, there was no duplication of expenses when they were traveling. In like manner there were no excess expenses since they were in a status of constant travel.The only contacts petitioners had with Palestine, Tex., were: Two of their children attended boarding school there; petitioner Deneke had a note with a bank there; they paid poll tax in Palestine; they spent 53 nights in a motel in Palestine; and their legal residence was stipulated to be Palestine. Although the petitioners' income tax return for 1959 claimed a deduction for a third child, Douglas, there is no evidence as to where he spent the year. We56 can only conclude that he was with his parents as they traveled over their territory. No address different from that of petitioners' is given for Douglas and since petitioners did not maintain a residence in Palestine, Tex., other than at the motel where they spent 53 nights in 1959, Douglas must have been with his parents.In James v. United States, supra, the petitioner had the following contacts with his claimed home, Reno, Nev.:He called upon a dozen accounts in Reno as he did upon similar accounts in other communities in his territory. During the year he spent approximately thirty days in Reno, which was about the same as the time spent in other cities of comparable size in his territory. While in Reno he stayed at a hotel or motel, and took his meals about town. His relationship with Reno differed from that with other cities in his territory in that he there maintained a Post 983 Office box and bank account, dealt with a stockbroker, purchased his automobile and insurance, filed his income tax return, and stored certain personal belongings. In Reno taxpayer "rested, took care of his mail, his banking, insurance, cars and other57 things, which he did not do in the other communities in which he stopped." He regarded Reno as his "headquarters" for these purposes.The court held that these contacts were not sufficient to give him a "home" in Reno for purposes of section 23(a)(1)(A) ( sec. 162(a)(2), I.R.C. 1954), and in like manner we hold there is not sufficient contact shown in the present case to establish a tax home for petitioners at Palestine, Tex.In the James case, the court pointed out that a taxpayer is deemed to have a tax home "only when it appears that he has incurred substantial continuing living expenses at a permanent place of residence." The absence of such expenses in the instant case requires a finding that petitioners did not have a "home" in Palestine, Tex., when they incurred the expenses they seek to deduct for 1959. Even if we consider that the petitioners maintained a domicile in Palestine, Tex., we are unable to find that they maintained a home there for purposes of section 162(a)(2). Their home was wherever they happened to be. James v. United States, supra;Wilson John Fisher, 23 T.C. 218">23 T.C. 218 (1954), affd. 230 F. 2d 7958 (C.A. 7, 1956). It is obvious that during the short period of 53 days in 1959 that they did maintain a home at the motel in Palestine, they were not incurring any expenses away from that home. Therefore, the expenses for meals and lodging when they were away from Palestine were not incurred while "away from home" and are not deductible under section 162(a)(2).The petitioners have failed to carry their burden of proof to substantiate the claimed business expenses. We must therefore concur in the determination of the respondent.Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621364/	JOHN and BARBARA WESTWICK, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWestwick v. CommissionerDocket No. 7015-78.United States Tax CourtT.C. Memo 1979-329; 1979 Tax Ct. Memo LEXIS 195; 38 T.C.M. (CCH) 1269; T.C.M. (RIA) 79329; August 22, 1979, Filed John Westwick, pro se. Donald T. Rocen, for the respondent. FEATHERSTONMEMORANDUM FINDINGS OF FACT AND OPINION FEATHERSTON, Judge: Respondent determined a deficiency in the amount of $327.67 in petitioners' income tax for 1976. Section 301 of the Tax Reform Act of 1976 reduced the amount of the exemption applicable to the minimum tax on tax preference items from $30,000 to $10,000, effective for taxable years beginning after December 31, 1975. The issue is whether under the due process clause of the Fifth Amendment to the Constitution this reduction may be applied in respect of gains derived from a transaction196 entered into prior to the enactment of the Tax Reform Act of 1976. FINDINGS OF FACT At the time the petition was filed, petitioners were legal residents of Boulder, Colorado. Petitioners filed a joint Federal income tax return for 1976. On September 13, 1976, petitioners entered into a contract for the sale of a duplex located in Boulder, Colorado, one-half of which had been rented and the other half had been occupied as petitioners' personal residence. The sale transaction was closed on October 4, 1976. On their income tax return for 1976, petitioners reported a gain from the sale of the duplex in the amount of $24,368.87. Petitioners reported one-half of the gain as capital gain in view of the dual function of the duplex and, having purchased another residence, deferred the other one-half. On October 4, 1976, the President signed the Tax Reform Act of 1976 (Pub. L. 94-455). Section 301 of that Act reduced the amount of the exemption from the section 56 minimum tax to $10,000 or one-half of the regular tax deduction for the taxable year, whichever is greater, in place of the greater of the $30,000 exemption or the regular tax deduction for the taxable year. For individuals, 197 this revision of the minimum tax provisions applies to taxable years beginning after December 31, 1975. In computing the deficiency here in dispute, the Commissioner applied the revised exemption provisions adopted in the Tax Reform Act of 1976. OPINION Petitioners contend that the amendments to the section 561/ minimum tax provisions in the Tax Reform Act of 1976 may not constitutionally be applied to transactions entered into before its enactment. To support their position they rely mainly upon Untermyer v. Anderson,267 U.S. 440">267 U.S. 440 (1928). Respondent maintains that the retroactive application of the disputed Tax Reform Act provisions is constitutionally permissible. We are compelled to agree with respondent. This precise issue was recently considered by the Court in Buttke v. Commissioner,198 72 T.C. (July 16, 1979), where we cited numerous prior court opinions sustaining the constitutionality of similar statutes. We adhere to that opinion. The argument here presented was considered in Brushaber v. Union Pac. R.R.,240 U.S. 1">240 U.S. 1 (1916), one of the first cases arising under the Sixteenth Amendment. In that case, the Supreme Court rejected a Fifth Amendment due-process-of-law attack on the Tariff Act of October 9, 1913, which imposed a tax on income realized after March 1, 1913. In sustaining that Act, the Supreme Court cited Stockdale v. Insurance Companies,87 U.S. 323">87 U.S. 323, 331 (1873), which sustained the constitutionality of a joint resolution adopted July 4, 1864, to impose a tax of 5 percent upon all income of the previous year. In Welch v. Henry,305 U.S. 134">305 U.S. 134, 148-149 (1938), rehearing denied 305 U.S. 675">305 U.S. 675, (1938), the Supreme Court sustained the constitutionality of a Wisconsin State law, adopted March 27, 1935, which imposed a tax on corporate dividends received in 1933 at rates different from those applicable in that year, stating: For more than seventy-five years it has been the familiar199 legislative practice of Congress in the enactment of revenue laws to tax retroactively income on profits received during the year of the session in which the taxing statute is enacted, and in some instances during the year of the preceding session. * * * Those statutes not only increased the tax burden by laying new taxes and increasing the rates of old ones or both, but they redistributed retroactively the tax burdens imposed by pre-existing laws. * * * The contention that the retroactive application of the Revenue Acts is a denial of the due process guaranteed by the Fifth Amendment has been uniformly rejected. The Court explained (305 U.S. at 147): In each case it is necessary to consider the nature of the tax and the circumstances in which it is laid before it can be said that its retroactive application is so harsh and oppressive as to transgress the constitutional limitation. In the light of these and other procedents, we cannot say that the change in the Tax Reform Act of 1976 with respect to the amount of the exemption applicable to the minimum tax or tax preference items is so harsh and oppressive as to trangress the constitutional limitation." Welch v. Henry,supra at 147.*200 The case of Untermyer v. Anderson,supra, is distinguishable. That case involved a statute which imposed a gift tax on transactions which occurred prior to its enactment. The statute did not merely change the applicable rate but imposed a completely new tax on transactions already completed. Petitioner presented his position with sincerity and eloquence. We can understand his viewpoint. As a Court, however, we must take the law as written by the Congress and, in the face of the well-established constitutional principles outlined above, we have no choice but to sustain respondent's position. To reflect the foregoing, Decision will be entered for the respondent. Footnotes1. /Sec. 56, Internal Revenue Code of 1954, for each taxable year with respect to the income of every person, a tax-- equal to 15 percent of the amount by which the sum of the items of tax preference exceeds the greater of-- (1) $10,000.00 or (2) the regular tax deduction for the taxable year (as determined under subsection (c)).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621368/	Estate of John T. Harrington, Charles F. Smith, Trustee v. Commissioner.Estate of Harrington v. CommissionerDocket No. 104194.United States Tax Court1943 Tax Ct. Memo LEXIS 173; 2 T.C.M. (CCH) 540; T.C.M. (RIA) 43369; July 29, 1943173 Donald J. Lynn, Esq., A. L. Jones, C. P. A., and C. F. Smith, Trustee, pro se, for the petitioner. Lawrence R. Bloomenthal, Esq., for the respondent. HILL Memorandum Findings of Fact and Opinion HILL, Judge: Respondent determined a deficiency of $2,201.12 in income tax for the calendar year 1938. Petitioner claimed an overassessment in its petition of $580.51. By amended answer respondent seeks to increase the deficiency to $4,283.46. The sole issue for our determination is whether or not petitioner realized either capital gain or ordinary income upon the settlement of certain obligations with stock. Findings of Fact Petitioner is a fiduciary whose address is, and was at all times material, 1200 Mahoning Bank Building, Youngstown, Ohio. The original return was filed with the collector of internal revenue for the eighteenth district of Ohio on or before March 15, 1939. The tax as shown thereon was paid on March 15, 1939. An amended return for the year 1938, together with claim for refund for that year of $599.90, was filed with the collector on or about June 9, 1939. On December 29, 1931, John T. Harrington, decedent, and the Republic Steel Corporation, hereinafter referred174 to as Republic, entered into a contract whereby Republic authorized decedent to subscribe in its name for 1,000 shares of capital stock of the Union National Bank of Youngstown, Ohio, sometimes referred to as Bank stock. The amount was $200,000 par value. Decedent covenanted and agreed that he would, on or before one year from the date of that subscription, purchase from Republic and Republic agreed to sell one-half of the number of shares so subscribed in its behalf. After a recital of the facts motivating the agreement, it was provided as follows: 2. Said Harrington hereby covenants and agrees that he will, on or before one year from the date of said subscription, purchase from Republic, and Republic agrees to sell, one-half of the number of shares so subscribed in its behalf, and said Harrington agrees to pay Republic therefor the full sum of One Hundred Thousand Dollars ($100,000) with interest at six percent (6%) per annum from the date of said subscription. 3. This agreement shall be binding upon and inure to the benefit of the heirs, executors, administrators, successors and assigns of the parties hereto. Harrington died testate on February 27, 1932. In the estate tax return175 100 shares of Bank stock were reported at $100 per share, the fair market value as of that date. In this return debts of decedent included this computation: Republic Steel guarantee on stockpurchase$106,000Less fair value of stock of UnionNational Bank at $10050,000$ 56,000 This amount was allowed as a liability of the estate. The fair market value of Union National Bank stock as of the date of death of Harrington was $100 per share. On December 28, 1932, the executors of decedent's estate paid to Republic the sum of $31,000 and on March 29, 1937, it paid the additional sum of $75,000. This was in full settlement of the agreement of December 29, 1931. The payments were on the agreed basis of $200 per share plus $6,000 for accrued interest. Republic, on April 2, 1937 delivered to the executors and their appointee a total of 500 shares of the capital stock of Union National Bank. The executors did not charge themselves with the stock until actually delivered to them. The stock was then entered in their asset account at $100 per share, the prevailing market price at that time. At the time of decedent's death, he owed unpaid charitable subscriptions in the following176 amounts: Youngstown Hospital Association$32,300.00Community Corporation5,000.00College of Wooster4,999.99$42,299.00The charitable pledges were listed as debts and allowed as deductions in determining the net estate subject to the Federal estate tax. The minutes of the executive committee of the Community Corporation for October 18, 1938, show inter alia: The Secretary read the following letter from the executors of the estate of John T. Harrington: "Gentlemen: - We understand that there is a balance still remaining due of $5000 upon the pledge of the late John T. Harrington to your Corporation for the fiscal year July 1, 1931 to July 1, 1932, the same being for the fourth quarter of that year. This is to advise you that we will deliver, or cause to be delivered, to The Community Corporation 25 shares of the Capital stock of The Union National Bank of Youngstown, on the basis of $200 per share, in full liquidation and settlement of the claim of your Corporation against the Estate of John T. Harrington for the $5000 still remaining due upon Mr. Harrington's pledge to your Corporation for the fiscal year July 1, 1931 to July 1, 1932. If this offer is acceptable177 to you, will you please advise us in writing at your earliest convenience. Charles F. Smith Donald J. Lynn - Executors." On motion of Herman C. Ritter, seconded by Tom H. Murray, and carried, the Executive Committee accepted this offer of settlement and authorized the Secretary to communicate this favorable action to the executors of The Estate of John T. Harrington. On October 29, 1938, 25 shares of Bank stock were delivered to the Community Corporation in full settlement of the unpaid pledge of $5,000. These 25 shares were delivered out of 100 shares purchased by Harrington during his lifetime and returned as part of his estate. On October 20, 1938, the Bank stock was quoted on the Youngstown Exchange as "bid, $100, asked $110, last sale $110." The fair market value of the stock was $110 per share on October 20, 1938. On December 20, 1938, 162 shares of Bank stock were transferred to the Youngstown Hospital Association in full settlement of decedent's unpaid pledge of $32,300. These shares were delivered out of the 500 shares which the executors had acquired from Republic. The Bank stock was quoted on the Youngstown Exchange on December 19 and 21, 1938, as "bid 110, asked 120, 178 last sale 110." The fair market value as of December 20, 1938, was $110 per share. On December 24, 1938, 25 shares of the Bank stock were transferred to College of Wooster in full settlement of decedent's unpaid pledge of $4,999.99. These 25 shares were delivered out of the 500 shares acquired by the executors from Republic. The Bank stock was quoted on the Youngstown Exchange as "bid 110, asked 120, last sale 110," on December 24, 1938. The fair market value was $110 per share as of that date. The College entered the stock upon its books at the value of $3,000, and the remainder of the pledge was cancelled. On or about February 2, 1939, the executors filed an account in Probate Court in which they reported "property sold or transferred by the Executors resulting in profit or increase to estate" and included the following computation: No. ofSaleInventorySharesDescription of PledgesPriceValueProfit25Union National Bank Capital Stock at $200.00$ 5,000.00$ 2,500.00$ 2,500.00Community Corporation of Youngstown, Ohio162Union National Bank Capital Stock at $200.0032,300.1616,200.0016,100.00Youngstown Hospital Association25Union National Bank Capital Stock at $200.004,999.992,500.002,499.99College of Wooster179 This account was considered and approved by the Probate Court. The book value of the Bank stock was approximately $250 per share at the beginning and end of 1938. In the original income tax return the executors reported the sum of $21,099.99 as capital gain representing the difference between a basis of $21,200 for the 212 shares of capital stock of Union Nationalbank and the unpaid liability to the three charitable institutions. Fifty percent was reported in gross income as long term capital gain. As amended return and claim for refund of an alleged overpayment were filed on June 9, 1939. The petitioner claimed a deduction for the sum of $21,099.99 for charitable contributions. All facts stipulated but not expressly found are incorporated herein by reference. Opinion The sole issue of this proceeding is whether or not petitioner received either capital gain or ordinary income by the transfer of stock in satisfaction of debts owed to charities. These debts were included and allowed as liabilities in the estate tax return. The facts show that petitioner discharged a debt of $5,000 owing to the Community Corporation with 25 shares of Bank stock. These shares were owned by decedent180 at the time of his death and their fair market value as of the date of his death was $100 each. Petitioner acquired 500 more shares of this stock by performing a binding contract which decedent had made for its purchase at $200 a share. One hundred sixty-two shares of this subsequently acquired stock were turned over to the Youngstown Hospital Association in satisfaction of decedent's pledge of $32,300. Twenty-five shares of this latter stock were turned over to the College of Wooster in satisfaction of decedent's pledge of $4,999.99. The first question which we must determine is the basis which the Bank stock had in the hands of petitioner. There is no doubt that the stock which decedent owned prior to his death and which had a fair market value of $100 at the date of his death had a basis of $100 per share in the hands of petitioner. Petitioner concedes as much. The controversy involves the basis of the stock received by petitioner from Republic. Petitioner contends that this stock was purchased by it and, therefore, in accordance with section 113 (a) of the Revenue Act of 1938, the basis was the cost of $200 per share. Respondent, conversely, contends that the facts of the instant181 case bring it within the purview of section 113 (a) (5) of the Revenue Act of 1938, such being an exception to the general rule pronounced by section 113 (a). We quote the pertinent portions of both sections: SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS. (a) Basis (Unadjusted) of Property. - The basis of property shall be the cost of such property; except that - * * * (5) Property Transmitted at Death. - If the property was acquired by bequest, devise, or inheritance, or by the decedent's estate from the decedent, the basis shall be the fair market value of such property at the time of such acquisition. * * Obviously, this stock was not acquired through bequest, devise or inheritance, since petitioner was neither legatee nor heir of Harrington. Respondent's contention can be sustained, if at all, only on the theory that this stock was acquired from decedent. On this point respondent's contention must fall. At the date of decedent's death he was merely a party to an agreement which incorporated within its terms an executory contract to sell this stock. Reference to the agreement discloses the unequivocal intention that no sale take place upon its execution but182 that, on the contrary, the sale transpire at a future time. We quote from the agreement, "Said Harrington hereby covenants and agrees that he will * * purchase from Republic * * ." (Emphasis supplied). Sale was contingent upon Harrington's payment of the agreed price. At the time of his death this payment had not been made. Accordingly, title then remained in Republic. Republic alone had the right to vote the stock, receive dividends thereon and otherwise act in its connection. Cf. Crocker v. Helvering, 76 Fed. (2d) 974. Petitioner correctly treated the purchase contract as an estate liability in the net sum of $56,000, being the purchase price less the fair value of the stock to be received therefor. Consistently, this stock was not inventoried as an asset of the estate. Petitioner acquired the stock directly from Republic some five years after Harrington's death and its acquisition came as a result solely of the liquidation of the state's liability to Republic. The facts clearly establish the inapplicability of section 113 (a) (5). That section as construed by article 113 (a) (5)-1 (b) of Regulations 101 to relate contingent titles back to183 the death of decedent does not embrace contingent or other kinds of titles to or interest in property which the decedent did not own at his death and consequently were not transferred by his death. Interests in property which do not have their incipience in the death of a decedent are not covered by section 113 (a) (5) or the construction thereof by the above cited articles of the Regulations. The petitioner here acquired no title or interest of any character to or in the Bank stock in question at or by reason of the death of the decedent. It acquired the full title to the stock by paying the full purchase price therefor. The title so acquired is not to be related back to the death of decedent. The cases of Estate of Robert L. Holt, 14 B.T.A. 564">14 B.T.A. 564, Rose Newman, et al., Executors, 31 B.T.A. 772">31 B.T.A. 772, Crocker v. Helvering, supra, and Schoenfeld v. Commissioner, 103 Fed. (2d) 964, upon which respondent also relies, are not in point. In each the principal question involved the valuation of securities for estate tax purposes. No question was raised with reference to*184 the basis for exchange or the includability of such securities in the estate assets. Since petitioner paid $100,000 principal for 500 shares of the stock the basis thereof to petitioner for gain or loss is $200 per share. Petitioner discharged its obligation of $32,300 to Youngstown Hospital Association by delivering to it 162 shares of the stock acquired from Republic. It settled its obligation of $4,999.99 to the College of Wooster by delivering to it 25 shares of the stock acquired from Republic. Since the stock so delivered to the two institutions named had a cost basis for gain or loss of $200 per share petitioner realized no gain in either of such transactions. Petitioner discharged its obligation of $5,000 to Community Corporation by delivering to it 25 shares of Bank stock which decedent owned at his death. This stock had a fair market value of $100 per share at the death of decedent which was its basis in the hands of petitioner for gain or loss. Consequently, in the transaction with Community Corporation, petitioner realized a capital gain of $2,500. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621369/	The Procter and Gamble Manufacturing Company v. Commissioner.P&G Mfg. Co. v. CommissionerDocket No. 3338.United States Tax Court1946 Tax Ct. Memo LEXIS 260; 5 T.C.M. (CCH) 93; T.C.M. (RIA) 46041; February 18, 1946260 C. Chester Guy, Esq., 618 Southern Bldg., Washington, D.C., for the petitioner. Cecil H. Haas, Esq., for the respondent. LEECH Memorandum Opinion LEECH, Judge: This controversy involves deficiencies in income taxes for the taxable years ended June 30, 1939 to June 30, 1941, inclusive, in the respective amounts of $2,019.72, $1,363.35 and $1,141.34. The sole contested issue is whether petitioner is entitled to a depletion deduction of 27 1/2 per cent on its share of the net profit realized from operations under an oil and gas lease. The facts have all been stipulated and are adopted as our findings of fact. Only a brief summary is necessary. Petitioner is an Ohio corporation with its principal office in Cincinnati, Ohio. Its Federal tax returns for the periods involved were filed with the collector of internal revenue for the first district of Ohio at Cleveland. On July 26, 1937, petitioner and Thomas Breslin, fee owners of two adjoining tracts of land in Los Angeles County, California, entered into an "Oil and Gas Lease" with Richfield Oil Corporation. That agreement has since continued in full force and effect. In substance the agreement contains the usual261 provisions of a typical oil and gas lease. The complete agreement is contained in the record, but a detailed analysis is unnecessary. The controversy arises from the fact that the lease contains no provision for the payment of a royalty to the lessor other than a percentage of the net profits determined under a prescribed formula. The respondent contends that where the owner leases solely for net profits he no longer has a direct interest in the production of mineral deposits and is not entitled to a 27 1/2 per cent depletion deduction under section 114 (b) (3). 1262 The respondent relies upon the principles set forth in , while petitioner rests on the analogy of , and . Since this case was submitted, the Supreme Court has determined the conflict between the Kirby and Crawford decisions, reversing the former and affirming the latter. Kirby Petroleum Co. v. Commissioner; (decided January 28, 1946). In the light of this recent pronouncement the petitioner is sustained. Effect will be given to the stipulation respecting the issue raised in paragraph 4 (b) of the amended petition in the computation under the Rule. Decision will be entered under Rule 50. Footnotes1. Section 114 (b) (3) of the Revenue Act of 1938 and the I.R.C. are identical and read as follows: SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION. * * * (b) Basis for Depletion. - * * * *(3) Percentage Depletion for Oil and Gas Wells. - In the case of oil and gas wells the allowance for depletion under section 23 (m) shall be 27 1/2 per centum of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance under section 23 (m) be less than it would be if computed without reference to this paragraph.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621371/	APPEAL OF FEIST & BACHRACH, INC.Feist & Bachrach, Inc. v. CommissionerDocket No. 1350.United States Board of Tax Appeals2 B.T.A. 1228; 1925 BTA LEXIS 2129; November 6, 1925, Decided Submitted May 4, 1925. 2129 Withdrawals by stockholders, held to be distributions of profits. Franklin C. Parks and H. R. Young, Esqs., for the taxpayer. Lee I. Park, Esq., for the Commissioner. LOVE 1228 Before GREEN, LANSDON, and LOVE. This appeal is from a determination of a deficiency in income and profits taxes for the years 1918, 1919, and 1920, in the aggregate amount of $13,606.82. The taxpayer assigns but one error, viz, that the Commissioner has excluded from invested capital the amount of certain obligations 1229 owing to the corporation from its stockholders, which were secured by stock of the corporation as collateral, and which were carried on the books of the corporation as "Bills receivable - Stockholders." FINDINGS OF FACT. The taxpayer is a Washington corporation, having its principal office at Tacoma. It has outstanding 1,000 shares of capital stock (par value $100, each), which are held as follows: Shares.Theo Feist500Jos. Bachrach249Irma Feist250Herbert Bachrach1Irma Feist is a sister of Theo Feist; Joseph Bachrach is a brother-in-law of Theo Feist; and Herbert Bachrach is a son of2130 Joseph Bachrach. The business is that of a department store, was founded by Theo Feist in 1895, and was incorporated in 1906. The business, prior to its incorporation, was operated as a partnership, with Theo Feist, Joseph Bachrach, and Irma Feist as the partners. While the business was being operated as a partnership very small salaries were paid to the partners, Theo. Feist and Joseph Bachrach, and each of them, as well as Irma Feist, had an account with the store, on which cash advances and the value of merchandise obtained by them were charged. These accounts were carried forward into the books of the corporation when the business was incorporated. On January 1, 1909, they showed that these three persons owed the corporation the following amounts: Theo Feist, $1,265.05; Joseph Bachrach, $6,450.75; and Irma Feist, $95.50. The amounts of these accounts increased each succeeding year from 1909 until January 1, 1920, at which date they showed that there was owing by Theo Feist, $43,751.68; by Joseph Bachrach, $49,592.38, and by Irma Feist, $28,184.50; a total of $121,528.56, which amount was claimed by the taxpayer as additional invested capital, and, as such, disallowed2131 by the Commissioner. The stock certificates belonging to each of the stockholders were kept in the safe of the corporation and in that way were in possession of the corporation; but they were not indorsed by the owners and there was no contract, written or oral, hypothecating them as collateral security for the debit accounts. Article V, section 2, of the corporate by-laws of the taxpayer provides: 1230 Transfers of stock shall be made by an endorsement upon the back thereof by the holder in person or by power of attorney duly executed and filed with the secretary of the company and by the surrender of the certificate of shares. None of the stockholders own property other than the corporate stock, except Joseph Bachrach, who owns his home. DECISION. The determination of the Commissioner is approved. OPINION. LOVE: The evidence as a whole is convincing that the stockholders, who withdrew from the business the amounts charged to them, respectively, never intended to repay them and that the withdrawals were intended to be and were distributions of profits. *2132 .	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621372/	Repplier Coal Company v. Commissioner.Repplier Coal Co. v. CommissionerDocket No. 105931.United States Tax Court1942 Tax Ct. Memo LEXIS 81; 1 T.C.M. (CCH) 141; T.C.M. (RIA) 42621; November 24, 194281 1. Allowances for the exhaustion, wear and tear of depreciable property during the taxable years determined. 2. Profits from the sale and rental of supplies furnished to petitioner's employees held not includible in "gross income from the property" for percentage depletion purposes; held, further, the total wages payable, without reduction by reason of amounts charged thereto for the supplies so furnished, must be deducted in computing "net income from the property" for the purposes of the 50 per cent limitation upon percentage depletion. 3. Petitioner, having elected to take depletion upon the percentage basis, must look only to percentage depletion deductions for the recovery of the capital required to construct a tunnel after its mine had passed the development stage, and may not obtain additional deductions for the same item as so-called deferred operating expenses. R. C. Peterson, Esq., for the petitioner. R. S. Garnett, Esq., for the respondent. ARUNDELLMemorandum Findings of Fact and Opinion The Commissioner determined income tax deficiencies for the years 1935 and 1936 in the respective amounts of $8,117.99 and $3,659.26, and a deficiency in excess profits tax for the 82 year 1935 in the amount of $2,741.67. Petitioner claims an overpayment of income tax for 1936 in the amount of $1,067.91. There are three issues: (1) the amount of depreciation, if any, to which petitioner is entitled with respect to improvements on leased property; (2) whether profits from the sale and rental of supplies to its employees should increase the allowable percentage depletion deductions, either as an inclusion in "gross income from the property" or as a reduction in the cost of labor in computing "net income from the property" for the purpose of the 50 percent limitation; and (3) whether the cost of constructing a tunnel may be recovered as a deferred operating expense over the period of production and sale of the coal made available thereby, or, on the other hand, is to be returned through percentage depletion deductions. The proceeding was submitted upon a stipulation of facts with exhibits attached thereto and the introduction of petitioner's returns for the years 1930 to 1934, inclusive. Findings of Fact Petitioner, a Pennsylvania corporation, is engaged in the business of mining, producing and selling coal. Its returns for the years involved were filed with the83 Collector at Philadelphia, Pennsylvania. On August 14, 1922, petitioner acquired by assignment two coal leases. The first lease was to expire on December 31, 1932, and at the time of its acquisition by petitioner there was situated thereon the socalled Darkwater Plant. The other lease was to expire on July 31, 1934 and upon this lease petitioner constructed a plant, hereinafter known as the New Castle Plant. Construction was begun in the fall of 1925 and completed in 1926. Petitioner also constructed a railroad siding on this leasehold during 1926. The cost of the three depreciable properties on January 1, 1930, before deducting depreciation for years prior to 1930, was as follows: New Castle Plant$912,336.11Darkwater Plant53,218.39Railroad Siding12,139.91Total$977,694.41The adjusted bases for determining gain or loss of the New Castle Plant, the Darkwater Plant and the railroad siding on January 1, 1930, after deduction of all depreciation allowed or allowable, were as follows: New Castle Plant$655,195.05Darkwater Plant26,613.12Railroad Siding8,671.37Total$690,479.54 Petitioner made improvements and additions to the New Castle Plant during84 1930 and subsequent years at the following costs: $2,922.86 in 1930; $20,468.76 in 1931; $7,775.47 in 1932; $3,500.00 in 1935; and $4,902.35 in 1936. In 1933 it sold part of this plant, which part had cost it $100.00. During the years 1930, 1932 and 1933 petitioner was affiliated with other corporations with which it filed consolidated returns. Separate returns were filed for 1931 and 1934. The following table shows, for the five years from 1930 to 1934, inclusive, the total depreciation deductions claimed by petitioner on its returns with respect to the two plants and the railroad siding, the separate net income or loss of the petitioner, the net income or loss of the affiliated company reported on consolidated returns, and the consolidated net income or loss for the years of affiliation: Net IncomeDepreciationPetitioner's(Or Loss) ofConsolidatedDeductionsNet IncomeAffiliatedNet IncomeYearGlaimed(Or Loss)Company(Or Loss)1930$226,710.29($29,757.18)($3,348.54)($33,105.72)1931226,710.24(207,874.13)1932226,710.24(215,531.16)71,230.78(144,300.38)193345,616.81131,070.42(236,301.03)(105,230.61)1934168,098.08(10,028.31)85 The Commissioner did not disturb or adjust the returns for the years 1930 to 1934, inclusive, except to reduce depreciation for the year 1930 to $207,323.86. Petitioner's net loss of $29,757.18 for the year 1930 was carried over and deducted on its return for the year 1931. The useful physical life of the mining plants was 20 years at the time of their construction. On January 1, 1933 the lease upon which the Darkwater Plant was situated was extended upon the same conditions for a term at the will of petitioner. The lease, as renewed, could be terminated by petitioner at any time upon the giving of 21 days' notice. A new lease covering the other tract, upon which petitioner had constructed the New Castle Plant, was granted to petitioner on August 1, 1934. The new lease was on a month-to-month basis, terminable by either party upon 30 days' notice. There have been no notices of termination under either of the latter leases. Until the execution of the leases on January 1, 1933 and August 1, 1934, petitioner had no assurance that they would be executed. The New Castle plant was constructed by petitioner without consideration of whether the then existing lease would be renewed. The 86 original Darkwater lease contained the following provision: And it is further covenanted and agreed that at the expiration of the term hereby created, the said party of the second part [lessee] having kept and performed, all the covenants and conditions herein contained, on its part to be kept and performed, any machinery or fixtures, attached to the said colliery after the date of this Indenture of Lease, or erected on the demised premises by the said party of the second part, and by it paid for, may be valued by two appraisers, one to be chosen by the parties of the first part [lessors] and one to be chosen by the party of the second part, the two thus chosen to choose a third, and it shall be optional with the parties of the first part to take such machinery and fixtures at such valuation, and if not so taken by the said parties of the first part, then the party of the second part may remove the same within sixty days after such appraisement. The original lease on which the New Castle Plant was constructed provided that in certain cases of fire the lessor may "declare this lease forfeited and at an end with the same effect as though the term hereof had then expired by limitation, 87 except that the party of the second part [lessee] shall have no right to remove any of the improvements and fixtures belonging unto it * * until the fire has first been extinguished and all claims of the party of the first part * * * have first been paid or satisfied." The New Castle Plant was carried on the balance sheets attached to petitioner's returns for the years 1930 to 1934, inclusive, as "machinery and equipment." In the notice of deficiency respondent disallowed depreciation of $99,108.10 for the year 1935 and $31,204.25 for the year 1936 with the explanation, "Excessive deduction for depreciation disallowed, because the assets acquired in previous years have been fully depreciated by allowable deductions claimed in prior years." A reasonable allowance for exhaustion, wear and tear of the New Castle Plant and the railroad siding during the years 1930 to 1934, inclusive, was five percent per annum of their respective costs. Under petitioner's contract with the Miners' Union petitioner was obliged to furnish to its miners' dynamite and miners' supplies, and to rent them mine lamps, at fixed charges to be deducted from wages payable. Petitioner's profit on these items 88 was $10,156.25 in 1935 and $9,203.84 in 1936. On each of its returns for the years 1930 to 1934, inclusive, income from the sale of dynamite and supplies and from lamp rentals was listed as an item separate from its gross receipts from the production and sale of coal. Petitioner duly elected to deduct depletion on the percentage basis for the taxable years 1935 and 1936. Respondent excluded from income from the mining report the profit derived by petitioner on selling and renting mining supplies to its employees. At the same time in computing net income from the mining property, respondent deducted as miners' wages the full amount to which they were entitled under the terms of their contracts without deduction therefrom on account of the charges made for the supplies sold or rented to the miners nor for the profit realized by petitioner on such sales and rentals. During the year 1936 petitioner constructed a certain mine tunnel at a cost of $86,394.03, thereby making available for production 394,000 tons of coal. Of the coal so made available petitioner produced and sold 5,659 tons in the year 1936. Petitioner's mine had long since passed the development stage. The proportionate 89 part of the cost of the tunnel allocable to the coal made available by the tunnel and which was produced and sold during the year 1936 was 5695/394,000, or $1,240.19. In the notice of deficiency respondent allowed petitioner percentage depletion for the year 1936 based upon income from its mining properties, which included income derived from the coal produced as a result of the construction of the tunnel. Opinion ARUNDELL, J.: The first issue raises the question of the proper amount to be allowed in each of the years 1935 and 1936 for the exhaustion, wear and tear of the two plants and the railroad siding. The reasonable allowance permitted by statute is to be computed upon the adjusted bases of the properties at the beginning of the taxable years, that is, upon their original cost plus subsequent capital additions and minus the greater of the allowed or allowable depreciation for prior years. Respondent determined that petitioner's total capital investment had been recovered in prior years through depreciation allowed or allowable. The stipulated figures disclose, however, that the unrecovered cost as of January 1, 1930, in the amount of $690,479.54, had not been entirely recouped90 by December 31, 1934; for, while the deductions for depreciation taken on the returns for the years 1930 to 1934, inclusive, exceeded that amount, the deductions did not offset taxable income in full in each of the years, and, to the extent that they did not, the depreciation was not "allowed" within the rule of Pittsburgh Brewing Co. v. Commissioner, 107 Fed. (2d) 155, and Kennedy Laundry Co., 46 B.T.A. 70">46 B.T.A. 70. Petitioner, therefore, is not precluded on this issue by reason of having been allowed depreciation in prior years equal to its cost. As a result, respondent's determination may be sustained only by holding that the depreciation "allowable" to petitioner during the five years 1930 to 1934, inclusive, that is, the amount it was entitled to claim, was equal to the agreed unrecovered cost of $690,479.54 at the beginning of 1930. This question, however, has been resolved in petitioner's favor as to the New Castle Plant and railroad siding by our finding of fact that the allowable depreciation thereon during the five crucial years was at the rate of five per cent, based upon the useful physical life of the properties 91 of 20 years. The dispute between the parties arose from the fact that the improvements, though they had a useful life of 20 years, were situated upon leased premises, and the leases were for a shorter period than 20 years. In fact, each of the leases expired prior to the taxable years involved. Respondent concluded from this that the useful life of the improvements was limited by the life of the leases. We think, however, that the rule of depreciating improvements over the shorter period of their usefulness or the terms of the leases has no application to the present facts. The important fact here is that upon the termination of the leases petitioner was to, and did, remain the owner of the improvements. The Darkwater lease so specified, making provision for the purchase of the Darkwater Plant by the lessors if they so desired; the New Castle lease inferentially recognized the lessee's retention of title; and the Pennsylvania cases are to the effect that, even in the absence of an express provision, property of this character remains that of the lessee. Radey v. McCurdy, et al., 209 Pa. 306">209 Pa. 306, 58 Atl. 558; Robinson v. Harrison, 237 Pa. 613">237 Pa. 613, 85 Atl. 879;92 Shellar v. Shivers, et al., 171 Pa. 569">171 Pa. 569, 33 Atl. 95; McClintock & Irvine Co. v. Aetna Explosives Co., 260 Pa. 191">260 Pa. 191, 103 Atl. 622; Prudential Insurance Co. of America v. Kaplan, et al., 330 Pa. 33">330 Pa. 33, 198 Atl. 68. Respondent on brief appears to concede that this is so. In this respect the case at bar is different from the ordinary case where title to improvements erected by the lessee vests in the lessor either at the time of their construction or upon termination of the lease. Under the latter circumstance the usefulness of the improvements to the lessee is limited by the term of the lease for if it is not renewed he loses both the use of and title to the improvements. 1620 Broadway Corporation, 36 B.T.A. 149">36 B.T.A. 149. Similarly, in Bonwit Teller & Co. v. Commissioner, 53 Fed. (2d) 381, certiorari denied 284 U.S. 690">284 U.S. 690, upon which respondent relies, the depreciable asset was the leasehold itself, which, as the court pointed out, would cease to exist upon expiration of93 the term. Here, however, respondent recognizes that petitioner could have removed the improvements upon termination of the leases. In addition, since it still owned them, it could have (1) sold them to the lessors, or (2) sold them to a new lessee, or (3), as actually occurred, remained in possession under new or extended leases. A somewhat analogous case is Eimer & Amend, 2 B.T.A. 603, where the lessor, upon expiration of the lease, was either to grant a renewal or purchase the improvements, and it was held that the original lease was not the proper period over which to compute depreciation. We are not impressed by respondent's argument that this issue must be decided against petitioner for failure to prove that the improvements would not have been reduced to scrap if they had been removed upon termination of the leases. Of the possibilities open to petitioner as the owner of the improvements, it may not be assumed that the only one disadvantageous to petitioner would eventuate. We think it safe to assume as a practical business matter that if the lessors had declined to renew and decided to carry on production themselves or to lease to a new tenant, 94 some way would have been devised to prevent the tearing down of a plant suited to the particular premises with years of useful life remaining, and the consequent necessity of constructing a new plant. Taxation is a practical matter and in our opinion the probability that a useful plant would be scrapped may not be presumed in determining the reasonable allowance for depreciation of which the statute speaks. As a practical matter the New Castle Plant and railroad siding had a useful life to petitioner of 20 years from the time of construction, and we think there is no reasonable basis in the facts for holding that it would have been authorized or required to depreciate the assets in excess of five per cent per annum. With respect to the Darkwater Plant, however, we are unable to say that respondent erred in determining that no depreciation is allowable. It is stipulated that the plant had a useful life of 20 years from the time of construction, but we do not know when it was constructed. It was already on the leased premises when petitioner acquired them in 1922, and we must assume that the cost of this plant had been completely depreciated prior to the taxable years. The deductions95 allowable for the taxable years may be computed under Rule 50, giving effect to the allowable depreciation for previous years and to the amounts claimed in excess thereof to the extent they offset taxable income not only of petitioner but of its affiliated companies as well. The second issue arises from petitioner's contention that in computing "net income from the property" for the purpose of the 50 per cent limitation upon percentage depletion, respondent erred in reducing gross income from the property by the amount of the gross rather than the net cost of petitioner's labor. The point made is that petitioner's labor cost was no more than the cash actually paid to the miners plus the cost to petitioner of supplies which it sold and rented to them. Petitioner objects to respondent's characterization of the difference between the cost of the supplies and the figures at which they were charged to the employees as profits in selling merchandise," insisting that the net effect was simply to reduce the cost of labor. We think petitioner's criticism is without merit. The single paragraph of the stipulation dealing with this issue refers in three different sentences to "the profit which96 petitioner derived on selling and renting mining supplies to its employees." On its returns for the years 1930 to 1934 petitioner reported income from such sales and rentals as an item separate and distinct from coal receipts, and presumably it deducted the full wages payable in determining net income from the sale of coal. The returns for the taxable years are not in evidence, and we cannot assume in petitioner's favor that this method of reporting was changed. And, finally, at the hearing petitioner's counsel stated his contention to be "that either the profit that was made from the sale of mining supplies to the miners should be included in the income from the mining property or that the wages actually paid, which should be a deduction from the income from the property, ought only to be the net amounts * ". On brief, however, petitioner refrains, and we think properly so, from contending that these profits should be added to the gross income from the property. Such profits cannot be distinguished from gain derived through the operation of a company store or from the leasing of tenement houses to employees. Dorothy Glenn Coal Mining Co., 38 B.T.A. 1154">38 B.T.A. 1154.97 Profits of this nature are not "income from the property" as that phrase is used in section 114 (b) of the Revenue Acts. Nor do we think it is correct to say that the profits reduced petitioner's cost of labor. Petitioner was obligated to pay its employees a fixed amount. That it was able to satisfy a part of that liability by furnishing them supplies which had cost it less than the liability so discharged, does not mean that its total liability was any less or that it was not discharged in full. The situation is the same as if the miners had received their entire wages in cash and had then purchased the supplies either from petitioner or someone else. The short-cut of withholding does not alter the essential nature of the situation, which was, as reported on the returns, the payment of wages in full and the realization of a profit upon a distinct and separate transaction. On this issue respondent's determination is affirmed. The remaining issue is whether petitioner may deduct th cost of a tunnel over the period of the production and sale of coal made available by it. In 1936 petitioner produced and sold 5,659 tons of the 394,000 tons so made available, and seeks to deduct as a98 deferred operating expense a proportionate part of the cost of $86,394.03, or $1,240.19. Respondent argues that the cost was capital expenditure to be recovered only through depletion, that percentage depletion based in part upon income derived from the 5,659 tons of coal has been allowed, and that to sustain petitioner in its present claim would result in the allowance of a double deduction. In effect, petitioner's method is to capitalize the expenditure over the period of the production and sale of the coal made available by the tunnel, and to secure the return of that investment by annual deductions spread over a like period. At the same time, however, petitioner, having elected percentage depletion, will secure a recovery of the same investment by depletion computed upon the income derived from such coal. Such facts as have been stipulated leave us little doubt that the expenditure was of a capital nature, and certainly there is nothing in the stipulated facts to rebut the commissioner's determination to that effect. As such the cost is to be recovered through depletion, and this it has elected to take on the percentage of income basis. We have found no provision in the revenue99 acts or the regulations promulgated thereunder, and petitioner has cited none, that would justify the double deduction sought. Petitioner relies upon G.C.M. 13954, XIII-2 C.B.-66; but if that ruling is to be read as sanctioning what amounts to deductions for depletion of both the percentage and cost bases, we cannot agree with it. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621373/	HUSCH BROS., INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Husch Bros., Inc. v. CommissionerDocket No. 7591.United States Board of Tax Appeals6 B.T.A. 1056; 1927 BTA LEXIS 3342; April 26, 1927, Promulgated 3342 At the time of a fire petitioner had on hand certain merchandise belonging to itself and certain other merchandise as bailee or warehouseman for customers. Insurance policies taken out by petitioner covered both classes of merchandise. An amount was set aside or held as a reserve, to meet customers' claims the amount of which were unknown and undeterminable. About two and a half years later the amount so set aside was reported as income. Held, that the amount was income in the year in which received and not in the subsequent year. Maurice W. Stoffer, Esq., and Miller P. Firestone, Esq., for the petitioner. Henry Ravenel, Esq., for the respondent. TRAMMELL1056 This is a proceeding for the redetermination of a deficiency in income and profits taxes in amount of $5,237.43 for the fiscal year ended January 31, 1920. The deficiency results from the respondent including in petitioner's income an amount of $8,982.06, representing a portion of the proceeds from fire insurance policies and from salvaged merchandise paid to petitioner during its fiscal year 1920. FINDINGS OF FACT. During the taxable year under consideration, petitioner3343 was engaged in the business of operating a retail store in St. Paul, Minn. It sold ladies' ready-to-wear goods. In connection with its retail trade, petitioner stored for its customers fur garments, fur-trimmed garments and any other articles of clothing that its customers desired to store. Upon accepting apparel for storage, the petitioner issued to the customer a storage receipt which contained a provision that the petitioner would keep the goods of the customer insured against loss by fire. Most of the stored garments were deposited in the spring and withdrawn in the fall. 1057 Petitioner in the operation of its retail business, in addition to selling for cash, had certain customers to whom it sold merchandise on credit. Frequently such customers after making a purchase would leave it with petitioner for alteration or remodeling. The petitioner had certain other customers to whom it would not extend credit. These customers would make a selection of merchandise, make a partial payment thereon, and petitioner would then put the goods aside. It carried such goods in a special account and held them until the customer completed payment. This class of business3344 petitioner designated as "Will-call" or "C.O.D." business. A fire occurred in petitioner's establishment on the night of May 23, 1919. While the walls and some of the lower floors remained, the entire stock of merchandise, together with that in storage, that left for alterations, and that on which partial payments had been made was almost totally destroyed. Only a portion of it was salvaged. Petitioner's records except certain of those that were in a vault were partially destroyed. The records relating to articles in storage, articles left for alterations and those held under partial payments were destroyed, and petitioner had no means of ascertaining the amount of goods in these classes which were held by it. After the fire the only information available from petitioner's records as to any of these classes of goods was the total balance due on all the goods held under partial payments. The petitioner carried fire insurance upon its merchandise and that of others held by it. The same policies covered both classes of merchandise. The policies contained no statement as to what portion of the insurance represented insurance on merchandise of the petitioner and what portion3345 represented insurance on merchandise of customers. During petitioner's taxable year ended January 31, 1920, a settlement was made with the insurance companies by which petitioner received the full amount of the insurance policies, $102,500 and $6,657.75 from the salvaged merchandise. The amounts received from the insurance companies, the amount received from salvage, and two other small amounts were credited by petitioner to an account called "Insurance Recovered Merchandise," which it had set up on its books. For about ten weeks following the fire, petitioner was out of business. However, immediately after the fire, it established an office in a nearby building, to which some of its customers who had goods in storage, or who had left goods for remodeling, or had made partial payments on goods they had selected, came to have adjustments made. 1058 During the remainder of petitioner's taxable year and down to about May, 1921, it continued to make adjustments with customers for losses resulting from the fire. Some adjustments were made by furnishing the customers with new merchandise which was taken directly out of stock. Other adjustments were made by allowing3346 credit on the customer's account and others were made by the payment of cash. Subsequent to the closing of petitioner's taxable year, January 31, 1920, no cash adjustments were made with customers. Where payments were made in cash, the amounts were charged against the account "Insurance Recovered Merchandise" to which was also charged the balance of petitioner's merchandise account at the time of the fire, the balance due from customers on will-call or C.O.D. business at the time of the fire and the amount of invoices for goods received prior to but not entered on the books at the time of the fire. At the close of the petitioner's taxable year, January 31, 1920, the "Insurance Recovered Merchandise" account had a credit balance of $10,122.06. The officers of petitioner after conferring among themselves and with petitioner's attorney and its accountant, decided to treat the amount as a reserve for liability on account of claims that had not yet been settled and which might arise in the future. No adjustment was made in the "Insurance Recovered Merchandise" account at the end of the petitioner's taxable year, and no part of the credit balance shown therein was reported as income. 3347 During the fiscal year ended January 31, 1921, the "Insurance Recovered Merchandise" account was charged with an item of $1,140, reducing the credit balance of $8,982.06 on January 31, 1921. No part of the amount of $8,982.06 was reported as income in petitioner's return for its taxable year 1921. While some adjustments were made with customers during the year 1922 by the delivery of merchandise out of stock, no cash payments were made. Petitioner did not report any part of the $8,982.06 as income for its taxable year 1922, but by an entry under date of January 28, 1922, transferred the amount from the "Insurance Recovered Merchandise" account to an account designated "Reserve from Insurance Recovered." By an entry dated December 16, 1922, this latter account was closed and the amount of $8,982.06 was transferred to surplus. Petitioner in its return for the taxable year ended January 31, 1923, reported the amount as income. The respondent has included it in petitioner's income for the taxable year ended January 31, 1920. OPINION. TRAMMELL: The parties have presented only one question for our decision and that is whether the amount of $8,982.06 was income 1059 3348 in that year or in the fiscal year 1923 when the petitioner claims the amount was actually realized as income upon the termination of its liability as bailee or warehouseman. In other words the question is whether the amount was taxable income in the fiscal year 1920 or 1923. No other issue is presented or argued. The insurance policies taken out by petitioner, while having a clause covering the merchandise of customers in the hands of petitioner, did not show what part of the face of the policy represented insurance on petitioner's merchandise and what part represented insurance on customers' merchandise. The petitioner did not know the extent of its liability to customers for merchandise destroyed in the fire, and had no means of accurately determining such amount. After charging against the receipts from insurance policies and from salvaged merchandise and certain other minor sources, certain amounts representing as nearly as could be determined the merchandise on hand belonging to petitioner at the time of the fire, the balance due on C.O.D. and will-call merchandise held by petitioner and cash payments made to customers as a result of adjustments, the petitioner held the3349 remainder as a reserve out of which to make payments to customers as further adjustments were found necessary. The credit balance remaining on January 31, 1920, was $10,122.06. After that date, no further cash payments were made to customers but their losses were adjusted either by allowing a credit to their accounts or by furnishing them with new merchandise. The only other charge made against the credit balance of $10,122.06 was an amount of $1,140 made on February 28, 1920, and after that date the balance stood at $8,982.06. The petitioner carried the undiminished balance on its books until December 16, 1922, when it was transferred to surplus, and in its return for the year ended January 31, 1923, reported the amount as income. With respect to the customers' goods the petitioner was in the position of bailee or warehouseman, and customers were entitled to collect from the petitioner whatever amount it had received as insurance on their goods in excess of any charges it was entitled to against the customer. The amount received by the petitioner in excess of its charges, if any, was the property of the customers, which petitioner held as trustee. 3 R.C.L. 108; 3350 ; ; ; ; . Consequently, such amount, or any part of it set aside or held as a reserve from which to make payment to customers for their losses as such became known to the petitioner, is in a different class from reserve set aside out of profits to meet contingent liabilities. The liabilities here were not contingent. 1060 Such amount as was received from insurance on goods belonging to others belonged to the persons who owned the goods. The petitioner received it only in a fiduciary capacity. The fact that it was not paid out until later is not material. The difficulty here, however, is lack of evidence as to the amount of money which the petitioner actually received in such capacity. It did not make any cash disbursements after 1921. We do not know whether the charge of $1,140 made in 1921 was a cash disbursement or not, but that fact is not material here. While we do know that adjustments were made with customers after 19203351 and also after 1921, there is no evidence as to the nature thereof or the amounts, if any, finally determined to be due to customers on account of the fire loss. Any amounts due them did not belong to the petitioner but we can not find what portion, if any, of the amount of $8,982.06, the amount finally reported as income by the petitioner, was ever paid or credited to customers, to what extent the petitioner was liable to make adjustments with respect thereto, or what part of that amount represented money which should have been paid to customers on account of their losses. In view of this fact we must hold that the amount of $8,982.06 was income to the petitioner in its fiscal year ended January 31, 1920, the year in which it was received by it, and not in 1923. The reserve set up by the petitioner is not deductible. ; ; ; ; 3352 ; . This disposes of the only issue presented by the pleadings, or in the argument of counsel. Judgment will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621376/	CROSSETT TIMBER & DEVELOPMENT COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Crossett Timber & Development Co. v. CommissionerDocket Nos. 62294, 67775.United States Board of Tax Appeals29 B.T.A. 705; 1934 BTA LEXIS 1490; January 10, 1934, Promulgated 1490 1. Petitioner received from its lessee a sum in settlement of a claim that the lessee had not produced from petitioner's lands one third of the lessee's total production of gas in accordance with the operating agreement. Held, the amount so received is not "income from the property" and not subject to percentage depletion allowance. 2. Petitioner paid to its lessee one half the cost of drilling four gas wells under an option to do so in the operating agreement. Upon electing so to participate petitioner relinquished all right of ownership in the wells and was granted additional royalties. Held, the amounts so paid by petitioner represented the cost of additional royalties, the portion allocated to physical equipment is not subject to depreciation and the portion allocated to intangible costs may not be deducted. 3. Royalties received in excess of royalties on production under minimum royalty requirements are taxable income when received, even though at some future time the excess may be applied against production above minimum requirements or the petitioner may be required to repay the excess in the event the field will not produce the minimum required. 1491 Donald Browne, C.P.A., for the petitioner. Frank B. Schlosser, Esq., for the respondent. ARUNDELL706 OPINION. ARUNDELL: The respondent has determined deficiencies in income tax for the fiscal years ended November 30, 1929 and 1930, in the respective amounts of $4,040.36 and $2,230.24. Only a portion of the deficiency for each year is in controversy. All of the issues relate to sums received or paid out by petitioner in connection with gas-producing properties which it owned and which were leased to others. The proceedings were consolidated, and the facts stipulated. The first issue is whether petitioner is entitled to a depletion deduction in respect of an amount of $20,173.57 received in 1929 under the circumstances herein set forth. Petitioner in 1923 acquired lands in Louisiana theretofore owned by another corporation and on which the predecessor corporation had granted oil and gas leases in 1921. The separate identities of petitioner and its predecessor are immaterial and we will speak of them indiscriminately as petitioner or lessor; likewise the original and successor lessees will be termed, without distinction, as the lessee. 1492 In connection with the original lease of the lands in 1921 an operating agreement was entered into between the lessor and the lessee under which the lessor was entitled to certain oil royalties and a gas royalty of one cent per thousand cubic feet of gas taken and marketed from wells drilled prior to January 1, 1928, with an increase of one fourth of one cent each five-year period thereafter. In the eighth article of the operating agreement it was provided "that of all gas sold, used or furnished by" and lessee "one-third will be drawn from lands owned by" the lessor. No oil wells have been brought in on the property covered by the agreement, but gas wells have been brought in and the petitioner received in the years 1924 to 1928, inclusive, the royalties agreed upon for all gas withdrawn from wells drilled on its lands. In 1929 a dispute arose as to whether the lessee had complied with the provisions of the eighth article of the operating agreement during the years 1926, 1927, and 1928. The petitioner contended that, because of more intensive drilling by the lessee on its own lands adjacent to those of the petitioner, less than one third of the total gas marketed had been produced1493 from petitioner's properties, in violation of the terms of the operating agreement. The controversy was not carried to the courts, but was settled by the payment to the petitioner by the lessee on September 12, 1929, of $20,173.57. This amount was computed by taking one third of the total production from all wells controlled by the lessee both on its own lands and those of the petitioner and multiplying by the royalty rate due the petitioner under the agreement. From the sum thus attained, a deduction was made for royalties paid to the petitioner during the years 1926, 1927, and 1928. The respondent has included the sum of $20,173.57 in the taxable income of petitioner for the 707 taxable year 1929, but has allowed no deduction for depletion with respect to this amount. Petitioner claims it is entitled to a depletion deduction of 27 1/2 percent of the amount of $20,173.47 received in 1929. The respondent's position is that the money so received was not a royalty payment, but damages for breach of contract, and not subject to a depletion deduction. The depletion deduction permitted by the statute applies to "income from the property", section 114(b)(3), Revenue Act1494 of 1928, and may be taken in respect of both royalties and bonuses. Murphy Oil Co. v. Burnet,287 U.S. 299">287 U.S. 299. Clearly the sum here involved was not a payment of royalties. In the words of the stipulation filed, "the petitioner received in the years 1924 to 1928, inclusive, the royalties specified * * for all gas withdrawn from wells drilled on its lands." Nor, in our opinion, was it a bonus. A bonus is consideration paid by the lessee "for the right which he acquires to enter upon and use the land for the purpose of exploiting it." It is "consideration for the lease." Burnet v. Harmel,287 U.S. 103">287 U.S. 103. See Lizzie H. Glide,27 B.T.A. 1264">27 B.T.A. 1264. Here the lessee had acquired the lease and operating agreement several years before, and it is to be assumed that any bonus required had been paid. At least the payment made in 1929 was neither demanded nor received as a bonus or any other consideration for the lease. It was demanded and paid, not for the right to enter upon and drill the lands, but as a penalty for failure to do so; it was not income from the property, nor "income derived from the extraction of the oil" or gas from the1495 property (Palmer v. Bender,287 U.S. 551">287 U.S. 551), but was in the nature of damages for the lessee's breach of contract in failing to exploit the property. The taxing statute makes no provision for the deduction in such cases of allowances for depletion, and we sustain the respondent's refusal to permit a deduction. The next two issues may be considered together, having to do with petitioner's portion of the cost of drilling wells on what may be termed a 50-50 basis. The operating agreement between lessor and lessee provided that the lessee should notify the lessor where it proposed to drill, whereupon the lessor could elect to participate in the drilling. Upon election made by the lessor to participate as to any well it was to "be drilled at the joint expense" of the lessor and lessee, the lessor to "advance one-half of the cost of drilling as the work progresses." It was further provided in the same (the fifth) article of the agreement that: If the grantor gives notice of its election to participate and the well is brought in as a gas well, then, and in that event, the grantor shall ipso facto relinquish all rights of ownership in said well, but the grantee shall1496 pay to the grantor a royalty of one cent per thousand cubic feet in addition to the royalties hereinbefore specified under the same terms and conditions as herein above provided. 708 Under these provisions of the agreement petitioner elected to participate in the drilling of four wells which were brought in as gas wells. Two of them were drilled in 1929 and two in 1930. As to each of them petitioner paid its one half of the costs as follows: 19291930Cost of phsical equipment$5,095.00$7,263.35Intangible expenditures6,077.957,842.99Total11,172.9515,106.34Petitioner considered that it had a right of election under article 243 of Regulations 74, and deducted the above amounts in its 1929 and 1930 returns, which deductions were disallowed by the respondent. Petitioner now concedes that the cost of physical equipment, $5,095 for 1929 and $4,263.35 for 1930, was properly capitalized by respondent, but contends that the amounts are subject to depreciation. No depreciation has been allowed by the respondent. The proper rate of depreciation, if allowable, is stipulated. As the result of petitioner's election to participate1497 in the drilling of four wells and its payment of one half of the drilling costs, it received during 1929 and 1930 the additional royalties provided for in the operating agreement. In order for the petitioner to prevail on the question of depreciation it must meet the burden of establishing ownership of depreciable property. Frank Holton & Co.,10 B.T.A. 1317">10 B.T.A. 1317; National Electric Ticket Register Co.,17 B.T.A. 42">17 B.T.A. 42; Leggett & Platt Spring Bed Co. v. Crooks, 34 Fed.(2d) 492; Iten Biscuit Co.,25 B.T.A. 870">25 B.T.A. 870. The contract under which petitioner paid some of the drilling costs provided that as to any well in which it participated it should "ipso facto relinquish all rights of ownership in said well." This would indicate that petitioner acquired no property right in the four wells in question, and there is nothing in the record to establish any other view of the matter. True, it is stipulated that the cost of physical equipment paid by petitioner had been properly capitalized by respondent, but it does not follow that such capital costs are subject to depreciation. The respondent's view is that the cost borne by petitioner1498 represents cost of the additional royalty of one cent per thousand cubic feet of gas to which petitioner became entitled by reason of its participation. If so, its capital outlay will be recovered through depletion deductions from the additional royalties which it appears from the stipulation have been allowed by the respondent. The remaining portion of costs borne by petitioner in the drilling of the four wells has been allocated to what are for convenience termed "intangible drilling and development costs." T.D. 4333, C.B. XI-1, p. 31. Under the cited Treasury decision and under the Commissioner's regulations, intangible costs may, "at the option 709 of the taxpayer, be deducted as a development expense or charged to capital account returnable through depletion." See W. R. Ramsey,26 B.T.A. 277">26 B.T.A. 277. These provisions, in our opinion, are not applicable to one in the position of this petitioner. It was not engaged in drilling wells for itself. The lessee drilled the wells and under the contract it became the owner of them. The substance of the arrangement between petitioner and the lessee was that petitioner reimbursed the lessee for expenses1499 incurred by the latter. The consideration for petitioner's expenditures was the increased royalty it was to receive. The sums so paid, like those allocated to physical equipment, are part of the cost of royalties and subject to recoupment through deductions for depletion which, for the taxable years, have been allowed by the respondent. The final issue is whether the amount of $6,279.16, received by petitioner in 1930 as advance royalties under minimum royalty provisions of a contract, constitutes income. In 1929 petitioner entered into an agreement with the lessee of its lands, modifying the operating agreement of 1921. The 1929 agreement provided for a specified minimum production of gas and concomitant minimum royalties for the twenty-year period from 1929 to 1948. In the event of shortage of production in any year the difference between the royalty on the gas produced and the minimum royalty is to be paid to petitioner on or before January 15 of the following year, and, if this occurs and in a subsequent year there is an excess over minimum requirements, the royalty payments for shortages in prior years are to be applied to the excess. If, after adequate and reasonable1500 development, the properties will not produce the minimum requirements the lessee is to be relieved of paying advance royalties on shortages, and if at the end of the twenty-year period the properties have not produced a specified amount of gas per year - in either event - petitioner will be required to pay back to the lessee all advance royalty payments, with interest at 6 percent. In 1929 the lessee did not produce the minimum requirements and on February 7, 1930, it paid to petitioner $6,279.16 as advance royalties on the 1929 shortage. Petitioner has retained the amount so received and recorded it on its books as a liability to the lessee. The lessee has not subsequently taken sufficient gas from petitioner's properties so that it could apply any part of the $6,279.16 as royalty on gas actually produced. The respondent has added the amount of $6,279.16 to petitioner's taxable income for the year 1930, and has allowed a depletion deduction with respect thereto of 27 1/2 percent. Petitioner concedes that the $6,279.16 received in 1930 constituted "advance royalty" but contends that it should not be included in income because of its liability to repay it either through application1501 710 to subsequent production in excess of minimum requirements or in cash in the event of demonstrated inability of the field to produce to minimum. Jamison Coal & Coke Co.,24 B.T.A. 554">24 B.T.A. 554; modified, 67 Fed.(2d) 342, and Hutchinson Coal Co.,24 B.T.A. 973">24 B.T.A. 973; affd., 64 Fed.(2d) 275, cited by petitioner, do not sustain its views. In those cases the taxpayers were the lessees, and the question was whether the amount paid by the lessees, representing the difference between the minimum royalties and the royalties on coal actually mined, was deductible currently as an expense or was a capital expenditure under which the lessee acquired an equity in property. As these cases now stand, one being modified and the other affirmed by the circuit court, they hold that the entire minimum royalties paid are deductible currently. The converse of these holdings would require that sums so paid and treated as royalties by the lessee should be included in income of the lessor. Bankers Pocahontas Coal Co.,18 B.T.A. 901">18 B.T.A. 901; affd., 1502 55 Fed.(2d) 626, and 287 U.S. 308">287 U.S. 308, and Louis Werner Saw Mill Co.,26 B.T.A. 141">26 B.T.A. 141, expressly hold that minimum royalties are taxable income to the lessor. The only difference between these latter cases and the one before us is the provision here under which the petitioner may eventually be required to repay a part of the royalties received. The conditions, however, which might require repayment were conditions subsequent and did not prevent petitioner's unfettered use of the money in the year of receipt. In Brooklyn Union Gas Co.,22 B.T.A. 507">22 B.T.A. 507; affd., 62 Fed.(2d) 505, litigation arose under which the taxpayer was required by court order to impound a portion of the moneys received. On the question of the year in which such moneys represented taxable income it was held that they were income in the year when earned and not in the year when the litigation was finally terminated. The principle of that case is applicable here. The contingent liability which might at some future time require repayment of some indeterminate portion of the royalties imposed no restriction upon petitioner's use of the money currently1503 as received. See also Consolidated Asphalt Co.,1 B.T.A. 79">1 B.T.A. 79; Uvalde Co.,1 B.T.A. 932">1 B.T.A. 932. All issues are decided for the respondent. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621377/	HERB M. GRIPENTROG and SUSAN E. GRIPENTROG, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentGripentrog v. CommissionerDocket No. 3960-71.United States Tax CourtT.C. Memo 1975-334; 1975 Tax Ct. Memo LEXIS 37; 34 T.C.M. (CCH) 1455; T.C.M. (RIA) 750334; November 10, 1975, Filed Herb M. Gripentrog, pro se. Michael W. Ford, for the respondent. WILESMEMORANDUM FINDINGS OF FACT AND OPINION WILES, Judge: Respondent determined deficiencies in petitioners' income taxes of $2,385.62 for 1964, $1,424.21 for 1967, and $2,226.16 for 1968. Respondent also determined negligence penalties of $71.21 for 1967 and $111.31 for 1968 under section 6653(a). 1 Petitioners accepted the determination of respondent on a number of questions, and so we decide only those issues not settled: (1) Whether Rib Mountain Cheese Corporation was a duly qualified Subchapter S corporation in 1967 so that corporate losses can pass through to Herb M. Gripentrog (hereinafter petitioner), a shareholder of that corporation; (2) whether petitioner is entitled to a net operating loss carryback from 1967 to 1964; (3) whether Rib Mountain was a duly qualified Subchapter S corporation in 196839 so that corporate losses can pass through to petitioner; (4) whether petitioner is entitled to a loss of $1,000 in 1967 and 1968 for worthless stock in Dairyland Cold Storage, Inc.; (5) whether petitioner received $5,000 and $14,080.22 in salary in 1967 and 1968, respectively, from Rib Mountain Cheese Corporation; (6) whether respondent can assert a deficiency for 1968 although a revenue agent may have informally stated to petitioner, after partially completing the audit of his return, that he would recommend no changes in the tax; (7) whether petitioner is liable for negligence penalties determined under section 6653(a) for 1967 and 1968. GENERAL FINDINGS OF FACT Some facts were stipulated and are found accordingly. Petitioner and his wife, Susan E. Gripentrog, resided in Wausau, Wisconsin, when they filed their joint 1964, 1967, and 1968 income tax returns with the District Director of Internal Revenue, Milwaukee, Wisconsin, and when they filed their petition in this case. Issues 1-3. Corporate Election of Subchapter S StatusFINDINGS OF FACT During the years in question, 40 petitioner was president and shareholder of Rib Mountain Cheese Corporation (hereinafter Rib Mountain), a Wisconsin corporation which stores cheese. Rib Mountain incurred a net operating loss of $24,402.82 during 1967. Petitioner claimed this loss on his 1967 individual income tax return, but the loss more than offset his other income. He therefore executed, in February of 1968, an appropriate United States Treasury Department form, "Application For Tentative Carryback Adjustment," to carry back the excess net operating loss from his 1967 return to his 1964 return. In March of 1968, the District Director of Internal Revenue, Milwaukee, Wisconsin, notified petitioner that the excess 1967 loss would be applied to his 1964 liability and that he was entitled to a refund, pending audit of the proper returns. In 1968, Rib Mountain sustained a net operating loss of $9,146.40. Petitioner claimed this amount on his 1968 individual return, but it did not completely offset his other income and so he did not apply for a carryback adjustment. The Internal Revenue Service Center, Kansas City, Missouri, has custody and control of all copies of United States Treasury Department Form 2553, "Election41 By Small Business Corporation As to taxable status under subchapter S of the Internal Revenue Code" (hereinafter Form 2553), filed by corporations located within the jurisdiction of the District Director of Internal Revenue, Milwaukee, Wisconsin, such as Rib Mountain. The Director of the Internal Revenue Service Center, Kansas City, Missouri, searched his records but has found no Form 2553 for Rib Mountain. James L. Gassner (hereinafter Gassner) began active practice as a certified public accountant in July of 1967 in Wausau, Wisconsin. He had been notified in February of that year that he had passed the examination which allowed his certification as a public accountant. Petitioner hired Gassner to do some work for him starting in December of 1967. Shortly after Gassner began work, still in December of 1967, petitioner requested and received from him four blank copies of Form 2553. Together Gassner and petitioner prepared a rough draft of Form 2553 at Gassner's office but did not complete it since they did not have answers to all questions asked. The evidence indicates that petitioner took the rough draft of Form 2553, along with the blank copies that he had received, to his home, 42 answered the remaining questions, and typed an original and two carbons, but dated them almost a year earlier to January 2, 1967. Even though petitioner backdated the form and obviously wanted Rib Mountain's losses to pass through to him, he did not file Form 2553 since the filing date for 1967 had long since passed when he and Gassner prepared the rough draft. Petitioner saved at least one of the carbons he prepared. There was no preparation of Form 2553 for Rib Mountain for 1967 and 1968 except that which occurred in late 1967 and early 1968 after petitioner had conferred with Gassner. OPINION The first issue is whether Rib Mountain was a duly qualified Subchapter S corporation in 1967 so that petitioner, a shareholder of that corporation, can claim corporate losses on his individual tax return. The second issue, which will be decided by the resolution of the first, is whether petitioner is entitled to a net operating loss carryback from 1967 to 1964. One purpose of the Subchapter S provisions is to permit shareholders of corporations which are sustaining losses to offset those corporate losses against their individual income from other sources. S. Rept. No. 1983, 85th Cong. 43 , 2d Sess. (1958), 3 C.B. 922">1958-3 C.B. 922, 1009. Any loss greater than the other sources of income can be carried back to the individual shareholder's prior taxable years. Secs. 1374 and 172. Rib Mountain sustained a loss in 1967 and petitioner took advantage of the Subchapter S provisions by deducting this loss on his 1967 individual return. Since the loss more than offset his other sources of income, he carried back the excess to 1964. For petitioner to take advantage of the Subchapter S provisions, it was necessary that Rib Mountain properly elect Subchapter S status by filing Form 2553. Sec. 1372 and sec. 1.1372-2(a), Income Tax Regs. Respondent contends that Rib Mountain did not file this form and petitioner, of course, contends that it did. The Internal Revenue Service Center, Kansas City, Missouri, has custody and control of all copies of Form 2553 filed by corporations located within the jurisdiction of the District Director of Internal Revenue, Milwaukee, Wisconsin, such as Rib Mountain. The director of that service center has searched his records but has found no Form 2553 for Rib Mountain. Petitioner's case is not hopeless merely because respondent has not located44 a copy of Form 2553 for Rib Mountain in his files. See Mitchell Offset Plate Service, Inc.,53 T.C. 235">53 T.C. 235 (1969), in which this Court found, after reviewing the testimony of an attorney, accountant, and the sole shareholder, that Form 2553 had been filed although respondent could not locate it. The question before us is whether petitioner can prove, as did petitioner in Mitchell Offset, that there was a filing. Petitioner submits a carbon copy of Form 2553, dated January 2, 1967, as evidence of the original he, as president of Rib Mountain, allegedly filed on that date with respondent, charging that respondent has lost or mislaid that original. He states that he received four blank copies of the form from his accountant, James L. Gassner, that he and Gassner partially prepared a rough draft of that form in Gassner's office in Wausau, Wisconsin, in December of 1966, and that he then completed an original and two carbon copies in his home and mailed the original to respondent on January 2, 1967. Petitioner's statements concerning the preparation of Form 2553 are true, except in two respects, which are fatal to his case: one, the events described did not occur in45 late 1966 and early 1967 but rather a year later, in late 1967 and early 1968; two, petitioner did not file Form 2553. Unfortunately for petitioner, Gassner did not begin active practice as an accountant until July 1967 in his office in Wausau. In light of this, petitioner's allegation that he conferred with Gassner in Gassner's office in December of 1966 is simply not true. Gassner remembers the conference, but it occurred in December of 1967, not December of 1966. Petitioner has misstated the time of this conference with Gassner; he backdated the original and two carbon copies he prepared by an entire year; finally, he did not file Form 2553 although he prepared an original and two carbons. It is obvious why petitioner did all this. He misstated the time of his conference with Gassner and backdated the original and carbons because section 1372(c)(1) and section 1.1372-2(b), Income Tax Regs., required that election of Subchapter S status for any taxable year must occur during the first month of such taxable year or during the month preceding it. Petitioner undoubtedly wanted the losses that Rib Mountain sustained to pass through to him, but when he conferred with Gassner in December46 of 1967 the time for filing Form 2553 for 1967 had long passed. Petitioner backdated the form to a proper date, 2 January 2, 1967. Obviously he did not file Form 2553 since, as we have said, the time for filing had long passed. Rather, he saved one of the carbons and now presents it to this Court as proof of proper filing. This Court is unwilling to accept a backdated carbon (of a form which was never filed) as proof of proper filing. Petitioner at no time contends that there was any preparation of Form 2553 except that which he contends occurred in late 1966 and early 1967 and which actually occurred in late 1967 and early 1968 (after the filing time for 1967 had passed). Accordingly, we hold that petitioner has failed to carry his burden of proving that there was a filing of Form 2553 for Rib Mountain for 1967. Since petitioner has failed his burden, we hold further that Rib Mountain has not properly elected Subchapter S status. Thus47 petitioner may not deduct Rib Mountain's corporate losses on his 1967 individual return or carry back excess losses to 1964. The third issue is whether petitioner may deduct Rib Mountain's 1968 corporate losses on his 1968 individual return. Rib Mountain need not elect Subchapter S status for each taxable year. Had petitioner, as president of Rib Mountain, timely filed Form 2553 in 1967 it would have been effective for 1968. Petitioner at no time contends that he filed a separate election for 1968. Thus, if any election is to be valid for 1968, it must be the one petitioner alleges he filed in 1967. Since we have held that petitioner has failed to carry his burden of proving that Form 2553 was filed for Rib Mountain for 1967, the same holding is required for 1968. We therefore hold that Rib Mountain has not properly elected Subchapter S status for 1968; thus Rib Mountain's 1968 corporate losses may not pass through to offset petitioner's 1968 individual income. 348 Issue 4. Deduction for Worthless StockFINDINGS OF FACT Petitioner deducted $1,000 in both 1967 and 1968 for worthless stock in Dairyland Cold Storage, Inc. (hereinafter Dairyland), a corporation which, like Rib Mountain, stored cheese. Petitioner admitted during audit of his returns and reaffirmed at trial that his stock in Dairyland became worthless in 1959 or 1960 but that he did not take a loss then because he did not need one. Petitioner prepared financial statements for submission to the State of Wisconsin in September of 1962 and 1963, which included schedules listing petitioner's assets; neither included Dairyland stock as an asset. Dairyland's own tax returns indicate no business transactions from 1962 through 1968. Petitioner's Dairyland stock became worthless no later than 1959 or 1960. OPINION The fourth issue is whether petitioner is entitled to a loss deduction in 1967 and 1968 for worthless stock in Dairyland. During audit of petitioner's tax returns, he admitted that his stock in Dairyland became worthless in 1959 or 1960 but that he did not take a loss then because he did not need one. He reaffirmed this admission at trial. In addition, petitioner prepared49 financial statements in 1962 and 1963 for the State of Wisconsin but did not list Dairyland stock as an asset. This is another indication that petitioner recognized the worthlessness of the stock in the late 1950's or early 1960's. Finally, Dairyland's own tax returns indicate no business transactions from 1962 through 1968. Accordingly, we find that petitioner's Dairyland stock became worthless no later than 1959 or 1960. The question is whether any loss for this worthless stock may be taken in 1967 and 1968. In 1959 and 1960, section 165(g) provided that if a security became worthless during the taxable year, the loss was to be treated as the loss from the sale or exchange of a capital asset. Section 1.165-5(c), Income Tax Regs., provided that the amount allowed as a deduction was subject to the limitations on capital losses described in section 1.165-1(c)(3), Income Tax Regs. This regulation, in turn, provided that a loss would be allowed only to the extent allowed in sections 1211 and 1212. Section 1212 provided that if a taxpayer had a net capital loss for any year, the amount of loss would be a shortterm capital loss in each of the five succeeding taxable years. Since the stock50 became worthless no later than 1960 and since section 1212 imposed a five-year limitation on loss carryovers, we accordingly hold that petitioner may not deduct $1,000 in 1967 and 1968 for his worthless stock. Issue 5. Petitioner's Salary from Rib MountainFINDINGS OF FACT Petitioner did not report any salary from Rib Mountain on his 1967 individual return, although records of Rib Mountain, prepared by petitioner, indicate that he received $5,000 in salary in that year. Petitioner surrendered no stock in 1967 to otherwise account for the $5,000 he received, nor was Rib Mountain's capital stock account reduced in 1967 to indicate a return of capital. Petitioner received $5,000 in salary in 1967 from Rib Mountain. Petitioner reported $12,458.84 in 1968 as salary from Rib Mountain. After a study of Rib Mountain's records, respondent determined that he actually received an additional $1,621.38 in salary. Rib Mountain's capital stock account did not change in 1968. Furthermore, at no time in 1968 did petitioner surrender any of his stock in Rib Mountain. Petitioner received $14,080.22 in salary in 1968 from Rib Mountain. OPINION The fifth issue is whether petitioner received51 $5,000 in salary from Rib Mountain in 1967 and $14,080.22 in 1968. He reported no salary from Rib Mountain in 1967, although records of Rib Mountain which he prepared indicate he received $5,000 in salary. Petitioner surrendered no stock in 1967 to otherwise account for the $5,000 received, nor was Rib Mountain's capital stock account reduced in 1967 to indicate a return of capital to petitioner. We find petitioner received $5,000 in salary in 1967 and accordingly hold that he must include this $5,000 in income for 1967. Petitioner reported $12,458.84 in 1968 as salary from Rib Mountain. After a study of Rib Mountain's records, respondent determined that petitioner actually received an additional $1,621.38 in salary, for a total of $14,080.22. Petitioner now contends that he received no salary in 1968, but rather that the full $14,080.22 was a return of capital. Rib Mountain's capital stock account remained constant throughout 1968; furthermore, petitioner did not surrender any stock during that year. While petitioner contends that the $14,080.22 was a return of capital, he has introduced no evidence to prove this. We hold that he has failed to meet his burden of proof. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933);52 Rule 142(e), Tex Court Rules of Practice and Procedure. We find that petitioner received $14,080.22 in salary from Rib Mountain in 1968 and accordingly hold that he must include this amount in income in 1968. Issue 6. Binding of Respondent by his Agent's Informal StatementsFINDINGS OF FACT The Internal Revenue Service began an audit in 1969 of petitioner's 1968 individual return. William A. Lassow, a tax auditor in the Office Audit Section, was first assigned to the case. The case was later transferred to Kenneth L. Fischer (hereinafter Fischer), a revenue agent, who contacted petitioner and requested a meeting with him at Internal Revenue Service offices. Such a meeting occurred in mid-February 1970; it was the only meeting between Fischer and petitioner. Fischer told petitioner that it appeared a "no change report could be in order." A "no change report" is a recommendation by a revenue agent that no audit changes will be made; he stamps his work papers, indicating "No Change in Tax Liability" and then initials those papers. The agent's recommendation of "no change" is reviewed by his supervisor and the Review Section of the Internal Revenue Service. If the agent's recommendation53 is accepted, the Review Section indicates on the file that a "no change letter" is to be sent to the taxpayer. The District Director sends this letter, on Internal Revenue stationery, to the taxpayer, indicating that no change is required in the tax reported and that the return is accepted as filed. During the meeting at which Fischer stated he thought a no change report could be in order, he may have also told petitioner that he would "recommend" that no changes be made. He did not provide petitioner with a written copy of a "no change report," since the audit of petitioner's 1968 return was not completed, nor did he give him a "no change letter," since agents such as Fischer are not authorized to issue "no change letters." Fischer left Wausau for reassignment in California in late February. After his meeting with petitioner but before he left for California, he prepared a handwritten memorandum informing his supervisor and the succeeding revenue agent as to the status of his audit of petitioner's 1968 return. The memorandum recommended no changes be made in the return for 1968, subject to a review of the petitioner's 1967 return, as actions that petitioner took in 1967 could have54 affected the 1968 return and the amount of tax owing. Fischer did not give petitioner a copy of this memorandum. It contains only Fischer's initials; no signature appears at all. Revenue Agent Thomas Spaay (hereinafter Spaay) succeeded Fischer in March of 1970 in auditing petitioner's 1968 return. The case file contained the handwritten memorandum from Fischer. During his examination, Spaay requested that petitioner produce his 1967 return since it might affect the 1968 tax. Petitioner objected, stating that Fischer had recommended "no change" for 1968. Spaay then explained that actions taken in 1967 could affect the 1968 return. After reviewing petitioner's 1967 return, Spaay concluded that actions taken by petitioner in 1967 had, indeed, affected 1968. When Spaay told petitioner of his conclusion and requested further documents, petitioner kept insisting that Fischer had recommended "no change." Spaay then gave petitioner a copy of Fischer's memorandum since it showed that Fischer's determination of "no change" was tentative and that the 1967 return had to be reviewed before a "no change report" could be recommended. Petitioner thus only received a handwritten, interoffice memorandum,55 tentatively suggesting "no change" subject to completion of audit. Petitioner never received a "no change report" or "no change letter" from Internal Revenue Service representatives for his 1967 or 1968 tax years. Spaay continued his audit, which eventually led to the deficiencies determined in this case. OPINION The sixth issue is whether respondent can assert a deficiency for 1968 because of a revenue agent's informal statements. Petitioner contends that Fischer, a revenue agent, gave him a "no change report" indicating no changes in the tax for 1968, that Fischer and petitioner discussed this report, and that respondent cannot assert a deficiency for 1968 because of the discussion and the report. Respondent contends that Fischer at most told petitioner that he would "recommend" no changes for 1968. Respondent further contends that Fischer did not give petitioner a "no change report" or any other document and that the only document Fischer ever prepared was an interoffice memorandum to his supervisor and the succeeding agent which indicated no changes for 1968, subject to a review of petitioner's 1967 return. He allegedly prepared this interoffice memorandum because he56 was being transferred to California. Respondent finally contends that Spaay, Fischer's successor, merely gave petitioner a copy of Fischer's interoffice memorandum to show him that Fischer considered 1968 subject to a review of petitioner's 1967 return. We accept respondent's contentions and reject petitioner's. Thus it is within the framework of the facts presented by respondent, which we have found to be true, that we must decide whether there is any basis for petitioner's argument that respondent cannot assert a deficiency for 1968. Petitioner argues that respondent is bound by his agent's statements and actions. Spaay certainly never told petitioner anything which would bind respondent. Throughout his discussions with petitioner he made it clear that actions taken in 1967 could affect the 1968 tax. Indeed, when he gave petitioner a copy of Fischer's interoffice memorandum, it was specifically to show him that Fischer also considered the 1968 tax subject to a review of petitioner's 1967 return. Turning to Fischer, he gave petitioner no documents at all and so we are left only with his statements as the basis for binding respondent. Admittedly, he may have told petitioner that57 he would recommend no changes for 1968. But see Homer A. Martin, Jr.,56 T.C. 1294">56 T.C. 1294 (1971), which effectively disposes of Fischer's statement as a basis for binding respondent. There taxpayers argued that certain inventory losses were deductible since a conferee revenue agent had allegedly allowed the deduction; petitioners were not informed of respondent's contrary conclusion until several months later. This Court rejected petitioners' argument as follows at page 1300: An argument to this effect was recently dealt with in Sampson v. Commissioner,444 F. 2d 530 (C.A. 6, 1971), affirming a Memorandum Opinion of this Court, where the taxpayer claimed medical expense and charitable deductions, as follows (p. 531): After disallowance of the deductions, the taxpayer husband met with a representative of the Appellate Division of the Internal Revenue Service in an attempt to settle his disputed tax liability. At this meeting an agreement was reached allowing all claimed deductions and taxpayer left the meeting with the understanding that a final settlement had been reached. However, the recommendations of the conferee of the Internal Revenue Service58 were rejected by his superiors and there were no further settlement negotiations. Unfortunately, from the taxpayer's standpoint, an informal agreement such as was reached in this case is not binding and has no legal effect. Botany Worsted Mills v. United States,278 U.S. 282">278 U.S. 282 (1929); Cleveland Trust Company v. United States,421 F. 2d 475 (6th Cir. 1970); Country Gas Service v. United States,405 F. 2d 147 (1st Cir. 1969). We must follow the same rule here. In both Martin and Sampson, the taxpayers may have genuinely felt an agreement was reached. But in this case there was never more than a recommendation. A recommendation implies that a higher authority must approve a subordinate's findings. If a recommendation must first be approved, then logically no agreement has yet been reached. If taxpayers cannot prevail when they thought there was an agreement, surely they cannot prevail where there was no agreement, but at most a recommendation. See also Estate of Ella T. Meyer,58 T.C. 69">58 T.C. 69, 70 (1972), which states that section 7121 "sets forth the exclusive procedure under which a final closing agreement59 as to the tax liability of any person can be executed." Section 301.7121-1(d), Proced. & Admin. Regs., provided that closing agreements "shall be executed on forms prescribed by the Internal Revenue Service." Such an agreement must be signed by the taxpayer and approved by the Secretary or his delegate. 26 C.F.R. sec. 601.202. In this case, of course, the only document is Fischer's interoffice memorandum. Petitioner certainly did not sign it. Thus section 7121, which sets forth the exclusive remedy for executing a final closing agreement as to tax liability, is not applicable. Petitioner represented himself and the basis of his theory that respondent may not assert a deficiency for 1968 is not altogether clear. Up to this point we have discussed his theory as though it were based upon contract law. However, petitioner in his petition and upon brief also uses the word "estoppel." Even if the basis of his theory that respondent is bound is one of estoppel, our answer is the same. See James v. Cole, 64 T.C. - (Sept. 25, 1975). We accordingly hold that respondent may assert a deficiency for 1968 though Fischer may have told petitioner that he would60 "recommend" no changes in tax for 1968. Issue 7. Negligence PenaltiesFINDINGS OF FACT Respondent imposed a negligence penalty for 1967 because petitioner did not report the $5,000 he had received in salary from Rib Mountain. Petitioner himself prepared the records indicating he had received $5,000 in salary. Petitioner's failure to report the $5,000 salary in 1967 was due to negligence or intentional disregard of rules and regulations. Respondent, in his notice of deficiency, determined that petitioner in 1968 received $1,620.00 in income from West Street Cold Storage, Inc., $1,124.67 from the sale of jewelry, and that petitioner deducted $1,170.06 for school tuition for his daughter. These three amounts are the basis for the negligence penalty for 1968. Petitioner conceded in his petition that these adjustments were correct. Petitioner's actions were due to negligence or intentional disregard of rules and regulations for 1968. OPINION The seventh issue concerns imposition of negligence penalties for 1967 and 1968. Respondent imposed a negligence penalty for 1967 under section 6653(a) because petitioner did not report the $5,000 he received in salary from Rib Mountain. *61 Petitioner himself prepared the records which indicate he received $5,000 in salary. The burden of proof is on petitioner to show respondent's determination incorrect. LeRoy Jewelry Co.,36 T.C. 443">36 T.C. 443, 445 (1961). He has not done so. We accordingly find that the failure to report the $5,000 salary in 1967 was due to negligence or intentional disregard of rules and regulations. Thus the imposition of the penalty under section 6653(a) for 1967 was correct. The negligence penalty for 1968 was imposed because petitioner did not report $1,620 he received in salary from West Street Cold Storage, Inc., or $1,124.67 he received from the sale of jewelry. In addition, the negligence penalty was imposed because petitioner deducted $1,170.06 for school tuition for his daughter. The petitioner has introduced no evidence contradicting the negligence determination for 1968. We accordingly find that there was negligence or intentional disregard of rules and regulations for 1968. Thus the imposition of the penalty under section 6653(a) for 1968 was correct. Decision will be entered for the respondent.Footnotes1. Statutory references are to the Internal Revenue Code of 1954, unless otherwise indicated.↩2. There is a question whether January 2, 1967, was, in fact, a proper date since Rib Mountain changed its accounting period in 1967. However, for the purpose of this discussion we will assume that January 2, 1967, was proper. See note 3.↩3. Since we have held that Rib Mountain did not properly elect Subchapter S status for 1967 or 1968, we need not reach two other issues. In one, the parties assumed the election had been made; the question was whether it was timely since Rib Mountain had changed its accounting period in 1967. See note 2. The other issue involved the amount of passive income that Rib Mountain had in 1967 and whether it would be sufficient to terminate a proper Subchapter S election. Section 1372↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621378/	MILDRED KIENBUSCH AND CITY BANK FARMERS TRUST COMPANY, AS EXECUTORS OF THE LAST WILL AND TESTAMENT AND CODICII THERETO, OF MABEL L. PRESSINGER, DECEASED, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Kienbusch v. CommissionerDocket No. 80550.United States Board of Tax Appeals34 B.T.A. 1248; 1936 BTA LEXIS 581; October 28, 1936, Promulgated 581 On January 30, 1928, petitioners decedent conveyed to a trustee by an irrevocable trust, a sum of money to be invested and reinvested and the income therefrom after the payment of all necessary expenses of the trust to be paid two-thirds to the grantor during the term of her natural life and one-third to the grantor's daughter, the trust to be terminated at the date of the death of the grantor and the principal of the trust to be paid over to the daughter if she be then living, free from any trust. The grantor of the trust died August 3, 1933, and the daughter survived her. Held, that the amendment to section 302(c), Revenue Act of 1926, made by section 803(a), Revenue Act of 1932, is not applicable, because the trust was executed prior to the effective date of the Revenue Act of 1932 and was irrevocable; held, further, that no part of the trust corpus is includable in decedent's gross estate under section 302(c), Revenue Act of 1926, as being intended to take effect in possession or enjoyment at or after decedent's death. Roswell O. Fish, Esq., for the petitioner. Frank T. Horner, Esq., for the respondent. BLACK 1248 OPINION. 582 BLACK: The respondent has determined a deficiency in estate tax against the estate of Mabel L. Pressinger, who died on August 3, 1933. Petitioners, who are the executors of decedent's last will and testament, assign one error, which is stated in their petition as follows: In determining the taxable net estate of the decedent for tax purposes, the Commissioner erroneously included two-thirds of the corpus of a $50,000 irrevocable trust fund set up by the decedent on January 30, 1928, which said two-thirds interest amounts to the sum of $33,333.33, by reason of the fact that in accordance with the terms of the trust instrument setting up said fund, the decedent retained a life income from two-thirds of the principal thereof, which 1249 the Commissioner asserts thereby makes two-thirds of the principal of said trust fund taxable under the provisions of section 302(c) of the Revenue Act of 1926 as amended. This proceeding has been submitted on the pleadings and a brief stipulation of facts, to which is attached a copy of the trust deed of January 30, 1928. These are a part of the record and no separate findings of fact are necessary. A brief statement of the facts will583 suffice for the purpose of a discussion of the one issue which we are called upon to decide. The decedent on January 30, 1928, as grantor, entered into an agreement with John D. Beals, one of her attorneys, as trustee, whereunder she paid, assigned, transferred, and set over unto the trustee the sum of $50,000 to invest and reinvest and to receive the income therefrom, and after paying all expenses in caring for said trust, to pay twothirds of the net income thereof to the said grantor during the term of her natural life, and to pay the remaining one-third of the income thereof to Mildred Kienbusch, the daughter of the grantor, for and during the natural life of the grantor. If the said Mildred Kienbusch died during the lifetime of the grantor, then the entire net income was thereafter to be paid to the grantor during her lifetime. Upon the death of the grantor, the trustee was to pay, transfer, and set over the principal of the trust outright and free from any trust to the daughter, Mildred Kienbusch, if she should be then living, and if she should not be living at the time of the death of the grantor, then the principal of the trust was to be distributed as the daughter by584 her last will and testament should appoint, any part thereof not so appointed to be distributed among the descendants of the daughter, then living, per stirpes and not per capita, or, failing such descendants, then as if the daughter had died the owner thereof and intestate, in accordance with the then laws of the State of New York. The deed of trust was by its terms irrevocable, the grantor reserving to herself no power whatsoever with respect to the revocation, alteration, modification, or change of the provisions of the trust instrument, and she retained no reversionary rights whatsoever therein as to the corpus. The trust was not executed in contemplation of death or to take effect in possession or enjoyment at or after decedent's death. Mildred Kienbusch survived the grantor and is one of the petitioners herein. The trustee, John D. Beals, died on August 11, 1928, and Roswell O. Fish was appointed as substitute trustee and was duly acting as such at the time of decedent's death on August 3, 1933. Respondent in his brief states the issue thus: Where the decedent, subsequent to the effective date of the Revenue Act of 1916, transferred property in trust to pay585 two-thirds of the income to herself for life, and the remaining one-third to her daughter for the trustor's life, with 1250 remainders over, is the value of two-thirds of the corpus of the trust subject to be included in the value of the decedent's gross estate, for the purpose of the tax, pursuant to the provisions of section 302(c) of the Revenue Act of 1926, as a transfer intended to take effect in possession or enjoyment at or after the decedent's death? Respondent in his brief does not contend that section 302(c) of the Revenue Act of 1926, as amended by section 803(a) of the Revenue Act of 1932, is applicable. As has been stated, the trust deed was executed January 30, 1928, and was by its terms irrevocable. The Revenue Act of 1932, which contains section 803(a) amending section 302(c) of the Revenue Act of 1926, became effective June 6, 1932. Decedent died August 3, 1933. Therefore it will be seen that the Revenue Act of 1932 was in effect at the time of decedent's death. However, Treasury Decision 4314, C.B. X-1, p. 450, was promulgated May 22, 1931. It reads in part as follows: Section 302(c) of the Revenue Act of 1926 was amended by a joint resolution (Pub. 586 131), approved 10:30 p.m., Washington, D.C., time, March 3, 1931, to read as follows (the portion added by the amendment is in italic): (c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, including a transfer under which the transferor has retained for his life or any period not ending before his death (1) the possession or enjoyment of, or the income from, the property or (2) the right to designate the persons who shall possess or enjoy the property or the income therefrom; except in case of a bona fide sale for an adequate and full consideration in money or money's worth. In view of the decisions of the Supreme Court of the United States in Nichols v. Coolidge (274 U.S., 531 (T.D. 4072, C.B. VI-2, 351)), May v. Heiner (281 U.S. 238">281 U.S. 238 (Ct. D. 186, C.B. IX-1, 382)), Coolidge v. Long (282 U.S., 582), Burnet v. Northern Trust Co. (51 S.Ct., 342), 587 Edgar M. Morsman, jr., v. Burnet (51 S.Ct., 343) and Cyrus H. McCormick v. Burnet (51 St.Ct., 343), the portion added by the amendment to section 302(c) of the Revenue Act of 1926, as set forth above in italic, will, notwithstanding the provisions of section 302(h) of that Act, be applied Prospectively only, i.e., to such transfers coming within the amendment as were made after 10:30 p.m., Washington, D.C., time, March 3, 1931. Section 302(c) of the Revenue Act of 1926 was further amended by section 803(a) of the Revenue Act of 1932. The amendment carried in the 1932 Act preserved the essential features of the amendment of March 3, 1931, referred to in the above Treasury decision. Of course if the above quoted Treasury decision is an incorrect interpretation of the law, it should not be followed by the Board and the courts. However, we think it is a correct interpretation of the law. We do not think that section 302(c) of the Revenue Act of 1926, as amended by section 803(a) of the Revenue Act of 1932, should be applied to irrevocable trusts created prior to the effective date of the 1251 Revenue Act of 1932. 588 Smith v.United States, Fed.Supp. (Dist. Ct. Mass., Aug. 3, 1936); Charles H. W. Foster et al., Executors,26 B.T.A. 708">26 B.T.A. 708; petition for review dismissed, C.C.A., 1st Cir., March 20, 1933. Cf. Bingham v. United States,296 U.S. 211">296 U.S. 211; Industrial Trust Co. v. United States,296 U.S. 220">296 U.S. 220; Helvering v. City Bank Farmers Trust Co.,296 U.S. 85">296 U.S. 85; Helvering v. Helmholz,296 U.S. 93">296 U.S. 93; Nichols v. Coolidge,274 U.S. 531">274 U.S. 531. So we think respondent is correct in making no contention that the amendment to section 302(c) of the Revenue Act of 1926 contained in section 803(a) of the Revenue Act of 1932 has any effect in the present proceeding. Respondent does contend however that two-thirds of the value of the property conveyed by the trust deed of January 30, 1928, should be included as a part of decedent's gross estate under the provisions of section 302(c) of the Revenue Act of 1926, which reads in part as follows: SEC. 302. (c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise in contemplation589 of or intended to take effect in possession or enjoyment at or after his death, except in case of a bona fide sale for an adequate and full consideration in money or money's worth * . Respondent does not contend that the trust deed involved in the instant case was executed in contemplation of death. He does contend that, by reason of the fact that the grantor of the trust reserved to herself for life two-thirds of the income from the property conveyed in trust, the conveyance of the remainder interest in two-thirds of the property was intended to take effect in possession or enjoyment at or after decedent's death and therefore the value of this two-thirds of the property should be included as a part of decedent's gross estate. Respondent's counsel supports this contention by an able brief which we have carefully considered. We think however that, as to irrevocable trusts created prior to the effective dates of the amendments to section 302(c) of the Revenue Act of 1926, above referred to, the Supreme Court of the United States has settled the question adversely to the contention made by respondent. 590 May v. Heiner,281 U.S. 238">281 U.S. 238; McCormick v. Burnet,283 U.S. 784">283 U.S. 784; Reinecke v. Northern Trust Co.,278 U.S. 339">278 U.S. 339; Morsman v. Burnet,283 U.S. 783">283 U.S. 783; Helvering v. St. Louis Trust Co.,296 U.S. 39">296 U.S. 39; Becker v. St. Louis Trust Co.,296 U.S. 48">296 U.S. 48. Cf. Elizabeth B. Wallace, Executrix,27 B.T.A. 902">27 B.T.A. 902; affd., 71 Fed.(2d) 1002; certiorari denied, 293 U.S. 600">293 U.S. 600; Flora M. Bonney et al., Executrices,29 B.T.A. 45">29 B.T.A. 45; affd., 75 Fed.(2d) 1008; Robert Taft, Executor,33 B.T.A. 671">33 B.T.A. 671 (on appeal C.C.A., 6th Cir.). On the only issue presented to us for decision we hold in favor of petitioners. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621379/	EUGENE SIEGEL, EXECUTOR, ESTATE OF JACOB SIEGEL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Siegel v. CommissionerDocket Nos. 28360, 29619.United States Board of Tax Appeals20 B.T.A. 563; 1930 BTA LEXIS 2093; August 13, 1930, Promulgated 2093 On May 21, 1918, the decedent transferred his leasehold interest in certain real property to a corporation in consideration of $12,000 and certain monthly payments to be made during the rest of his life. On January 25, 1922, he assigned his rights under the contract of May 21, 1918, to his six children, and thereafter they received them. With the exception of the payment made to the decedent in January, 1922, prior to the execution of the assignment, the respondent erred in including the payments in the decedent's gross income. Fred R. Angevine, Esq., for the petitioner. Brooks Fullerton, Esq., for the respondent. MURDOCK 563 The Commissioner determined deficiencies of $9,053.24 and $6,953.40 in the income tax of the decedent, Jacob Siegel, for the calendar years 1922 and 1923, respectively. The petitioner alleges that the Commissioner erroneously included $37,139.93 in the decedent's gross income in 1922 and $36,620.55 in 1923. The cases were consolidated. FINDINGS OF FACT. The petitioner is the duly appointed and qualified executor of the estate of Jacob Siegel. He resides in Detroit, Mich.In the year 1911 the decedent acquired, 2094 purchased and had assigned to himself a leasehold interest in certain property situated in Detroit. The original lease was for a term of 99 years, terminating on December 31, 2004. Under the terms of the lease and the assignment thereof to him, the decedent was required to pay a net annual rental of $12,500. On or about July 7, 1914, the decedent entered into an agreement by which he contracted to erect a new building on this property and to sublet the premises to the S. S. 564 Kresge Corporation. The building was erected pursuant to this agreement and on July 7, 1914, the lease was executed for a term beginning on November 14, 1914, and ending on November 14, 1939. It provided for a net annual rental of $50,000 for the first 10 years of its term, and of $55,000 for each of the remaining 15 years. Rental payments were to be made in equal monthly installments in advance. The sublessee was to pay all taxes and assessments against the property, and also to keep it insured. On May 21, 1918, the decedent entered into an agreement with the Jacob Siegel Corporation by which he assigned to it his interest in the 99-year lease in consideration of a cash payment of $12,0002095 and certain monthly payments to be made to him during the rest of his life. The agreement was in part as follows: To have and to hold said premises, with the appurtenances, for the balance of the term, computed from this date, as said term is given by said recorded indenture of lease, the said party of the second part yielding and paying, any law to the contrary notwithstanding, during the period of the natural life of the party of the first part, the sum of Twenty-five hundred Dollars ($2,500.00) on the first day of each month in advance, Provided, however, that the annual total of the payments herein provided to be paid by the party of the second part shall never amount to more than the net revenue, that is, the revenue remaining after paying the ground rent, taxes, insurance, and necessary repairs. And the said party of the second part does hereby covenant well and truly to pay or cause to be paid unto the party of the first part the amount of money above specified, and does now, for itself and for its successors and assigns, personally accept and assume all the terms, covenants, and agreements contained in the said recorded indenture or lease made the first day of August, 1905, 2096 as aforesaid, and will personally comply with them and be bound by them, and will keep and perform all the covenants and agreements in said recorded indenture or lease. During the period from May 21, 1918, to February 1, 1922, the Kresge Corporation made its rental payments to the Jacob Siegel Corporation, the money was deposited to the account of the latter, and the whole net amount, even though in excess of $2,500 monthly, was paid to Jacob Siegel. During this period he received $137,108.50 from the Jacob Siegel Corporation in addition to the $12,000 cash payment. On January 25, 1922, the decedent entered into an agreement with his six children by which he relinquished and assigned to them his rights under the agreement of May 21, 1918. This instrument provided in part as follows: Now, THEREFORE, in consideration of the premises, the promises hereinafter contained, and the sum of One Dollar ($1.00) and other good and valuable considerations, the parties have agreed as follows. The said party of the first part does hereby assign and set over to the parties of the second part all his interest in and to the reservation in the assignment of May 21, 1918, of the said leasehold. 2097 565 The parties of the second part severally agree that they will fulfill and perform all of the covenants and agreements in said lease contained, which the party of the first part would have been required to fulfill and perform had this assignment not been made, and the parties of the second part do further agree to indemnify and save harmless the party of the first part from any claim, liability, debt, or demand whatsoever, arising out of the said leasehold, or any matter or thing connected therewith, or connected with the maintenance and operation of the premises therein described. In January, 1922, Jacob Siegel received a monthly payment from the Jacob Siegel Corporation in the amount of $3,095, which he reported as income in his return for that year. From and after February 1, 1922, the Kresge rentals were paid during the years 1922 and 1923 to the Jacob Siegel Corporation, and the net amounts thereof were turned over by it to Jacob Siegel's children individually in equal shares. In determining the decedent's income-tax liability for each of the years in question, the respondent included the payments so made in his gross income. OPINION. MURDOCK: The petitioner2098 contends that the payments in question constitute a return of capital and not income, and, alternatively, that in no event are the amounts taxable income to the decedent. The first contention fails for lack of evidence to support it. On any theory of the case, the facts disclose no basis by which we might determine what part, if any, of the payments in question would be a proper deduction from the decedent's gross income in either of the years 1922 and 1923. There is no contention by the petitioner that a different principle applies to the excess over $2,500 of the payment made to the decedent in January, 1922, than applies to $2,500 thereof. We therefore can not hold that the Commissioner erred in including in the decedent's gross income the payment of $3,095 for January, 1922, which was received and retained by him. The remaining question is to determine the effect of the agreement of January 25, 1922, upon the net amount of the payments made during the period from February 1, 1922, through December 31, 1923, by the S. S. Kresge Corporation to the Jacob Siegel Corporation and turned over by the latter to Jacob Siegel's children. 2099 The transfer by the decedent of his leasehold interest on May 21, 1918, was absolute and irrevocable. It effected a valid conveyance of his estate in the property to the Jacob Siegel Corporation. See . From and after that date the decedent had a right to receive $2,500 monthly so long as he lived; or in case the property produced less than that amount, the total net revenue thereof. On January 25, 1922, he made a valid 566 written assignment by which he divested himself of all of his right under the former contract and by which the right to the annuity was vested in his children. See ; ; ; . The present case presents a set of facts at least as favorable, if not more favorable, to the petitioner's contention than were present in the following cases involving this same question, all of which were decided in favor of the taxpayer. 2100 ; ; ; affirmed as to this point, ; ; ; ; . See also . We hold that the amounts paid after January 25, 1922, were not properly taxable to the decedent. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621381/	DORCAS G. REHTZ, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Rehtz v. CommissionerDocket No. 54187.United States Board of Tax Appeals26 B.T.A. 807; 1932 BTA LEXIS 1246; August 15, 1932, Promulgated 1246 An amount paid by the petitioner to a retiring partner in connection with the acquisition by the petitioner and her husband of such retiring partner's interest in a partnership, of which they were all members, held to be a capital expenditure and as such not an allowable deduction in determining taxable net income. John T. Kennedy, Esq., for the petitioner. I. Graff, Esq., for the respondent. TRAMMELL 807 This proceeding is for the redetermination of a deficiency in income tax of $1,727.90 for 1928. Errors assigned by the petitioner are as follows: I. The Commissioner erred in finding that the deduction of $11,875.00 taken by taxpayer was not a loss paid out of gross profits of the business in which this taxpayer was engaged. II. The Commissioner erred in holding that this taxpayer was not under legal obligation in making the payment of the $11,875.00 in question. FINDINGS OF FACT. Prior to June 18, 1926, Henry Rehtz, his wife, the petitioner, Christine Plusch, and Dora Harvier were members of a partnership engaged in the business of selling gowns and wraps for women in New York City. The business was conducted under the1247 firm name of D. Maxon and Company, and each of the partners had a one-fourth interest in the capital and profits of the firm. On June 18, 1926, by written agreement the petitioner and her husband, therein designated as parties of the first part, acquired the interests in the partnership of Christine Plusch, designated as party of the second part, and Dora Harvier, designated as party of the third part. With respect to the consideration paid for such interests, the agreement provided as follows: The party of the second part [Christine Plusch] does hereby acknowledge receipt of a deed duly made and executed by Henry Rehtz and Dorcas G. Rehtz, his wife, transferring and conveying unto her lots Nos. 3 to 11 inclusive, and Nos. 13 to 48 inclusive in Block 12, according to a plat of Lauderdale, as recorded in Transcript Plat Book No. 1, page 20, of the Public Records of Broward County, Florida, in full payment and satisfaction of her interest in the said copartnership, and the party of the second part grants to the parties of the first part, or either of them, the option to buy the said real property for Thirty thousand dollars ($30,000.) at any time within two years of the date1248 of this agreement. 808 The parties of the first part do hereby agree to pay the party of the third part, [Dora Harvier] in full payment and satisfaction of her interest in the said copartnership, the sum of Thirty Thousand ($30,000) Dollars, as follows: One thousand ($1,000) Dollars on the signing of this agreement, receipt whereof is hereby acknowledged, and the balance thereof in instalments of Five Thousand ($5,000) Dollars or more, (at the option of the parties of the first part) per annum, until the full sum of Thirty Thousand ($30,000) Dollars has been paid. The unpaid balance shall bear interest at the rate of six (6%) per cent. per annum, payable annually. At the time the foregoing agreement was entered into the petitioner was of the opinion that the lots conveyed to Christine Plusch by that agreement were worth the full amount of $30,000. After the acquisition of the interests of Christine Plusch and Dora Harvier as set forth above the petitioner and her husband continued to conduct the business as partners until November 17, 1927, when he died. The petitioner acquired by inheritance his interest in the partnership and since then has conducted the business1249 as a sole proprietorship. Upon returning from Florida in the early part of 1928, Christine Plusch informed the petitioner that the lots which had been conveyed to her in 1926 in connection with the sale of her partnership interest had greatly depreciated in value as a result of a storm which had occurred subsequent to the time they were conveyed to her. She contended that the lots previously conveyed to her were intended only as security for the payment to her of the amount of $30,000 by the petitioner and Henry Rehtz for her interest in the partnership and demanded that the petitioner pay her the difference between the amount of $30,000 and the then value of the lots. The petitioner contended that the conveyance of the lots was intended to be as recited in the agreement of June 18, 1926, namely, in full payment and satisfaction of Christine Plusch's interest in the partnership. While the petitioner took the position that she was not legally obligated to pay any additional amount, she was of the opinion that she was morally obligated to do so, since Christine Plusch was to get for her interest in the partnership the same amount as the other retiring partner, $30,000. She consulted1250 counsel about the matter and was advised to pay the amount in controversy because of the arrangement between her husband and Christine Plusch. The petitioner was also of the opinion that if her husband had lived he would have made payment of the additional amount demanded and she felt that she should do so. She felt that litigation with respect to the matter might cause embarrassment to her and her business, and this was one of the causes moving her to make payment. The controversy was settled by an agreement entered into on May 18, 1928, whereby the petitioner and the National City Bank of New York, as executors of the will of Henry Rehtz, conveyed to Christine 809 Plusch, at an agreed value of $1,250, three additional lots situated in the same block as those previously conveyed to her, which it was agreed had a value of $16,875, and the payment to her of $11,875. The amount of $11,875 was paid by the petitioner to Christine Plusch by a check dated May 16, 1928. In her income-tax return for 1928 the petitioner deducted as a loss the amount of $11,875 paid by her to Christine Plusch in settlement of the controversy. In determining the deficiency here involved the1251 respondent disallowed the deduction. OPINION. TRAMMELL: The petition in this proceeding presents two issues: (1) Whether the petitioner was under legal obligation to make payment of the $11,875 paid by her to Christine Plusch in May, 1928, under the circumstances set out in our findings of fact, and (2) whether the petitioner is entitled to deduct from her gross income for the taxable year the amount thus paid. The real question is whether the amount paid out is deductible in determining taxable income. Whether there was a legal or moral obligation to make the payment may fairly be considered in determining the question, but we do not regard that as being an issue in and of itself. It may well be that if there was no legal or moral obligation to make the payment, it might have been a gift. In any event, even if this question were considered an issue in the pleadings, it apparently has been abandoned and the proceedings are disposed of by our decision on the other issue in the petition. The petitioner contends that the amount here in controversy was not an additioval cost of Christine Plusch's interest in the partnership, but was an ordinary or necessary business expense1252 or a loss arising from a transaction entered into for profit and therefore an allowable deduction. The respondent contends that the amount represented an additional sum paid by the petitioner to Christine Plusch for the conveyance of the latter's interest in the partnership and that it is, therefore, a capital expenditure and as such is not an allowable deduction. In support of her contention the petitioner urges that the amount was paid solely for the purpose of settling a controversy, avoiding litigation and fulfilling what she deemed to be a moral obligation arising out of a transaction entered into respecting the business. In , affirming , the court said: It is contended on behalf of the petitioners that because any liability on the part of the coal companies to the railroad was denied, and the payments only made by way of compromise to avoid litigation, they constituted expense and not capital expenditures. We think not. The fact that a payment is made 810 voluntarily or involuntarily, in the course of legal proceedings or as a result of a compromise1253 settlement does not change the nature of the transaction. The real test is the character of the transaction that occasions the payment. What was the character of the transaction that occasioned the payment by the petitioner to Christine Plusch? We think it is clear that it was the acquisition by the petitioner and her husband of property, the one-fourth interest of Christine Plusch in the petitioner that occasioned the payment. The demand for payment was based on the transaction by which they became the owners of such interest. Neither the demand nor the payment was based upon any transaction arising out of or connected with the management or operation of the business either by the petitioner or her deceased husband either before or after June 18, 1926, but both demand and payment were founded upon the acquisition of a retiring partner's interest in the firm. The petitioner's testimony shows that Christine Plusch was to get for her interest in the firm the same amount as the other retiring partner, $30,000. While in negotiating a settlement of the controversy the petitioner disclaimed any legal liability in the matter, she recognized her moral obligation to make the payment*1254 demanded. Irrespective of whether the petitioner considered her liability to be a legal liability or a purely moral obligation, the fact remains that the payment was made primarily in connection with the petitioner's acquisition of an interest in the partnership, and the fact that the controversy was thereby settled and possible litigation avoided was only incidental. Under the facts in the case we think the amount of $11,875 here in controversy constituted an additional payment for Christine Plusch's interest in the partnership and therefore a capital expenditure, and, as such, is not an allowable deduction in computing the petitioner's taxable income. The petitioner having continued to hold, at the end of the taxable year, the interest which she and her husband had acquired from Christine Plusch, we do not perceive and basis for allowing the amount in controversy as a loss. The action of the respondent is sustained. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621382/	Montana Sapphire Associates, Ltd., Petitioner v. Commissioner of Internal Revenue, RespondentMontana Sapphire Assoc., Ltd. v. CommissionerDocket No. 22195-87United States Tax Court95 T.C. 477; 1990 U.S. Tax Ct. LEXIS 103; 95 T.C. No. 34; October 30, 1990, Filed 103 MSA is a limited partnership. C, the accountant for MSA, was elected the managing "general partner" of MSA in 1985. C also prepared an amended return for the 1983 taxable year of MSA. C has never owned a capital or profits interest in MSA. R issued a generic FPAA to the tax matters partner (TMP) of MSA and sent it to three separate addresses. A petition was filed within the period provided by sec. 6226(a), I.R.C. The petition was captioned in the name of MSA and signed by counsel as "counsel for petitioner." Counsel was authorized by C to prepare and file the petition. R moved to dismiss on the ground that the petition was not filed by the TMP and therefore could not be filed pursuant to sec. 6226(a), I.R.C. C argues that he was the TMP and, thus, the petition was proper. C argues in the alternative that even if he was not the TMP, that he was authorized to act for MSA. Held, C was not and is not a partner in MSA and, therefore, could not qualify under the statute as TMP. 1983 Western Reserve Oil & Gas Co. v. Commissioner, 95 T.C. 35 (1990). Held, further: That the petition filed does not conform with sec. 6226(a), I.R.C. or Rule 104 240(c)(1), Tax Court Rules of Practice and Procedure. The petition is, thus, defective and the Court will allow petitioner 60 days to advise the Court of the name of the partner to be appointed TMP. If a proper TMP is appointed, said TMP will be permitted to file an amended petition. Larry E. Johnstone, for the petitioner.Mark E. Bohe, for the respondent. Ruwe, Judge. Panuthos, Special Trial Judge. RUWE; PANUTHOS478 OPINIONThis case was heard by Special Trial Judge Peter J. Panuthos pursuant to the provisions of section 7443A of the Code. 1 The Court agrees with and adopts the Special Trial Judge's opinion, which is set forth below.OPINION OF THE SPECIAL TRIAL JUDGEPanuthos, Special Trial Judge: This case is before the Court on respondent's motion to dismiss for lack of jurisdiction. 105 By notice of final partnership administrative adjustment (FPAA) dated April 6, 1987, respondent determined adjustments to the partnership return of Montana Sapphire Associates, Ltd. (Montana Sapphire), for its 1983 taxable year.FINDINGS OF FACTDuring the taxable year 1983, Montana Sapphire was a limited partnership organized under the laws of the State of Washington. A certificate and agreement of limited partnership was filed with the Secretary of State, State of Washington, on December 8, 1983. According to the agreement, Geotechtonic Developments, Inc. (Geotechtonic), was named as the corporate general partner with primary management power and responsibility. Ronald W. Colwill (Colwill) was named as individual general partner with no 479 management power except in case of incapacity or dissolution of the corporate general partner. The parties have stipulated that Geotechtonic was the managing corporate partner and tax matters partner of Montana Sapphire during the taxable year 1983. While not entirely clear from the record, it appears that at some point after 1983 Geotechtonic no longer continued to serve as managing partner and Colwill took over these duties pursuant106 to the partnership agreement.Again, while not entirely clear from the record, it appears that sometime in 1984 a limited partner, Robert E. Erlich, was elected to replace Colwill to manage the partnership. In March 1985, James F. McAuliffe (McAuliffe) was elected "Managing General Partner" of Montana Sapphire by a ballot of the limited partners. McAuliffe was the accountant for Montana Sapphire, and he prepared an amended return, Form 1065, for the partnership's 1983 taxable year. At no time, however, has McAuliffe owned a capital or profits interest in Montana Sapphire.The limited partnership agreement also provided that the managing general partner would serve as the tax matters partner under section 6221 and have all powers granted under that section.The FPAA's issued by respondent were mailed on April 6, 1987, to "Tax Matters Partner, Montana Sapphire Associates, Ltd." at three separate addresses -- 144 Railroad Avenue, Suite 107, Edmonds, Washington 98020; 1750 Dexter Avenue North, Seattle, Washington 98109-3073; and P.O. Box 590, Edmonds, Washington 98020. FPAA's were also mailed to 17 individuals or couples holding partnership interests in Montana Sapphire.A petition107 for readjustment of partnership items was filed on July 6, 1987, which was within the period prescribed under section 6226(a). The petition was captioned "Montana Sapphire Associates, Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent." The petition was signed by Larry E. Johnstone as "counsel for petitioner." Neither a tax matters partner nor any other partner is named in the caption of the petition; however, the parties agree that McAuliffe authorized the petition to be filed.480 Respondent has moved to dismiss the petition on the ground that the petition was not filed by the tax matters partner of Montana Sapphire.OPINIONRespondent argues that this case must be dismissed for lack of jurisdiction because only the tax matters partner may file a petition during the first 90 days after an FPAA is issued, and McAuliffe is not the tax matters partner of Montana Sapphire. Counsel for petitioner contends that McAuliffe is the tax matters partner of Montana Sapphire, and, in the alternative, that McAuliffe was the authorized agent of the partnership to file a petition on behalf of its partners.Section 6226(a) provides that within 90 days after respondent mails108 an FPAA to a partnership, "the tax matters partner may file a petition for readjustment." The petition for readjustment of partnership items was mailed to the Court on July 2, 1987. The parties do not dispute that pursuant to sections 7502 and 7503 the petition was filed within the period prescribed in section 6226(a).The first question to be resolved is whether McAuliffe is the tax matters partner. "Tax matters partner" is defined in section 6231(a)(7) as:(7) Tax matters partner. -- The tax matters partner of any partnership is -- (A) the general partner designated as the tax matters partner as provided in regulations, or(B) if there is no general partner who has been so designated, the general partner having the largest profits interest in the partnership at the close of the taxable year involved * .If there is no general partner designated under subparagraph (A) and the Secretary determines that it is impracticable to apply subparagraph (B), the partner selected by the Secretary shall be treated as the tax matters partner.Section 6231(a)(2) defines "partner" (for purposes of sections 6221-6233) as:(2) Partner. -- The term "partner" means -- (A) a partner109 in the partnership, and (B) any other person whose income tax liability under subtitle A is determined in whole or in part 481 by taking into account directly or indirectly partnership items of the partnership.Section 301.6231(a)(7)-1T, Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6791 (Mar. 5, 1987), provides the methods by which a partnership may designate a tax matters partner. The partnership may make a designation on the partnership return in the space for such designation, or if there is no such space on the return, then by attaching to the return a statement which: (1) Identifies the partnership and the tax matters partner by name, address, and taxpayer identification number, (2) declares that the statement is a tax matters partner designation for a particular taxable year, and (3) is signed by the partner signing the return. A designation can also be made after the return is filed by the majority interest general partners' filing a statement with respondent designating a partner as tax matters partner. Sec. 301.6231(a)(7)-1T(e), Temporary Proced. & Admin. Regs. When no formal designation is made, the tax matters partner "shall be" 110 the general partner having the largest profits interest. Sec. 6231(a)(7)(B); sec. 301.6231(a)(7)-1T(m)(2), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6792 (Mar. 5, 1987); 1983 Western Reserve Oil & Gas Co. v. Commissioner, 95 T.C. 51">95 T.C. 51 (1990).Since McAuliffe was not and is not a partner in Montana Sapphire, he can not qualify under the statute as tax matters partner. 1983 Western Reserve Oil & Gas Co. v. Commissioner, supra; see also Sente Investment Club Partnership of Utah v. Commissioner, T.C. Memo 1988-376">T.C. Memo. 1988-376. Under section 6226(a), only the tax matters partner may petition for readjustment of the partnership items within the first 90 days after an FPAA is issued. Chomp Associates v. Commissioner, 91 T.C. 1069">91 T.C. 1069, 1077 (1988); Computer Programs Lambda, Ltd. v. Commissioner, 89 T.C. 198">89 T.C. 198, 205 (1987); Transpac Drilling Venture 1982-22 v. Commissioner, 87 T.C. 874">87 T.C. 874 (1986); Sierra Design Research & Development Ltd. Partnership v. Commissioner, T.C. Memo. 1989-506.111 In holding that McAuliffe cannot qualify as tax matters partner under the statute, we reject petitioner's argument that respondent's treatment of McAuliffe evidences that respondent "selected" McAuliffe as tax matters partner 482 under section 6231(a)(7). McAuliffe could not be selected by respondent as the tax matters partner of Montana Sapphire for the same reason that he could not qualify under section 6231(a)(7)(A) or (B): he is not and never was a partner in the partnership. We also note that no FPAA was addressed to McAuliffe in his name as tax matters partner. Rather, all of the FPAA's issued by respondent were generic notices addressed simply to "Tax Matters Partner."The petition filed at the direction of McAuliffe within the 90-day period was not filed by the tax matters partner of Montana Sapphire. It was not signed by the tax matters partner of the partnership or counsel on behalf of the tax matters partner. The petition does not comply with section 6226(a) or Rule 240(c)(1). Accordingly, the petition is defective in this regard.The second question to be resolved is whether the petition must be dismissed since it is defective.In several cases where a defective112 petition was timely filed, we have granted leave to a petitioner to file an amended petition. "Defects in an imperfect petition may be cured by the filing of an amended petition if there is evidence that the original signatory was duly authorized to file the original petition on behalf of the nonsigning petitioner." Summerland Partnership v. Commissioner, T.C. Memo 1988-548">T.C. Memo. 1988-548, 56 T.C.M. (CCH) 759">56 T.C.M. 759, 761, 57 P-H Memo T.C. par. 88,548 at 2837. See also Rules 60(a) and 41(d); Sente Investment Club Partnership of Utah v. Commissioner, T.C. Memo. 1988-376. The grant or denial of leave to amend a defective petition is within the Court's discretion. Rule 60(a); Brooks v. Commissioner, 63 T.C. 709">63 T.C. 709, 714 (1975).Where there is evidence that the taxpayer on whose behalf the petition was filed had intended to be represented by the person who actually signed the petition, and the taxpayer subsequently ratifies the petition, we have been liberal in allowing necessary amendments to the petition. Kraasch v. Commissioner, 70 T.C. 623">70 T.C. 623 (1978); Carstenson v. Commissioner, 57 T.C. 542">57 T.C. 542 (1972);113 Hoj v. Commissioner, 26 T.C. 1074">26 T.C. 1074 (1956). * * * [Gruevski v. Commissioner, T.C. Memo. 1990-291, 59 T.C.M. (CCH) 842">59 T.C.M. 842, 844, 59 P-H Memo T.C. par. 90,291 at 1356. Fn. ref. omitted.]In Carstenson v. Commissioner, 57 T.C. 542 (1972), cited in Sente Investment Club Partnership of Utah v. Commissioner, 483 , we held that individual taxpayers had authorized their accountant, who was not admitted to practice before the Tax Court, to file a petition on their behalf, and we permitted amendment of the petition after the 90-day period for filing a petition had elapsed. Here, the readjustment petition was filed by the elected "managing partner" of the partnership. The "managing partner" was elected by a majority of the partners. According to the partnership agreement, the "managing partner" was authorized to act as the tax matters partner under section 6221 and was purportedly granted all powers of the tax matters partner. In this regard, we note that McAuliffe was thus the agent of the partners, any of whom could have qualified as114 tax matters partner if selected by respondent. At some point, in order for this litigation to proceed and ultimately be concluded, the Court may be required to appoint a tax matters partner, or to dismiss this case, if the partners do not advise the Court of the name of a person who is qualified under the statute to serve as tax matters partner.In this case, the petition was filed by counsel, who believed that he was properly filing a petition under section 6226(a) based on the representation of McAuliffe and the power granted in the partnership agreement. If we were to grant respondent's motion, the partners of Montana Sapphire would have no judicial remedy with respect to the partnership adjustments determined in the FPAA. This is not a situation where multiple petitions were filed under section 6226(a) and (b). Cf. Amesbury Apartments, Ltd. v. Commissioner, 95 T.C. 227 (1990); 1983 Western Reserve Oil & Gas Co. v. Commissioner, supra.We do not believe that it is appropriate to dismiss the petition under these circumstances without first giving (1) the partnership the opportunity to advise the Court of the name115 of a person to be appointed tax matters partner and (2) the tax matters partner the opportunity of ratifying the original petition.Respondent's motion to dismiss for lack of jurisdiction will be held in abeyance and the Court will allow 60 days (1) for petitioner to advise the Court of the name of the partner 484 to be appointed as tax matters partner and (2) for such tax matters partner to file an amended petition.An appropriate order will be issued. Footnotes1. This case was assigned pursuant to sec. 7443A and Rule 180 et seq. All section references are to the Internal Revenue Code as amended. 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/4621383/	L. Helena Wilson, Petitioner, v. Commissioner of Internal Revenue, RespondentWilson v. CommissionerDocket No. 5407United States Tax Court7 T.C. 1469; 1946 U.S. Tax Ct. LEXIS 5; December 31, 1946, Promulgated 5 Decision will be entered for the respondent. Petitioner paid income tax in the Dominion of Canada on $ 20,000 received under a testamentary trust whose terms constituted such annual payment a legacy, as construed by the United States courts ( Burnet v. Whitehouse, 283 U.S. 148">283 U.S. 148). However, such payment was held to be income by the Canadian taxing authorities. Petitioner is not entitled to a credit for such tax so paid under the provisions of section 131 (a) (3), Internal Revenue Code. Rex W. Kramer, Esq., for the petitioner.A. J. Hurley,6 Esq., for the respondent. Van Fossan, Judge. VAN FOSSAN 1469 OPINION.The respondent determined a deficiency of $ 258.23 in the income tax of the petitioner for the year 1940, consequent on a disallowance in part of a credit claimed under section 131, Internal Revenue Code, as amended by the Revenue Act of 1939, for taxes paid to the Dominion of Canada.1470 All of the facts were embodied in the following stipulation:1. The petitioner, is and during the taxable year here involved was, an individual and an alien, a citizen of the Dominion of Canada but domiciled in the United States of America, being a resident of 2306 Hillhurst Avenue, Los Angeles 27, California. Petitioner duly filed her income tax returns for the calendar year 1940 with the collector of internal revenue at Los Angeles, Sixth District, California.2. During the year 1940 all of petitioner's income was derived from Canadian sources, the principal source being a trust created by the Will of her deceased husband, F. C. Wilson, of which trust, National Trust Co., Ltd., F. W. Wilson and Ashwell Quarles, all of Montreal, P. Q., Canada, were the trustees.Under and by the laws of the Province of Quebec7 wherein said trust was created, said trust is based directly upon the Will by which it is provided and the Will becomes, in effect the declaration of trust.Said Will directs the Trustees of said trust to pay out of the net annual revenue thereof to petitioner the sum of $ 20,000.00 per annum during her lifetime and couples this direction with the provision that "if at any time the revenues of the residue of my estate should be insufficient to pay the said annual sum(s) to my wife . . . my Executors and Trustees shall draw upon the capital of my estate to provide for any such deficiency. Any payments from capital to implement the said annual sum(s) . . . shall cease to form a part of the residue of my estate, and shall not be reimbursable to said residue."Said Will, after providing certain other annuities, to be paid from trust income, provides that any surplus income shall be paid annually to Petitioner during her lifetime.3. During 1940 petitioner received from said Trustees as income of said trust to which she was entitled a total of $ 33,831.84 (Canadian) and as dividends paid by Canadian corporations $ 808.25 (Canadian). The taxpayer had no other income in 1940. These sums8 in full were subject to a Canadian income tax, on account of which there was withheld at source (and Petitioner paid) for the Dominion of Canada $ 1,691.59 (Canadian) as to the trust disbursements and $ 40.41 (Canadian) as to the dividends.4. Petitioner's U. S. income tax return for 1940 reports as taxable income the amount of "surplus" revenue received from said trust, i. e., $ 33,831.84, less $ 20,000.00, to wit, $ 13,831.84, and the amount of said dividends, to wit, $ 808.25, or a total of $ 14,640.09 (Canadian). The said sum of $ 20,000 was not subject to U. S. income tax for the reason that its payment being guaranteed by the principal, or corpus, of the trust estate, it amounted to a legacy.5. During all of 1940 the rate of exchange on funds remitted from Canada was fixed at 9.91 per cent. $ 14,640.09 reduced by this rate of exchange amounts to $ 13,189.26. Taxpayer reported this in her Federal tax return as the amount of her total income for 1940. After subtracting from this claimed deductions amounting to $ 1,177.27 a net income of $ 12,011.99, results, upon which a U. S. income tax of $ 917.68 has been computed. The total income tax paid to Canada was $ 1,732.00 less9 9.91 per cent, or $ 1,560.36.The issue before us, definitely drawn by the pleadings and set forth in the stipulated facts, is this: Was the income tax paid to the Dominion of Canada by the petitioner on the $ 20,000 received by her as a legacy, but construed by the Canadian Government to constitute taxable income, properly to be credited to her in the computation of her 1471 Federal income tax for the year 1940, under the provisions of section 131 (a) (3) of the Internal Revenue Code. 110 The sum of $ 20,000 was agreed not to be income, as defined by the Internal Revenue statutes of the United States, since it was the equivalent of a legacy under the decision of Burnet v. Whitehouse, 283 U.S. 148">283 U.S. 148. In Biddle v. Commissioner, 302 U.S. 573">302 U.S. 573, it was held that the tax imposed by the foreign country must be a tax on income as that term is used and understood in our own taxing statutes. There the Supreme Court said:Section 131 does not say that the meaning of its words is to be determined by foreign taxing statutes and decisions, and there is nothing in its language to suggest that, in allowing the credit for foreign tax payments, a shifting standard was adopted by reference to foreign characterizations and classifications of tax legislation. The phrase "income taxes paid," as used in our own revenue laws, has for most practical purposes a well-understood meaning to be derived from an examination of the statutes which provide for the laying and collection of income taxes. It is that meaning which must be attributed to it as used in section 131.In Keasbey & Mattison Co. v. Rothensies, 133 Fed. (2d) 894;11 certiorari denied, 320 U.S. 739">320 U.S. 739, the Circuit Court of Appeals for the Third Circuit had before it the question of whether or not a tax paid to the Province of Quebec was an income tax within the meaning of section 131 (a) (1), in which the same phraseology is used as in subsection (a) (3). There the court stated that it was conceded that in the application of the statute the criteria prescribed by our revenue laws are determinative of the meaning of the term "income taxes" as used therein. The court then said:It necessarily follows that a tax paid a foreign country is not an income tax within the meaning of Section 131 (a) (1) of the Act unless it conforms in its substantive elements to the criteria established under our revenue laws. These commonly accepted criteria, although not defined in the statute, may be easily ascertained. It is clear from a reading of the Act, as well as the revenue acts which preceded it, and the cases interpretive of its provisions, that an income tax is a direct tax upon income as therein defined. [Cases cited.] The defined concept of income has been uniformly restricted to a gain realized or a profit derived from capital, 12 labor, or both. Section 22 (a) of the Internal Revenue Act of 1936. [Cases cited.] It seems logical to conclude that any tax, if it is to qualify as a tax on income within the meaning of Section 131 (a) (1), is 1472 subject to the same basic restrictions. The Supreme Court, without advancing any precise definition of the term "income tax", has unmistakably determined that taxes imposed on subjects other than income, e. g., franchises, privileges, etc., are not income taxes, although measured on the basis of income. [Cases cited.] These criteria are determinative of the nature of the tax in question.Thereupon the court denied the credit sought. See St. Paul Fire & Marine Insurance Co. v. Reynolds, 44 Fed. Supp. 863.In the case at bar the tax paid by the petitioner on the $ 20,000, although called an "income tax" in the Dominion of Canada, was not such a tax in the United States. The petitioner has not brought herself within the statutory provision on which she relies and the strict construction thereof. Consequently, no credit here may be allowed to her under the provisions of section 131 (a) (3). New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435;13 United States v. Stewart, 311 U.S. 60">311 U.S. 60; United States Trust Co. of New York v. Helvering, 307 U.S. 57">307 U.S. 57.It is almost superfluous for us to add that section 131 was enacted to prevent the double taxation of the same income in a foreign country and in the United States. Hubbard v. United States, 17 Fed. Supp. 93; certiorari denied, 300 U.S. 666">300 U.S. 666. In the very nature of the facts before us, there is no double taxation. The contrary appears. There was only a single taxation on the item in controversy, and that was imposed by the Dominion of Canada. If the petitioner should prevail and credit be allowed, she would escape the full taxation to which she is subject in this country upon that portion of her income which is taxable in both countries. Certainly that result is not contemplated by the statute.Furthermore, we think that the statutory phrase, "if the foreign country of which such alien resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of the United States residing in such country," (sec. 131 (a) (3)) is deserving14 of comment. The stipulated facts do not recite that the Dominion of Canada allows a similar credit to citizens of the United States residing within her borders. However disastrous that omission may be to the petitioner's cause, it is logical to conclude that no such credit is allowed by the Dominion of Canada because it could not be asked to allow, nor could it allow, a credit for taxes on a legacy, a type of accretion nontaxable in the United States. The allowance of credit under section 131 (a) (3) is conditioned upon such reciprocal allowance by the foreign country. Until that condition is fulfilled the section can not become operative. 215 1473 The petitioner relies solely on I. B. Dexter, 47 B. T. A. 285. That case, however, is readily distinguishable from the case at bar in two major respects: (1) The income there in controversy was derived from the same source, i. e., the sale of capital assets, taxable in both jurisdictions but on different bases; whereas here the receipt of the $ 20,000 legacy was not taxable at all in the United States; and (2), the problem was posed upon the applicability of section 131 (b) and its solution was reached by limiting the credit strictly in accordance with the directions of subsection (b).We may observe also that the credit allowances afforded to a citizen of the United States and an alien resident of the United States are not identical, in view of the condition imposed in subsection (a) (3). The petitioners in the Dexter case were citizens of the United States. Here the petitioner is a resident alien and must conform strictly to the requirements of the statute whose benefit she seeks to secure. Keasbey & Mattison Co. v. Rothensies, supra.The respondent's determination is sustained.Decision will be16 entered for the respondent. Footnotes1. SEC. 131. TAXES OF FOREIGN COUNTRIES AND POSSESSIONS OF UNITED STATES.(a) Allowance of Credit. -- If the taxpayer signifies in his return his desire to have the benefits of this section, the tax imposed by this chapter shall be credited with:(1) Citizen and domestic corporation. -- In the case of a citizen of the United States and of a domestic corporation, the amount of any income, war-profits, and excess-profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States; and * * (3) Alien resident of United States. -- In the case of an alien resident of the United States, the amount of any such taxes paid or accrued during the taxable year to any foreign country, if the foreign country of which such alien resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of the United States residing in such country * ↩2. Sec. 8. [Income War Tax Act of the Dominion of Canada.] A taxpayer shall be entitled to deduct from the tax that would otherwise be payable by him under this Act * * *(b) Income tax paid in any foreign country. -- the amount paid to any foreign country for income tax in respect to the income of the taxpayer derived from sources therein, if such foreign country in imposing such tax allows a similar credit to persons in receipt of income derived from sources within Canada.[See also T. D. 5206↩, art. XV.]	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621384/	Kerrigan Iron Works, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentKerrigan Iron Works, Inc. v. CommissionerDocket No. 19767United States Tax Court17 T.C. 566; 1951 U.S. Tax Ct. LEXIS 80; September 28, 1951, Promulgated 80 Decision will be entered under Rule 50. The amounts petitioner is entitled to deduct as ordinary and necessary business expenses in the taxable years 1941, 1942, and 1943 are determined with respect to the following: (1) compensation paid to its president, Philip Kerrigan, Jr.; (2) rental of trucks; (3) rental of Northside Plant and equipment; and (4) compensation paid to Regina Kerrigan. The deduction of the amount paid in 1943 to McCarver in connection with petitioner's labor difficulties is disallowed for failure of proof. Cecil Sims, Esq., W. W. Berry, Esq., and Hilary H. Osborn, Esq., for the petitioner.S. Earl Heilman, Esq., for the respondent. Leech, Judge. LEECH566 This proceeding involves deficiencies in income, declared value excess-profits and excess profits taxes for the years and in amounts as follows:Declared valueexcess-profitsExcess profitsYearIncome taxtaxtax1941$ 1,867.12$ 1,964.54$ 5,042.211942569.1114,178.0119432,795.333,871.09By amended answer respondent requests an increase in deficiency in income tax for 1941, if any, which may result from the adjustment of petitioner's excess81 profits tax for that year in a recomputation under Rule 50 in accordance with our decision.The issues are:(1) Whether the respondent erred in disallowing in part the amounts claimed by petitioner as deductions for salary paid to Philip Kerrigan, Jr., in the respective taxable years 1941, 1942, and 1943.(2) Whether the respondent erred in disallowing in part the 567 amounts claimed by petitioner as deductions for the respective years 1942 and 1943 as rental for the use of certain trucks owned by Philip Kerrigan, Jr.(3) Whether the respondent erred in disallowing the amount of $ 2,282.48 of the amount of $ 2,750 claimed by petitioner in 1943, as rent paid to Philip Kerrigan, Jr., for the use of the so-called Northside Plant and certain equipment therein.(4) Whether the respondent erred in disallowing $ 2,600 of the amount of $ 3,400 claimed by petitioner as a deduction for salary paid to Regina Kerrigan for 8 months of 1943.(5) Whether the respondent erred in disallowing the amount of $ 500 which petitioner claimed as a deduction in 1943 as "Labor Relations Expense."The case was submitted upon a stipulation of facts, oral testimony and exhibits. The facts stipulated are82 found accordingly.FINDINGS OF FACT.Petitioner is a Tennessee corporation, organized in May 1929 with an original invested capital of $ 1,700. During the taxable periods involved its authorized and issued capital stock consisted of 150 shares of no-par common stock, all of which shares were owned by Philip Kerrigan, Jr.Prior to 1941 petitioner engaged principally in the business of manufacturing fine hand-wrought iron work, ornamental iron such as entrances to estates, balconies, fine hardware and miscellaneous items of an ornamental kind generally used by the building and construction industry. In 1941 petitioner began to engage in war work, and during that year manufactured truck parts, tank towbars, oil settling tanks, ammunition boxes and cases, and prefabricated high-pressure pipe lines for ships, among other iron and steel products.In 1942 the principal items which petitioner manufactured were landing mats for airfields or air strips, truck cabs, many miscellaneous parts for trucks, including radiator grills, siren guards, bumpers, motor supports, transmission housing supports and welding screens.During the year 1943 the principal items which petitioner manufactured were83 T-6-V pontoons for the Bureau of Yards and Docks, locomotive cabs and ash pans, and cabs for large Army trucks. During the taxable years involved the great bulk of petitioner's production was in connection with the war effort.During the taxable years petitioner's officers were Philip Kerrigan, Jr., president and treasurer, and Regina Kerrigan, secretary. Its board of directors consisted of Philip Kerrigan, Jr., his brother, Frank P. Kerrigan, and his sister Regina Kerrigan. Regina Kerrigan was 20 years of age in the year 1943.568 During the taxable periods involved Philip Kerrigan, Jr., was general manager and sole executive. He devoted 12 to 18 hours a day, except Sundays, to the business. He attended to all of the sales, contacting buyers, writing contracts and overseeing the fulfillment of the contracts. He attended to the procurement of materials, the hiring of labor, the engineering, the cost estimating and the blueprints. He handled all the collections and arranged all the petitioner's financing. He was responsible for the procurement of petitioner's business and its production, although he had a superintendent at each plant who worked with the men and expedited84 production.The following schedule shows the amount of net sales, the net income after Federal income and excess-profits taxes, the salary of the president, and the percentage of the salary to net sales, for the years 1938 to 1943, inclusive:PercentageNet incomePresident'sof president'sYearNet salesafter taxessalarysalary tonet sales1938$ 62,692.80$ 2,668.17$ 2,3503.74841939120,484.23182.984,8003.98391940127,575.362,606.309,5007.44661941262,824.2211,577.2525,0009.51211942374,854.429,613.9925,0006.669319431,660,205.77142,828.4825,0001.5058The number of petitioner's employees and their classification for the years 1941, 1942, and 1943 were as follows:OfficeNumberYearof employeesEngineersDraftsmenMenWomen194111922111942157231219432225312Two shifts were working from September 1942 through August 1945.During the taxable years 1941, 1942, and 1943 petitioner paid no dividends.The amounts paid as salary to petitioner's president, Philip Kerrigan, Jr., and claimed as deductions, and the amounts disallowed 85 by the respondent in the taxable years 1941, 1942, and 1943 are as follows:Amounts paidYearandAmounts disallowedclaimed asby respondentdeductions1941$ 25,000$ 15,000194225,00012,500194325,00010,000569 A reasonable salary for the services which Philip Kerrigan, Jr., rendered to petitioner as its president and treasurer in the respective taxable years 1941, 1942, and 1943 is as follows:YearAmount1941$ 15,000194220,000194325,000During the year 1942 Philip Kerrigan, Jr., owned a 1/2-ton Chevrolet truck and a 1 1/2-ton G. M. C. truck and stakebody trailer. The Chevrolet truck was a used truck purchased in April 1941 at a cost of $ 849.16. The G. M. C. truck was purchased in the early part of 1942 at a cost of about $ 1,150. It was unsatisfactory, and was sold at some undisclosed date in 1942 for $ 500. Kerrigan leased these two trucks to petitioner. The expenses paid by Kerrigan for maintenance and operation, including wages of drivers during the year, amounted to $ 3,152.26. Petitioner paid Kerrigan for the use of such trucks, during 1942, the sum of $ 5,590.91, which amount it claimed as a deduction for that86 year. In determining the deficiency the respondent allowed petitioner a deduction in connection with these trucks in the sum of $ 1,390.During the year 1943 Philip Kerrigan, Jr., owned and leased to petitioner the aforementioned 1/2-ton truck, a new 1942 1 1/2-ton G. M. C. truck, which he had purchased in April 1943 at a cost of $ 1,496.97, and a 1 1/2-ton 1939 used Diamond T truck, which he had purchased in April 1943 at a cost of $ 1,050. During the year 1943 Kerrigan incurred expenses in maintaining and operating the three trucks, including wages of the drivers, in the amount of $ 3,357.15. Petitioner paid Kerrigan for the use of these trucks in the year 1943 the sum of $ 8,906.27, which amount petitioner claimed as a deduction on its return for that year. The respondent allowed the sum of $ 3,475.Said trucks leased to petitioner were at the sole disposal of petitioner during the period they were leased. There was no written lease between petitioner and Kerrigan and no fixed amount of rent per day, week, month, or year. The amount of rent which petitioner paid Kerrigan was arrived at on the basis of what he thought was fair and reasonable from information he had, such as87 U-Drive-It companies and express and freight charges.In the years 1942 and 1943 Philip Kerrigan, Jr., on his individual return, claimed and was allowed deductions, as expenses incurred in connection with such trucks, in the respective amounts of $ 2,323.46 and $ 3,357.15. It is not disclosed whether or not he claimed any depreciation deduction with respect to such trucks in either of those years.A proper allowance or rental for the use of said trucks by petitioner was the sum of $ 4,928.46 for the taxable year 1942 and the sum of $ 6,093.16 for the taxable year 1943.570 On November 13, 1943, Philip Kerrigan, Jr., purchased certain real estate, machinery, and equipment in Nashville, Tennessee, at a cost of $ 57,602.50. The real estate was valued at $ 46,000 and the remainder of the purchase price was paid for cranes and other machinery and equipment. Petitioner had a certificate of necessity for amortization for certain pieces of machinery in the plant but not on the plant.Philip Kerrigan, Jr., leased the plant and equipment to petitioner for a term of 1 year from December 1, 1943, for a monthly rental of $ 2,750. The lease further provided that petitioner was to pay 88 insurance, taxes and assessments. Lessee was given permission to erect additional buildings or improvements which, if constructed, were to immediately become the property of the lessor. The property was located at Eleventh and Herman Streets and was referred to as petitioner's "Northside Plant."Prior to the leasing of the Northside Plant petitioner was operating two plants in Nashville, Tennessee. Philip Kerrigan, Jr., purchased the Northside Plant solely for the purpose of enabling petitioner to manufacture pontoons for the Navy, which the Navy urged petitioner to produce.In order for petitioner to obtain a contract to produce the pontoons it was necessary that it acquire another plant. Kerrigan acquired the plant with the idea that it would be used during the war to manufacture items for defense, and after the war petitioner would have no need for it.The Northside Plant was purchased by Philip Kerrigan, Jr., personally, rather than by petitioner, because it was not desired to burden petitioner's financial statement with such additional liability, and petitioner was advised that to do so might jeopardize its credit; also petitioner was advised by its bank that it would be better89 for this plant to be purchased by Kerrigan individually and leased to petitioner.At the beginning of 1943 petitioner had bonds, notes, and mortgages payable with original maturity of less than 1 year in the amount of $ 87,400. At the date of the acquisition of the plant by Kerrigan, on November 13, 1943, petitioner had cash of approximately $ 618,000. At the end of the year it had no bonds, notes or mortgages payable; it had cash of $ 318,135.98, and tax anticipation certificates of $ 300,000. It had accrued taxes of $ 593,528.21 set up as a liability. Its earned surplus and undivided profits were $ 206,712.48.Philip Kerrigan, Jr., borrowed $ 25,000 of the purchase price of the Northside Plant from a local bank and the remainder of the purchase price was obtained from Kerrigan's life savings. As security for its loan the bank insisted that the rental to be paid by petitioner be fixed at the sum of $ 2,750 per month and that the lease be assigned to the bank.571 Prior to the purchase of the Northside Plant Philip Kerrigan, Jr., attempted to lease it from its then owner, who offered to lease it for a monthly rental of $ 5,000, but Kerrigan refused the offer.Petitioner90 paid Philip Kerrigan, Jr., as rental for the Northside Plant and equipment for the month of December 1943, the sum of $ 2,750, which amount it claimed as a deduction on its 1943 return. In determining the deficiency, the respondent disallowed the sum of $ 2,282.48.A reasonable rental for the Northside Plant and equipment for the month of December 1943 is the sum of $ 1,500.Regina Kerrigan (now Mrs. D. G. Everett), sister of Philip Kerrigan, Jr., was elected secretary of petitioner on December 16, 1939. At that time she was 16 years of age and in school. She attended meetings of the directors, signed corporate documents and minutes of the meetings, which were dictated by Philip Kerrigan, Jr., and typed by a typist. After Regina Kerrigan was graduated from high school she was employed in the mailing, shipping and receiving department of the Loveman Department Store. She served as secretary of petitioner without pay until the Spring of 1943.At a meeting of petitioner's board of directors held on July 27, 1943, a resolution was adopted fixing the salary of the secretary at $ 425 per month.At this meeting it was stated that "Mrs. D. G. Everett had been functioning without any 91 particular defined hours or relationship as to time, up until the last of April, 1943, but that beginning with May, 1943, she was devoting her entire time and services to the corporation; therefore, the Chairman announced that her salary of $ 425.00 per month should commence as of the month of May, 1943 and thereafter her full salary should be paid. The Chair further stated that, anticipating this meeting, the bookkeeping personnel had been instructed to pay her $ 425.00 per month, commencing as of May, 1943." Whereupon, upon motion duly made, seconded and unanimously adopted, it was "RESOLVED, that the action of the President as to putting the Secretary upon a salary of $ 425.00 per month, commencing as of the month of May, 1943, be hereby ratified and confirmed."Petitioner was having trouble with its employees at its River Plant, and Philip Kerrigan, Jr., thought it would be advantageous to have someone by the name of Kerrigan at the office there. Regina Kerrigan was placed in charge of the office and, in addition to keeping a watchful eye on the employees, worked on the payroll, made out shipping and receiving papers, and did clerical work such as typing and keeping records. 92 The morale of the employees at the River Plant improved after Regina Kerrigan was employed at the plant.572 During the year 1943 petitioner paid its other female office employees who had several years' experience in stenographic and clerical work $ 45 or $ 50 per week.On its 1943 return petitioner claimed the sum of $ 3,400 as a deduction for salary paid to Regina Kerrigan for 8 months of 1943. The respondent disallowed $ 2,600 of the amount claimed.A reasonable salary for the services rendered to petitioner by Regina Kerrigan for the 8 months of 1943 is $ 1,600.In 1943 petitioner was having labor difficulties. Philip Kerrigan, Jr., was introduced to a Mr. McCarver, a public relations man, who represented himself as having influence with certain union officials. On behalf of petitioner, Kerrigan paid McCarver a fee of $ 500. Kerrigan did not know what McCarver did with the money. Thereupon petitioner's labor difficulties ceased. About five or six weeks later the labor situation "tightened up" and McCarver requested more money, which Kerrigan refused, and he terminated the relationship.Petitioner, on its 1943 return, claimed the amount of $ 500 paid to McCarver as 93 an ordinary and necessary business expense. The respondent, in determining the contested deficiency, disallowed the entire amount as not representing an allowable deduction.OPINION.Our first question relates to the reasonableness of the salary paid by petitioner to its president, Philip Kerrigan, Jr., in the taxable years 1941, 1942, and 1943. In each of those years petitioner paid Kerrigan the sum of $ 25,000, which amount it claimed as a deduction. In determining the deficiency the respondent disallowed $ 15,000 in 1941, $ 12,500 in 1942 and $ 10,000 in 1943.What constitutes a reasonable allowance for salary expense is a question of fact under the circumstances of each particular case. Gem Jewelry Co. v. Commissioner, 165 F.2d 991">165 F. 2d 991, certiorari denied 334 U.S. 846">334 U.S. 846. Where the challenged payment is made to an officer who is the sole owner of the capital stock of the corporation, as in the instant case, the transaction is subjected to rigorous scrutiny.The record establishes that Kerrigan was petitioner's sole executive. He was responsible for the entire management of the business. He had charge of the sales, the94 engineering and general supervision of the entire production, including the procurement of materials and the hiring of labor. In addition, he had the responsibility of obtaining the necessary finances and the collection of accounts receivable. Although the rapid growth of petitioner's business in the taxable years was due largely to the impetus of defense contracts, nevertheless Kerrigan's industry, ingenuity and ability to produce efficiently at low cost were principal factors in the procurement for petitioner of the 573 large volume of war contracts. Kerrigan testified that he devoted 12 to 18 hours per day to the business. Commencing in September 1942, petitioner operated two shifts per day. It also appears that the articles which petitioner produced for the war effort were different from those produced in prewar years. Such fundamental conversion necessarily imposed new burdens upon petitioner's sole executive. While added responsibilities warrant increased compensation, the amount must not be disproportionate to the value of the services rendered.In support of petitioner's contention that the amount of $ 25,000 paid to Kerrigan in the taxable years involved should95 be allowed, it is argued that the salary was fixed by the board of directors; that the War Price Adjustment Board, in determining petitioner's excessive profits in renegotiation proceedings, did not disturb the salary paid to its president; and that we are obligated to accept the opinion testimony of petitioner's expert witnesses, since the respondent offered no witnesses in support of his position.Ordinarily we hesitate to disagree with the judgment of directors where exercised in an arm's-length transaction. But the fact that the salary was fixed by the board of directors is not persuasive under the circumstances existing here. Philip Kerrigan, Jr., owned all of petitioner's capital stock except two qualifying shares. In addition to Kerrigan, petitioner's board of directors consisted of his brother Frank and his sister Regina. It also appears that during the taxable years involved Regina Kerrigan was a minor and not qualified to act as a director. The corporate law of the State of Tennessee provides that the business of a corporation is to be managed by a board of directors of not less than three directors, all of whom shall be of full age. 1 The presence of Philip Kerrigan, 96 Jr., was therefore necessary to constitute a quorum and his vote was required to adopt a resolution. The courts of Tennessee have held that a director may not vote to fix his own salary. Harris v. Lemming-Harris Agricultural Works, 43 S. W. 869. Under these circumstances, the action of petitioner's board of directors in fixing Kerrigan's salary is without significance.Nevertheless, Kerrigan is entitled to receive a reasonable compensation for the services he rendered to petitioner.The fact that the War Contracts Price Adjustment Board, in its proceedings to renegotiate petitioner's excessive profits, did not adjust the salary petitioner paid Kerrigan, while of some evidentiary value, is not binding upon this Court. Clearly it was not the intent of Congress that a taxpayer who was subjected to renegotiation should be given any preferred treatment in the administration of the revenue laws.574 Nor do we find any merit in petitioner's97 further contention that we are obligated to accept the opinion of petitioner's expert witnesses as to the reasonableness of the salary paid to Kerrigan, in the absence of such testimony being offered by the respondent. We know of no such rule. Oswald Co. v. Commissioner, 185 F.2d 6">185 F. 2d 6, certiorari denied 340 U.S. 953">340 U.S. 953.In the recent case of Sartor v. Arkansas Gas Corp., 321 U.S. 620">321 U.S. 620, the Supreme Court, at page 627, said:In considering the testimony of expert witnesses as to the value of gas leases, this Court through Mr. Justice Cardozo has said: "If they have any probative effect, it is that of expressions of opinion by men familiar with the gas business and its opportunities for profit. But plainly opinions thus offered, even if entitled to some weight, have no such conclusive force that there is error in law in refusing to follow them. This is true of opinion evidence generally, whether addressed to a jury or to a judge or to a statutory board." [Citing cases]Petitioner offered the testimony of three experts, who expressed the opinion that the salary paid to petitioner's executive98 in the taxable years was reasonable. W. J. Diehl is chairman of the board of the Third National Bank of Nashville, Tennessee. It was through this bank that Kerrigan financed the operations of petitioner in the taxable years involved. When asked the question, "What was your judgment as to the reasonableness or the unreasonabless of Mr. Kerrigan's salary?" he replied, "We accepted it as being reasonable."C. H. Maltby, a senior vice-president of the Lincoln National Bank of Syracuse, New York, became connected with the Government in October 1942. In June 1944 he became chairman of the Price Adjustment Board for the South Atlantic Division, Corps of Engineers, at Atlanta. The petitioner was then under investigation by that office with respect to renegotiation for 1943, an analysis having already been made for the year 1942. His opinion as to the reasonableness of Kerrigan's salary was based on the testimony which Kerrigan gave at the hearing of this proceeding. It does not appear that Maltby had ever visited the plant of petitioner or had any personal contact with Kerrigan during the taxable years.George P. Rice, a civil engineer, was commissioned as an officer in the Corps of99 Engineers, A. U. S., and was assigned as Chief of the Engineering Branch of the Construction Division of the Southwest Pacific area. In August 1944 Rice became a negotiator with the Price Adjustment Board for the South Atlantic Division, under Maltby. His testimony was taken by deposition and his opinion as to the reasonableness of Kerrigan's salary was in answer to a hypothetical question.Upon the basis of the entire record, giving due consideration to the fact that Kerrigan was the sole owner of petitioner, that no dividends were paid, and that Kerrigan was the sole executive, and to his industry, experience, ability, the long hours he devoted to the business, 575 the added responsibility imposed upon him in successfully producing for the war effort, and the amount of petitioner's net earnings and sales and according due weight to the opinions of the expert witnesses and all other relevant factors, we have found as a fact a reasonable compensation for the services which Kerrigan rendered to petitioner in the taxable years 1941, 1942, and 1943 to be the respective amounts of $ 15,000, $ 20,000, and $ 25,000. We hold such amounts to constitute ordinary and necessary business100 expenses, deductible in the respective taxable years under section 23 (a) (1) (A) of the Internal Revenue Code.The second issue involves the question of the amounts petitioner is entitled to deduct in the taxable years 1942 and 1943 as rental for the use of certain trucks owned by Kerrigan and leased to petitioner.In 1942 Philip Kerrigan, Jr., rented to petitioner a 1/2-ton truck and a 1 1/2-ton truck. The latter was purchased early in 1942. Kerrigan had no written lease or agreement as to a fixed rental, but charged petitioner what he thought it would cost the latter for cartage by commercial companies. In 1942 petitioner paid Kerrigan as rental for the use of such trucks the sum of $ 5,590.91. This transaction was not one entered into at arm's length. Nevertheless we think petitioner is entitled to a deduction of an amount approximating what it would be required to pay commercial companies for similar services.The record shows that the Office of Price Administration had established a regulation fixing the base rental to be charged for various types of trucks. The rate fixed for trucks of the type here in question was $ 85 for the 1/2-ton truck and $ 150 for the 1 1/2-ton101 truck, on the basis of a 30-day month of 240 hours. Petitioner's plant was operated on a 24-day work month, so that the proportionate rate would be four-fifths of $ 85 and $ 150, or $ 68 per month for the 1/2-ton truck and $ 120 for the 1 1/2-ton truck. The 1/2-ton truck was available for the entire year, so that the base rental would be $ 816 ($ 68 x 12). The 1 1/2-ton truck was purchased early in 1942, and on a basis of 8 months the base rental for such truck would be $ 960 ($ 120 x 8). The total rental for the two trucks would be $ 1,776. It is stipulated that Kerrigan expended for drivers, operation, maintenance, repairs, insurance, etc., the sum of $ 3,152.26 in 1942. The base rental of $ 1,776, plus the expenses of $ 3,152.26, makes a total of $ 4,928.26, which amount we have found as a fact was the reasonable rental value of the two trucks used by petitioner in 1942.In the taxable year 1943 Kerrigan leased to petitioner three trucks, the 1/2-ton truck and two 1 1/2-ton trucks. The latter two trucks Kerrigan had purchased in April 1943. Petitioner paid Kerrigan for the use of the three trucks the sum of $ 8,906.27. It is stipulated that Kerrigan expended in 1943 for102 drivers, maintenance, repairs, etc., the sum of $ 3,357.15. Using the same basis for 1943 that we have above 576 applied to 1942, the base rental for the 1/2-ton truck would be $ 816, and for each of the two 1 1/2-ton trucks the sum of $ 960, or an aggregate amount of $ 2,736. The base rental of $ 2,736, plus the expenses of $ 3,357.15, makes a grand total of $ 6,093.15, which amount we have found to be a reasonable rental value for the use of the three trucks in the taxable year 1943. The amounts of $ 4,928.26 and $ 6,093.15 constitute ordinary and necessary business expenses of petitioner, deductible in the respective years 1942 and 1943, under section 23 (a) (1) (A) of the Internal Revenue Code.The third issue presents the question whether the respondent erred in disallowing the amount of $ 2,282.48 of the $ 2,750 claimed in 1943 as rental paid to Philip Kerrigan, Jr., for the use of the so-called Northside Plant and certain equipment therein. The respondent contends that the difference between the amount he allowed and the amount claimed by petitioner was in effect a distribution of profits.In 1943 Philip Kerrigan, Jr., was urged by the Navy to manufacture pontoons. 103 The plant facilities of petitioner were not adequate to enable it to enter into such a contract. Kerrigan was able to locate only one plant in Nashville available and suitable to such production. The plant is known as the Northside Plant. A real estate agent was engaged to negotiate with its then owner for the rental of such plant. The owner was asking a monthly rental of $ 5,000, which amount was considered absurd by Kerrigan. Later the owner offered to sell, and Kerrigan purchased the plant and its equipment on November 13, 1943, for a total consideration of $ 57,602.50. Kerrigan did not want to burden petitioner's financial statement with such an obligation, and so arranged with the Third National Bank of Tennessee for a loan and purchased the plant in his individual name. The bank, as a condition to making the loan, insisted that the property be leased to petitioner at a monthly rental of $ 2,750, and that the lease be assigned to the bank as security. Kerrigan thereupon leased the plant and its equipment to petitioner for 1 year at the monthly rental of $ 2,750. The contested deduction is for the rental paid by petitioner for the month of December 1943.The contract104 with the Navy for the manufacture of pontoons was subject to cancellation at any time, and Kerrigan felt that if the contract was terminated he would not have any need for the plant. He testified that he thought the real property, which was valued at $ 46,000, would have a resale value of $ 25,000 in the event the contract was cancelled. In support of the contention that the rent paid by petitioner was reasonable under the circumstances, petitioner offered the opinion of the same three experts heretofore referred to in connection with the reasonableness of Kerrigan's salary and, in addition, the testimony of the real estate agent who negotiated the sale. All of the expert witnesses except Rice expressed the opinion 577 that the rental of $ 2,750 per month was reasonable. Rice testified that a reasonable rental would range between $ 1,500 and $ 2,500 per month. The respondent offered no witnesses with respect to this issue. At a monthly rental of $ 2,750, the annual return would be $ 33,000, which would exceed the maximum amount of risk Kerrigan was assuming in the event of immediate cancellation of the contract by the Navy. We regard such a result as too abnormal to justify105 our approval, especially since the transaction was between Kerrigan and his solely-owned corporation, and therefore not one entered into at arm's length. We find it rather difficult, in view of the evidence, to evaluate the reasonable rental under the unusual circumstances existing. However, upon considering all relevant factors and giving due weight to the opinions expressed by the expert witnesses, we have found as a fact that a reasonable rental for the month of December 1943 of the Northside Plant and equipment was $ 1,500.In so holding, it is to be understood that we are here determining only the reasonable rental for the month of December 1943, which is involved in this proceeding.We hold that petitioner is entitled to deduct the amount of $ 1,500 as an ordinary and necessary business expense incurred and paid in the taxable year 1943, under section 23 (a) (1) (A) of the Internal Revenue Code.The fourth issue presents the question whether the respondent erred in disallowing $ 2,600 of the amount of $ 3,400 claimed as a deduction for salary paid to Regina Kerrigan for 8 months of 1943.The record shows that Regina Kerrigan is a sister of Philip Kerrigan, Jr. In the taxable106 year 1943 she was 20 years of age. She had served as a director and secretary of petitioner since December 1939. As secretary, Regina Kerrigan signed the corporate minutes dictated by Philip Kerrigan, Jr., and typed by someone else. She had not received any compensation for her services as secretary in the years prior to 1943. The services she rendered as secretary were nominal. After being graduated from school she was employed in the mailing and shipping department of a Nashville department store.In 1943 Philip Kerrigan, Jr., on occasion detected the smell of whisky on the breath of the superintendent at the River Plant, and he thought it would have a good effect upon the employees in the plant if someone by the name of Kerrigan was in the office. He employed his sister Regina, and fixed her salary at $ 425 per month, which action was later approved by the directors. Regina's duties while employed at the River Plant were those of a clerk and typist. The other clerical and stenographic help employed by petitioner, with several years' experience, were paid $ 45 to $ 50 per week.Petitioner contends that the amount of $ 425 was reasonable and should be allowed because it was107 fixed by the board of directors, who 578 took into consideration the fact that Regina Kerrigan had not received any compensation for her services rendered as secretary during the period 1939 to May 1943. The record is silent as to what part of the amount fixed as salary was for back salary and what was for services currently rendered. Nor is there any evidence that there was any agreement or understanding that she was to be paid for her services in prior years.It is well recognized that directors can not legally vote to themselves or other officers compensation for past services where there is no agreement that such officers should be paid. Services must not only be valuable but shall have been rendered with the understanding and intention that they were to be paid for, or under such circumstances as would raise a fair presumption of such intention. Fitzgerald Construction Co. v. Fitzgerald, 137 U.S. 98">137 U.S. 98, 111; Church v. Harnit, 35 F.2d 499">35 F. 2d 499. Since the past services rendered by Regina Kerrigan were merely nominal and rendered while still in school or otherwise employed, and being a sister of Philip Kerrigan, 108 sole stockholder of petitioner, we think the fair presumption, under the circumstances, is that it was the intent of all parties that the services were to be gratuitous.On the basis of this record, we have found as a fact that the reasonable value of the services rendered by Regina Kerrigan for the period of 8 months in the taxable year 1943 is the sum of $ 1,600. Such amount constitutes a proper deduction for the year 1943, as an ordinary and necessary expense under section 23 (a) (1) (A) of the code.The final issue involves the propriety of respondent's disallowance of the amount of $ 500 paid by petitioner to McCarver in 1943 and claimed as a deduction as "Labor Relations Expense."In 1943 petitioner was having labor troubles. Philip Kerrigan, Jr., was advised to contact one, McCarver, who might be able to help petitioner in its labor troubles. McCarver convinced Kerrigan he could help the situation, and Kerrigan paid him the $ 500 fee he demanded. The labor disturbance did not materialize. The respondent disallowed the entire amount on the ground that the payment was not an ordinary and necessary business expense but was akin to a bribe and against public policy. We sustain*109 the respondent. We think the petitioner has failed to show that this payment was not against public policy. Therefore its deduction as an ordinary and necessary business expense incurred and paid in the taxable year 1943 is denied. See Excelsior Baking Co. v. United States, 82 F. Supp. 423">82 F. Supp. 423.If, in the recomputation under Rule 50, any increase in the deficiency in income tax for the year 1941 is shown to result from the adjustments made in accordance with our decision, such increase is hereby allowed.Decision will be entered under Rule 50. Footnotes1. Williams Tennessee Code (1934), vol. 3, § 3742.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621387/	JAMES O'CONNELL AND MARGARET MUREL O'CONNELL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentO'Connell v. CommissionerDocket No. 4524-78.United States Tax CourtT.C. Memo 1980-432; 1980 Tax Ct. Memo LEXIS 160; 41 T.C.M. (CCH) 62; T.C.M. (RIA) 80432; September 25, 1980, Filed John R. Kline, for the petitioners. Stewart C. Walz, for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined deficiencies in petitioners' income tax as follows: YearDeficiency1974$15,726.99197510,623.45161 The issues are (1) whether petitioner James O'Connell, executor of his father's estate, is taxable on the executor's fees paid by the estate in 1974 and 1975, and (2) if petitioner is taxable on such fees, whether he is entitled to any deductions for services rendered to the estate by a family-owned corporation. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. James O'Connell ("Petitioner") and Margaret Murel O'Connell, 1 husband and wife, resided in Helena, Montana, at the time they filed their petition in this case. Petitioner's father, J. E. O'Connell ("decedent"), died testate on October 8, 1972, in Helena, Montana. Decedent's Will was filed in the District Court of the First Judicial District of the State of Montana, in and for the County of Lewis & Clark (the "district court") on October 16, 1972. On November 2, 1972, decedent's Will was admitted to probate and petitioner was appointed executor. At the time of his death, decedent owned 34,423.5 shares (95.74 percent) of the total outstanding stock of Capri, Inc. 162 ("Capri") and petitioner owned the remaining shares. Petitioner is president and a full-time employee of Capri. Capri is a small holding company with interests in two insurance companies and two real estate companies, a motel located in Butte, Montana, and various rental properties. Decedent's Will authorized petitioner to redeem some of decedent's shares of Capri stock to obtain funds to pay for federal estate taxes and administration expenses. Any remaining Capri stock was left in trust for the benefit of decedent's ex-wife, petitioner, petitioner's children, and petitioner's grandchildren. On June 27, 1973, petitioner, as executor, entered into an agreement ("Agreement") with Capri wherein he agreed to pay Capri his executor's fees of $141,000, 2 plus an additional $14,000 of extraordinary fees for accounting and appraisal services, for services to be performed by Capri for decedent's estate. Because the Agreement is the focal point of the dispute in his case, it is reproduced here in full: THIS AGREEMENT, made and entered into this 27th day of June, 1973, by and between163 JAMES O'CONNELL as Executor of the ESTATE OF J. E. O'CONNELL, deceased, hereinafter referred to as "Executor" and CAPRI, INC., a Delaware Corporation, with principal place of business in Helena, Montana, hereinafter referred to as cCapri". WITNESSETH: WHEREAS, J. E. O'Connell died testate on the 8th day of October, 1972, in the City of Helena, State of Montana; and WHEREAS, the Executor was appointed Executor under the Last Will and Testament of the said J. E. O'Connell; and WHEREAS, Letters Testamentary were issued to the Executor on the 2nd day of November, 1972, and the Executor has served since that date; and WHEREAS, the Executor is the President of and a full time employee of Capri, and as such dedicates his entire time and talents to the business of Capri; and WHEREAS, the Executor has engaged the employees of Capri to work on the Estate of J. E. O'Connell and has used the facilities of Capri for the administration of the Estate during working hours; and WHEREAS, the Capri, Inc. stock is the subject of a Trust under the Will of J. E. O'Connell for the benefit of others as well as the Executor; NOW, THEREFORE, Executor agrees that in consideration of: his continued164 employment with Capri; the use of Capri's facilities and employees in the administration of the estate and because of this fiduciary relationship both in respect to the Estate and the Trust created under the Will to which the Capri stock is to be distributed, he will pay to Capri his Executor's fee in the total amount of $141,000.00 and an additional amount of $14,000.00 for extraordinary accounting and appraisal services on the following terms and conditions: I. Allocation of FeeIt is agreed that the fee will be paid in equal annual installments of $31,000.00 per year for a period of five years, the first such payment to be made in the month of June, 1973, and a like amount each June thereafter until the final payment is made in June, 1977. II. Duties of CapriIt is agreed that Capri will afford the Executor time during business hours to administer the Estate of J. E. O'Connell, deceased, and will likewise furnish any or all of its employees upon the request of the Executor to perform accounting and appraisal services for the Executor. It is further agreed that the physical facilities of Capri shall be made available to the Executor for use in administering165 the Estate. III. Term of ContractIt is understood that the Estate will be in the process of administration for a minimum of ten years in that the Estate has elected to pay the Federal Estate Tax in installments and in addition has elected to delay the payment of Estate Tax on the reversionary interest in a Trust until six months after reversion of said interest. Capri agrees to make its employees and facilities available for the administration of the Estate, the redemption of stock to pay costs of administration, and for any and all other services necessary in administering or executing the Estate of J. E. O'Connell, deceased. IV. Binding EffectThis contract shall extend to and be binding upon the successors and assigns of the respective parties hereto. V. Effective DateThis contract shall be effective upon the receipt of Court approval. IN WITNESS WHEREOF, this contract has been signed and delivered the day and year first above written. /s/ James O'Connell / JAMES O'CONNELL Executor of the Estate of J. E. O'Connell, Deceased CAPRI, INC. /s/ By James O'Connell / JAMES O'CONNELL President Capri could not, pursuant to Montana law, 166 act as executor of the estate. On June 29, 1973, petitioner filed his First Accounting in which he requested approval of the Agreement. On July 13, 1973, the district court approved the Agreement. On June 13, 1974, the estate paid $31,405,34 to Capri. The check stub for this payment read: 31,405.34 in full payment ofExecutor & Actg. FeeInstallment$31,000.00 3HousekeeperLabor & Taxes405.34$31,405.34The estate's Journal reflected this payment as "Housekeeper Expense Executor & Actg. Fee." Both the Journal entry and the check stub were included in petitioner's Third Accounting and approved by the district court. On June 13, 1975, the estate paid $31,000 3 to Capri. The check stub for this payment read "Annual Installment for Accounting Fee & Executor Fee." The Journal entry for this payment stated: "Capri, Inc. Annual Installment for Accounting & Executor Fees." Both the Journal entry and the check stub were included in petitioner's Fifth167 Accounting and approved by the district court. Capri included these payments from the estate in its gross income in 1974 and 1975. Petitioner as executor was responsible for marshalling the estate's assets, paying the estate's debts and taxes, preserving the assets from waste, preparing and presenting to the probate court an inventory and accountings, and distributing the residue. 3a Petitioner could not have administered the estate without assistance. On October 9, 1972, the day after decedent's death, Capri began rendering services to the estate. However, no fee arrangement for such services was decided upon until the Agreement was executed on June 27, 1973. Capri was uniquely qualified to assist in the probate of the estate because its stocks were a major asset in the estate and because its employees were familiar with all the assets in the estate. The employees of Capri, and the work each did on the estate, are as follows: 168 Petitioner (the president, whose work for Capri consisted primarily of investment management for the two insurance companies which Capri owned in whole or in part) dealt primarily with the estate's investments. He managed the investments, decided which assets to sell in order to raise cash to pay debts and taxes, and made certain reinvestment decisions. Martha Farmer (bookkeeper for Capri) did primarily bookkeeping for the estate. She established and kept a set of double entry books, made monthly statements, evaluated the estate's stocks and bonds monthly, kept a running balance of the amounts in the estate's bank accounts, kept a cash journal, handled the estate's banking and reconciled bank statements, handled the mechanics of stock sales and Capri stock redemptions, assisted in preparing semi-annual accountings submitted to the probate court, assisted in preparing the Federal estate tax return, assisted in preparing the inventory submitted to probate court, and testified at the Tax Court case concerning the valuation of the estate's assets. Wanda Radley (Capri's secretary) did secretarial work for the estate. Don Campbell (Capri's vice president and comptroller) is169 a C.P.A. He did primarily accounting and tax work for the estate. He worked with Martha Farmer in setting up the estate's books and journal, caused the estate to elect to pay estate tax over 10 years, prepared all estate income tax returns and decedent's final income tax return, worked with appraisers in preparing the inventory of the estate's assets, did tax research, prepared an annual report for the estate, made a valuation of the estate's assets both as of the date of death and alternative valuation date, reviewed semi-annual accountings presented to the probate court, determined whether to take expenses as deductions on the estate tax return or the income tax returns, estimated the estate's tax liabilities and the estate's revenues, handled the audit of the estate's income tax returns, assisted in the preparation of the estate's Montana Inheritance Tax Return, settled decedent's federal gift tax controversy, and handled the audit of the estate tax return from the time the estate tax examiner audited it until it was to be litigated in the Tax Court. (The estate was represented by the law firm of Kline & Niklas throughout its probate for which the firm received extraordinary170 fees for legal services it performed.) None of Capri's employees, except petitioner, received payments from the estate. All are paid salaries by Capril. Capri used its office facilities and equipment in the probate of the estate. In addition, Capri used its company car and paid some of the travel expenses incurred in connection with the probate of the estate. Capri charges a fee to the insurance companies in which it holds an interest and to petitioner for services it renders to them. Capri also charged decedent for services rendered to him prior to his death. Had Capri's facilities and employees been unavailable to the estate, petitioner would have had to hire an accounting firm and a trust company to assist him. An accounting firm would have charged him approximately $160,000 to prepare all tax returns and do the work needed to prepare for audits and the litigation of the Tax Court case. A trust company would have charged him $136,650 for the period 1973 through 1978 only to take custody of and manage all the securities, handle security sales and purchases, given investment advice, and provided detailed accountings.The $155,000 paid to Capri for the services it rendered171 was reasonable. Petitioner did not waive his executor's fees; instead he received them and then paid them over to Capri, in accordance with the Agreement, for services rendered by Capri. In his statutory notice for the years 1974 and 1975, respondent determined that petitioner had failed to include in income executor's fees of $28,200 each year. OPINION The issues for determination are (1) whether petitioner is taxable on the executor's fees paid by the estate in 1974 and 1975, and (2) if petitioner is taxable on those fees, whether he is entitled to deduct the amounts paid to Capri for the services it performed. Both parties agree that income is taxable to him who earns it. Lucas v. Earl,281 U.S. 111">281 U.S. 111 (1930). Petitioner asserts that Capri earned the fees paid to it, and, under the principles set forth in Lucas v. Earl, he cannot be taxed on income earned by Capri. Respondent, on the other hand, maintains that the executor's fees paid by the estate in 1974 and 1975 are taxable to petitioner because he earned them. We agree with respondent.Gross income172 means all income from whatever source derived, including compensation for services such as fees and commissions. Sec. 61(a)(1). Fees and commissions earned as an executor of an estate are income to the executor. The executor must recognize as income fees and commissions either actually or constructively received by him. Sec. 1.451-2, Income Tax Regs.Petitioner was named executor in the decedent's will and was appointed the executor by the district court.Petitioner has at all times since his appointment acted as executor of the estate. Petitioner submitted documents to the district court which he signed as executor. Petitioner, as executor, signed all federal and state tax returns. Capri, the only other party that might arguably have been the executor, could not, pursuant to Montana law, act as executor of the estate. The Agreement between the estate and Capri dated June 27, 1973, was signed by petitioner as executor and as president of Capri. In that Agreement petitioner specifically agreed to "pay to Capri his Executor's fee in the total amount of $141,000." Petitioner paid Capri five payments of $31,000 each; $28,200 of each payment was one-fifth173 of the total amount ($141,000) of executor's fees allowed under Montana law in the absence of a provision in the will providing for other compensation. 4Mont. Rev. Codes Ann. §§ 91-3405 and 91-3407. The remaining $2,800 per year was for extraordinary accounting and appraisal services. In the estate's Journal for 1974 the $31,405.34 payment was recorded for "Housekeeper Expense Executor & Actg. Fee." In 1975 the Journal entry for the $31,000 payment read "Capri, Inc. Annual Installment for Accounting & Executor Fees." Petitioner submitted these entires to the district court on his periodic accountings and the court approved them. Petitioner made numerous arguments why he should not be taxed on his executor's fees. First, petitioner argues that he waived his executor's fees. Second, petitioner claims that Capri earned the fees paid to it and was taxable on them, and petitioner cannot also be taxable on those fees. Third, petitioner claims that he assigned both his right to the executor's fees and his obligations as executor to Capri, and an assignment of the right to earn174 income is not a prohibited assignment of income under Lucas v. Earl. Fourth, petitioner argues that the Agreement is a covenant not to compete between petitioner and Capri pursuant to which petitioner is obligated to turn over to Capri any executor's fees he earns. Petitioner first argues that he waived his executor's fees. If an executor clearly establishes as intent to waive his executor's fees prior to rendering substantial services to the estate, he will not be treated as constructively receiving fees or commissions for his services. Breidert v. Commissioner,50 T.C. 844">50 T.C. 844 (1968). Petitioner argues that he specifically waived his executor's fees in the Agreement, that he had no intention of receiving any executor's fees and that he has received no executor's fees. We find, however, that petitioner did not waive his executor's fees in the Agreement nor did he intend to waive his executor's fees. Petitioner's intent to pay "his Executor's fee" to Capri is established by the clear language in the Agreement and by petitioner's accountings and reports to the district175 court. Petitioner argues that the language of the Agreement merely creates an ambiguity as to what was intended by the Agreement. The use of "his Executor's fee" in the Agreement he calls "unfortunate." According to petitioner's testimony, the Agreement was not executed with the present situation in mind. Don Campbell testified that the Agreement was entered into to avoid the possibility that there was a constructive dividend from Capri to the estate or petitioner, based on the value of the services rendered by Capri to the estate. We conclude that the effect of the Agreement was to compensate Capri for the services it would render to the estate on behalf of petitioner in his capacity as executor. Petitioner's second argument is that if Capri earned the fees paid to it, then Capri properly reported the fees and petitioner cannot be taxed on income earned by Capri. That simply is not so. Petitioner earned the income for acting as executor; Capri earned the income as compensation for services performed for the executor. Petitioner's third argument is that, if he assigned his executor's fees to Capri, he also assigned the obligation to perform the executor's services to Capri. 176 Petitioner cites Iowa Bridge Co. v. Commissioner,39 F. 2d 777 (8th Cir. 1930), as authority for the proposition that a valid assignment of an entire contract will shift the contract income to the assignee. To come under Iowa Bridge Co. v. Commissioner,supra, petitioner must assign both the rights and obligations under a contract. Petitioner did not do so in this case. Compare National Contracting Co. v. Commissioner,105 F. 2d 488 (8th Cir. 1939). Petitioner was and remained executor, and alone was responsible as such. He merely hired Capri to work for him in carrying out his duties as executor. Petitioner's fourth and final argument is that the Agreement is actually a covenant not to compete between himself and Capri.We find no merit in this argument. The Agreement is a contract for services from Capri. There is no language indicating that the Agreement or any part of it is a covenant not to compete. Having concluded that petitioner is taxable on the $28,200 of executor's fees paid by the estate in each of 1974 and 1975, we turn to the second issue, whether petitioner is entitled to deduct those amounts which under177 the Agreement he paid to Capri for services rendered by Capri.Section 212(1) provides that an individual may deduct all ordinary and necessary expenses paid by him during the taxable year for the production or collection of income. Rev. Rul. 55-447, 2 C.B. 533">1955-2 C.B. 533, provides that where an executor of an estate, who receives executor's fees from the estate, makes payments from his own funds to co-executors or others for their experienced assistance to him in the administration of the estate, such assistance made necessary because of their greater familiarity with the problems of the estate, the payments so made are deductible in the year made as nontrade or nonbusiness expenses incurred in the production of income. So here petitioner paid Capri for services to help him perform his duties as administrator. The amount paid for those services was reasonable. Moreover, at least $28,200 worth of those services in each year were for services for which the executor was compensated by his executor's fees and for which the estate could not be charged an amount in addition to his178 executor's fees. Under the circumstances petitioner is entitled to a deduction for the $28,200 in issue in each of 1974 and 1975. Decision will be entered under Rule 155. Footnotes1. Margaret Murel O'Connell is a petitioner solely by virtue of having filed a joint return with her husband.↩2. The executor's commissions were calculated under Mont. Rev. Codes Ann. § 91-3407 (1947).↩3. $28,200 of each $31,000 installment represents executor's fees; only these fees are in issue. The remainder represents extraordinary fees paid to Capri for accounting and appraisal services.↩3. $28,200 of each $31,000 installment represents executor's fees; only these fees are in issue. The remainder represents extraordinary fees paid to Capri for accounting and appraisal services.↩3a. Mont. Rev. Codes Ann. § 91-3201 (1947).↩4. The decedent's will in this case contained no provision providing for other compensation.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621390/	Urantia Foundation, Petitioner v. Commissioner of Internal Revenue, RespondentUrantia Foundation v. CommissionerDocket No. 2480-81XUnited States Tax Court77 T.C. 507; 1981 U.S. Tax Ct. LEXIS 68; August 27, 1981, Filed 68 P was organized to publish and sell The Urantia Book, and the IRS determined that it was an exempt organization described in sec. 501(c)(3), I.R.C. 1954, and that it was not a private foundation within the meaning of sec. 509(a)(2), I.R.C. 1954. Later, P requested a ruling that for purposes of applying the public support test of sec. 509(a)(2), the customers who ultimately purchased the book should be considered the persons to whom P's sales were made, not the chain bookstores which purchased the book from P and sold it to such customers. However, the IRS ruled that the chain bookstores must be considered the purchasers for such purposes. Held, the Court lacks jurisdiction to review such ruling since it was not a determination with respect to the exemption or classification of P. John F. Beggan and Quin R. Frazer, for the petitioner.Carolyn A. Boyer and Virginia C. Schmid, for the respondent. Simpson, Judge. SIMPSON508 OPINIONThis is an action for declaratory judgment under section 7428 of the Internal Revenue Code of 1954. 1 We have before us at this time the Commissioner's motion to dismiss for lack of jurisdiction. The petitioner has filed an objection to the motion, and a hearing was held on the matter.The petitioner, Urantia Foundation, is a trust with its principal offices in Chicago, Ill. Its charitable purpose is to publish and sell The Urantia72 Book, a religious-philosophical work.In 1959, the Internal Revenue Service determined that the petitioner was a tax-exempt organization described in section 501(c)(3), and in 1970, the IRS determined that the petitioner was not a private foundation because it met the public support test set forth in section 509(a)(2)(A). Such section states in relevant part:(a) General Rule. -- For purposes of this title, the term "private foundation" means a domestic or foreign organization described in section 501(c)(3) other than -- * * (2) an organization which -- (A) normally receives more than one-third of its support in each taxable year from any combination of -- * * (ii) gross receipts from admissions, sales of merchandise, performance of services, or furnishing of facilities, in an activity which is not an unrelated trade or business (within the meaning of section 513), not including such receipts from any person, or from any bureau or similar agency of a governmental unit (as described in section 170(c)(1)), in any taxable year to the extent such receipts exceed the 509 greater of $ 5,000 or 1 percent of the organization's support in such taxable year,from persons73 other than disqualified persons (as defined in section 4946) with respect to the organization, from governmental units described in section 170(c)(1), or from organizations described in section 170(b)(1)(A) (other than in clauses (vii) and (viii)) * On May 8, 1980, the petitioner requested from the IRS a ruling that when the petitioner sells copies of The Urantia Book to a chain of bookstores, the chain bookstores shall not be considered the "person" to whom the sales are made for purposes of applying the limitations of section 509(a)(2)(A)(ii), but that the sales shall be considered to be made to the individuals who are the ultimate purchasers of the book. However, on November 13, 1980, the IRS issued a ruling denying the petitioner's requests. The ruling stated in part:We * * rule that the chain bookstores and not the individual purchasers, are the persons described in section 509(a)(2) of the Code and that sales to them must be taken into consideration when applying the * * * test of section 509(a)(2) of the Code.In its petition in this Court, the petitioner asks that we declare such ruling invalid.Section 7428 provides, in part: (a) Creation of Remedy. 74 -- In a case of actual controversy involving --(1) a determination by the Secretary -- (A) with respect to the initial qualification or continuing qualification of an organization as an organization described in section 501(c)(3) which is exempt from tax under section 501(a) or as an organization described in section 170(c)(2), [or](B) with respect to the initial classification or continuing classification of an organization as a private foundation (as defined in section 509(a)), * ** * * (2) a failure by the Secretary to make a determination with respect to an issue referred to in paragraph (1),upon the filing of an appropriate pleading, the United States Tax Court * * may make a declaration with respect to such initial qualification or continuing qualification or with respect to such initial classification or continuing classification. Any such declaration shall have the force and effect of a decision of the Tax Court * * * and shall be reviewable as such. For purposes of this section, a determination with respect to a continuing qualification or continuing classification includes any revocation of or other change in a qualification or classification.(b) Limitations. 75 --510 * * * (2) Exhaustion of administrative remedies. -- A declaratory judgment or decree under this section shall not be issued in any proceeding unless the Tax Court * * determines that the organization involved has exhausted administrative remedies available to it within the Internal Revenue Service. An organization requesting the determination of an issue referred to in subsection (a)(1) shall be deemed to have exhausted its administrative remedies with respect to a failure by the Secretary to make a determination with respect to such issue at the expiration of 270 days after the date on which the request for such determination was made if the organization has taken, in a timely manner, all reasonable steps to secure such determination.In his motion to dismiss, the Commissioner argues that for purposes of section 7428, there is no "actual controversy" in this case since the petitioner's classification as an organization other than a private foundation has not yet been revoked. The Commissioner also argues that for purposes of section 7428, there has been no "determination" in this case by him.In support of his arguments, the Commissioner relies primarily 76 upon the decision of this Court in New Community Sr. Citizen Housing Corp. v. Commissioner, 72 T.C. 372">72 T.C. 372 (1979). There, in 1976, the organization was determined by the IRS to be an exempt organization described in section 501(c)(3). Subsequently, the organization requested from the IRS a ruling as to whether certain proposed transactions would jeopardize the exemption. The IRS ruled that the proposed transactions would jeopardize the exemption, and thereafter, the organization filed its petition for declaratory judgment. After the filing of the petition, but before the hearing on a motion to dismiss by the Commissioner, the proposed transactions were completed.On the facts in New Community, we held that we did not have jurisdiction to issue a declaratory judgment since the ruling of the IRS had not actually revoked the exemption of New Community. 72 T.C. at 375. We stated that:Congress was primarily concerned that a taxpayer have judicial review of respondent's determination that it is not exempt from tax * * A reasonable reading of the quoted provisions indicates that Congress intended to limit declaratory judgment77 proceedings to issues involving the initial or continuing tax-exempt qualification of the organization. * * The evil associated with a revocation of tax-exempt status -- a loss of a 511 deduction for contributions to the organization -- is simply not present in this case. * * * [72 T.C. at 375-376.]We also observed:Finally, Rule 210(b)(8)(iv), Tax Court Rules of Practice and Procedure, provides that a "determination" means: "A determination with respect to the * * * continuing qualification of an organization as an exempt organization." Rule 210(b)(9) defines a "revocation" as: "a determination * * * that an organization, previously qualified as an exempt organization * * , is no longer qualified or classified as such an organization." * * [72 T.C. at 376.]In J. David Gladstone Foundation v. Commissioner, 77 T.C. 221">77 T.C. 221 (1981), we again dealt with our jurisdiction to issue declaratory judgments under section 7428. In that case, the organization was determined in 1973 to be an exempt organization described in section 501(c)(3) and not to be a private foundation under section 509(a)(1). 78 In August 1977, the IRS sent the organization a letter proposing to revoke its classification under section 509. In September 1977, the organization filed a written protest, but in January 1980, it was notified that the District Director in Los Angeles had been instructed by the National Office of the IRS to issue a final determination letter revoking the classification. In March 1980, the organization filed its petition for declaratory judgment, and in May 1980, the IRS issued a final determination letter revoking the classification of the organization as of January 1, 1976. After the determination letter was issued, the organization filed a second petition.Although the first petition in Gladstone was filed before the IRS finally revoked the classification of the organization as a nonprivate foundation, we held that we had jurisdiction of such petition. We reasoned that the organization's protest letter of September 1977 constituted a request for determination under section 7428 and that since the IRS had not issued a final determination within 270 days of such request, we were vested with jurisdiction. 77 T.C. at 233. We reached such result 79 specifically without regard to the second petition or to the May 1980 revocation.In Gladstone, we recognized that in New Community we had declined to review an adverse ruling by the IRS where there had been no actual revocation, but we distinguished New Community: we stated that in New Community the IRS had taken no steps to revoke the exemption of the organization, 512 whereas in Gladstone, the IRS had proposed to revoke the classification of the organization. 77 T.C. at 228.We have reviewed our opinions in New Community and Gladstone and conclude that the facts herein do not present a case of which we have jurisdiction: at this time, there is no "actual controversy" within the meaning of section 7428(a), and there has not been a determination, or a request for a determination, which is reviewable under such section. As we have held in New Community, we do not have jurisdiction unless there has been a determination or a request for one, and a determination within the meaning of section 7428(a) deals directly with the exemption or classification of the organization. The ruling in New Community did not deal directly80 with either such issue. In Gladstone, we held that we had jurisdiction without regard to the final determination revoking the classification of the organization, but in that case, the IRS had initiated the proceedings questioning the classification of the organization; thus, the classification of the organization was at issue. In this case, the petitioner has not requested a determination dealing directly with its classification as a nonprivate foundation, and the IRS has not initiated any proceeding challenging its classification.The petitioner contends vehemently that the ruling by the IRS threatens its way of doing business and its procedures for carrying out its charitable purposes. In its request for ruling and argument before this Court, the petitioner alleges that there have been significant changes in the book-selling business. According to the petitioner, at an earlier time, there were many independent bookstores, but in recent years, those independent bookstores have been acquired by several large chains of bookstores. Today, the most efficient means of selling The Urantia Book is to deal with the large chain bookstores; yet, if each chain is considered a person81 for purposes of applying the $ 5,000 and 1-percent limitations, there is a real risk that the sales to a chain will exceed those limitations and that the excess sales would not be considered public support within the meaning of section 509(a)(2)(A). Thus, the petitioner vigorously maintains that the IRS ruling jeopardizes its classification as a nonprivate foundation and that, therefore, the Court has jurisdiction to review such ruling.We recognize that if we do not review the ruling, the petitioner may be forced to choose between carrying on its 513 operations in its customary manner with the risk of losing its classification as a nonprivate foundation or finding some new means of distributing its book. Yet, at this time, we cannot anticipate with any degree of certainty the actions the petitioner will take. When it is forced to choose between the available options, there is the possibility that the petitioner may find some other means of effectively distributing the book. At this time, we do not know whether the sales to any particular chain will exceed the $ 5,000 or 1-percent limitation, the extent to which they will exceed such limitations, the effect of any excess82 sales to a chain on the application of the one-third test, or when, if ever, the combination of circumstances will cause the petitioner no longer to qualify as a nonprivate foundation. Despite the problems which the IRS ruling will no doubt cause the petitioner, we cannot now conclude that the ruling will most likely lead to its disqualification.It seems to us that the distinction between New Community and Gladstone is meaningful and should continue to be followed. A ruling by the IRS may cause problems for an exempt organization as to its exemption or classification as a nonprivate foundation, but the mere existence of such problems is not sufficient to treat such ruling as a determination subject to judicial review under section 7428. When an organization has received a determination that it is exempt and that it is not a private foundation, there is no actual controversy which gives rise to judicial review unless the IRS directly determines that the organization is no longer exempt or no longer entitled to its classification or unless there is a request for such a determination with respect to which the IRS fails to act timely. Since the ruling in this case did not83 directly deal with the exemption or classification of the petitioner, the circumstances have not ripened into an actual controversy which is cognizable in the courts.The petitioner also argues that section 7428 was enacted in response to the decision of the Supreme Court in Bob Jones University v. Simon, 416 U.S. 725">416 U.S. 725 (1974), and that therefore we should take jurisdiction of its case. See H. Rept. 94-658 (1975), 1976-3 C.B. (Vol. 2) 701, 975. In that case, in 1942, Bob Jones University was determined by the IRS to be an exempt 514 organization described in the predecessor of section 501(c)(3). In 1970, the IRS announced in a revenue ruling that racially discriminatory schools would not be considered to qualify under section 501(c)(3) and that all schools would be required to furnish proof of a nondiscriminatory admissions policy. Subsequently, Bob Jones University advised the IRS that it did not admit blacks, and as a result, the Commissioner instructed the District Director to commence administrative procedures leading to the revocation of the university's exemption. In response, the university filed suit for an 84 injunction to prevent both revocation and the threat of revocation, but the Supreme Court held that such suit was barred by section 7421(a) of the Anti-Injunction Act.Such argument does not compel the conclusion urged by the petitioner. In the first place, it is not clear that Congress meant to provide relief in the precise circumstances involved in the Bob Jones case. In section 7428, Congress laid out with some precision the conditions under which declaratory judgments are to be issued, and those conditions may not wholly coincide with the circumstances that existed in the Bob Jones case. Moreover, in Bob Jones, the Commissioner had actually commenced some actions leading to the revocation of the exemption. Accordingly, we hold that we do not have jurisdiction in this case.An appropriate order will be entered. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect during the years in issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621337/	Appeal of JOSEPH A. ANWYLL.Anwyll v. CommissionerDocket No. 1120.United States Board of Tax Appeals1 B.T.A. 772; 1925 BTA LEXIS 2810; March 16, 1925, decided Submitted February 25, 1925. 2810 Mr. Joseph A. Anwyll, the taxpayer, pro se. Ward Loveless, Esq., for the Commissioner. 772 Before GRAUPNER, LANSDON, LITTLETON, and SMITH. FINDINGS OF FACT. After an examination by a revenue agent of the taxpayer's accounts and records, the Commissioner has determined an overassessment of income tax for the year 1919 of $186.36, and deficiencies in tax for the years 1920 and 1921 of $355.77 and $543.80, respectively, or a net deficiency for the three years of $713.21. The revenue agent found that the taxpayer had no accurate books of account and the net income shown by him was verified by bank deposits and expenditures shown by canceled checks. During 1919 and 1920 the taxpayer was engaged as a sole proprietor in the manufacture and sale of ice cream. This business was sold in the early part of 1921 to the Imperial Ice Cream Co. and from the date of sale until some time in July the taxpayer was not engaged in any business. About July 15, 1921, the taxpayer and W. E. Hartley organized the Marion Bag & Paper Co., a partnership. The net income of the taxpayer, as disclosed by his income-tax return for the calendar year 1920, was $8,144.15. 2811 To this amount the revenue agent added $3,283.95. This was due to the disallowance of deductions as follows: Salaries and wages$84.37Depreciation932.62Other expense2,266.96The taxpayer filed no income-tax return for 1921, as he did not consider that any profit had been made upon the sale of his business and he had less income from other sources than the amount of the exemption to which he was entitled. The revenue agent computed his total net income at $10,415.04. Included in the gross income is a profit of $5,025.43 from the sale of the taxpayer's business to the Imperial Ice Cream Co. and $5,556.63 from the conduct of the ice cream business. The taxpayer's books of account were kept upon a receipts and disbursements basis, and during the year 1921 the taxpayer collected outstanding accounts from the sales of ice cream in 1920 of $10,322.14 and paid during the year bills appertaining to the ice cream business in the amount of $4,765.51. The difference between these items was found by the revenue agent to represent income liable to tax. The profit of $5,025.43 from the sale of the ice cream business was computed as follows: Business sold to Imperial2812 Ice Cream Co., of Fairmont, W. Va., January 1, 1921: Sale price$14,000.00Investment Jan. 1, 1918$12,400.00Additional investment in 1918350.00Additional investment in 19192,492.79Additional investment in 19202,471.18Total investment17,713.97Less depreciation8,739.408,974.57Net profit5,025.43*773 The ice cream business was acquired in February, 1913, at a cost of $3,000, and during the same year $2,000 was expended for additional equipment. In December, 1917, a competitor's business was purchased for $10,000. The revenue agent found that the depreciated cost of plant and equipment at January 1, 1918, was $12,400. The taxpayer claimed depreciation on plant and equipment in his income-tax returns for 1918, 1919, and 1920 of $8,739.40. DECISION. The Board discovers no errors in the computations of the Commissioner resulting in a net deficiency in income tax for the years 1919, 1920, and 1921, of $713.21. His determination of the net deficiency is, therefore, approved.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621338/	Richard Kovner and Joyce Kovner, Petitioners v. Commissioner of Internal Revenue, RespondentKovner v. CommissionerDocket No. 39751-85United States Tax Court94 T.C. 893; 1990 U.S. Tax Ct. LEXIS 62; 94 T.C. No. 57; June 20, 1990, Filed 62 This case was submitted for the limited purpose of deciding whether petitioner husband qualified as a "commodities dealer in the trading of commodities" as provided in sec. 108(b) of the Deficit Reduction Act of 1984, as amended by the Tax Reform Act of 1986. Petitioner husband was a commodities investor and was employed as an account executive with a brokerage firm. He was registered as an associated person with the Commodity Futures Trading Commission (CFTC) and as a registered commodity representative with the Chicago Board of Trade. He was not a member of any commodities exchange, and was not a floor trader or floor broker. He was required to use the services of a floor broker to place an order. Petitioners also invested some of their own funds in commodities straddles. Petitioner husband made the investment decisions for some of those funds, and his brother decided how to invest the remainder. Petitioners incurred substantial losses in commodities straddles transactions in 1980, for which they claimed deductions. Held, petitioner husband's status as an investor and associated person does not qualify him as a "commodities dealer in the trading of commodities" for purposes63 of sec. 108 of the Deficit Reduction Act of 1984, as amended by the Tax Reform Act of 1986. Larry Kars, for the petitioners.William F. Halley and Michael R. Rizzuto, for the respondent. Colvin, Judge. Nims, Chabot, Parker, Korner, Shields, Hamblen, Jacobs, Gerber, Wright, Parr, and Wells, JJ., agree with the majority. Swift and Ruwe, JJ., did not participate in the consideration of this opinion. Whalen, J., dissenting. Cohen and Clapp, JJ., agree with this dissent. COLVIN893 OPINIONThe sole issue for decision is whether petitioner Richard Kovner was a "commodities dealer in the trading of commodities" within the meaning of section 108(b) of the Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 630, as amended by section 1808(d) of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2817. As described below, we hold that petitioner was not a "commodities dealer in the trading of commodities" for purposes of section 108(b).The parties agreed to submit this case for the limited purpose of deciding whether petitioner was a commodities 894 dealer in the trading of commodities under section 108(b). We treat this as we would a64 motion for partial summary judgment. Other issues were left for later disposition. Thus, this opinion does not decide whether petitioners may deduct commodities losses under section 108(a).Respondent determined deficiencies in petitioners' 1980 and 1981 Federal income taxes of $ 104,528 and $ 27,831, respectively, and additional interest pursuant to section 6621(c), formerly section 6621(d).Unless otherwise noted, all section references are to the Internal Revenue Code as amended and in effect for the year at issue. Also, unless otherwise noted, the term "section 108" refers to section 108 of the Deficit Reduction Act of 1984, as amended by the Tax Reform Act of 1986.Factual BackgroundThe issue of petitioner Richard Kovner's status as a commodities dealer for purposes of section 108 was submitted fully stipulated.Petitioners resided at Emerson, New Jersey, at the time they filed their petition. Petitioners filed joint income tax returns for 1980 and 1981, the years in issue. All references to petitioner, singularly, are to Richard Kovner.1. Petitioner's Commodities Industry RegistrationsSince 1975, petitioner has been registered with the Commodity Futures Trading65 Commission (CFTC) as an associated person of Rosenthal & Co., a futures commission merchant (FCM). An associated person (AP) is a partner, officer, or employee of a futures commission merchant (or an agent thereof) who solicits or accepts customers' orders, other than in a clerical capacity (or a person who supervises persons so engaged). 7 U.S.C. sec. 6k (1981); 17 C.F.R. sec. 1.3(aa) (1981). An FCM is an individual, corporation, or partnership, etc., that engages in soliciting or accepting orders for purchase or sale of any commodity for future delivery subject to the rules of any contract market, and that, in connection with such solicitation or acceptance of orders, accepts any money, securities, or property (or extends credit in lieu thereof) to margin, guarantee, or secure any trades or contracts that result therefrom. 17 895 C.F.R. sec. 1.3(p) (1981). FCM's have been likened to brokerage houses in the securities business. See 1 P. Johnson, Commodities Regulation 101 (1st ed. 1982).Petitioner was not a member of a commodities exchange (i.e., a contract market). A member of a contract market is an individual, corporation, partnership, 66 etc., who owns or holds membership in a contract market or who is given members' trading privileges thereon. 17 C.F.R. sec. 1.3(q) (1981).Petitioner was not a floor trader. A floor trader is a member of a contract market who, on the floor of such market, executes a futures trade or a commodity option transaction for his own account or an account controlled by him, or has such a trade made for him. 17 C.F.R. sec. 1.3(x) (1982).Petitioner was not a floor broker. A floor broker is any person who, in or surrounding any pit, ring, post, or other place provided by a contract market for the meeting of persons similarly engaged, purchases or sells for any other person any commodity for future delivery subject to the rules of any contract market. 17 C.F.R. sec. 1.3(n) (1981).Petitioner, as an associated person employed by a futures commission merchant, was required to use the services of floor brokers to execute orders.On January 5, 1976, petitioner registered as a registered commodity representative (RCR) on the Chicago Board of Trade (CBOT). As defined by CBOT rules and regulations (CBOT rule 938.00), an RCR is a member or nonmember who solicits, accepts, or services business for67 a member. Petitioner's registration remained in effect until March 11, 1986. The CBOT also requires registration of members, membership interest holders, floor clerks, and broker's assistants.Only a member can conduct transactions or execute orders in securities or commodities upon the floor of the CBOT. CBOT rule 301.00. There are three types of membership: full, associate, and conditional associate. Certain restrictions apply to floor trading by associate and conditional associate members. CBOT rules 211.00 and 212.00. Associate memberships are issued in 1/4 participation (membership interests) and are freely transferrable to any approved applicant. CBOT rule 211.00.896 Neither the CFTC nor the CBOT limit contract market memberships to those employed in particular occupations or living in specific geographic areas. See 17 C.F.R. sec. 1.3(q); CBOT rule 200.00 et seq. 168 Petitioner was also registered during 1976 with the Chicago Mercantile Exchange (CME). Both the CBOT and CME are domestic boards of trade and are designated as a contract market by the CFTC.2. Petitioner's Entry Into the Commodities Industry and Employment With Rosenthal & Co.In 1976 and 1977, petitioner engaged in a program of learning and studying the commodities market. He read commodities books and periodicals, made contacts in the commodities industry, and began to keep commodity price charts. In addition, he also began "paper trading," i.e., imaginary trading. In 1978, petitioner began to engage in commodities transactions on his own account. Petitioner decided which commodities to buy and sell.During 1980 and 1981, petitioner was employed as an account executive by Rosenthal & Co. (Rosenthal). As a futures commission merchant (FCM), Rosenthal was in the business of executing, as agent, commodities futures contracts at the direction of and for the account of its customers. Petitioner's responsibilities as an account executive included: soliciting customers for the purpose of opening commodity futures trading accounts with Rosenthal, providing information to customers69 regarding trends and other developments affecting various commodities, making recommendations regarding the purchase or sale of particular commodity futures contracts, and accepting and placing orders on behalf of customers.Petitioner was a salesman for Rosenthal. He placed orders for customers, which were then forwarded to the trading floor for execution.To place an order for customers, petitioner wrote an order ticket which reflected the commodity, quantity, and price of 897 the futures contract to be purchased or sold. The order ticket was then given to the Rosenthal order desk which transmitted the information to the appropriate exchange floor where it was executed by a floor broker. As an account executive, petitioner received a percentage of gross commissions generated on trades executed on behalf of and for the account of customers.Throughout the 1980-81 period, petitioner had about 8-12 customers, mostly friends and family. These included his brother-in-law, Jeffrey Bender; his father, Isidore Kovner; his accountant, Elliot Goldberg; as well as individual accounts for his business associates Michael Appell and Harvey Klaris. Petitioner made the investment decisions70 for these accounts.Petitioner placed orders for contracts listed on most U.S. exchanges designated as contract markets by the CFTC. During 1980-81, petitioner placed orders for regulated futures contracts virtually every day. He was engaged approximately 50-60 hours per week in placing orders for commodities, monitoring commodities markets, and providing related advice to customers.3. Kovner Associates and ComartIn 1980, petitioner formed Kovner Associates, Inc., to invest in commodities for himself and others. In 1981, the corporation's name was changed to Comart, Inc.Comart sought to match clients with commodities brokers best suited to their needs.Although the tax years at issue here are 1980 and 1981, we note that in 1983 Comart became an introducing broker with the CFTC. An introducing broker is any person who, for compensation or profit, solicits or accepts orders for the purchase or sale of any commodity for future delivery subject to the rules of any contract market and who does not accept money, securities, or property (or extend credit in lieu thereof) to margin, guarantee, or secure any trades or contracts that result therefrom. An introducing broker71 does not include a futures commission merchant, floor broker, or associated person acting in its capacity as such. 17 C.F.R. sec. 1.3(mm). Comart was also a member of the National Futures Association.898 4. Petitioners' Commodities AccountsPetitioners had three separate investment accounts. The sole name on the first account was petitioner's wife, Joyce Kovner. Upon inception, this account had approximately $ 20,000 in equity. As the market fluctuated, the equity ranged between $ 6,064 and $ 66,599. Petitioner made the investment decisions for this account.The sole name on the second account was also Joyce Kovner. Petitioner's brother, Bruce Kovner, made the investment decisions for that account under a power of attorney. The equity in this account ranged from $ 115,000 to $ 140,000.The third account was held by MNA Commodities Investors (MNA). MNA was a partnership engaged in buying and selling commodities of which petitioner was the managing partner. Petitioners invested $ 50,000 of the initial $ 165,000 total capital invested in MNA, and the other partners contributed the balance. Petitioner made the investment decisions for this account, placed the orders, 72 and managed the partnership.Petitioners had approximately $ 171,000 to $ 266,000 of their own funds in commodities markets during 1980 and 1981. This represented a substantial part of their net worth at that time. During this time, petitioner received most of his earnings from commodities transactions.5. Summary of Petitioners' Commodities AccountsPetitioners' accounts are summarized below:Did petitioner makeinvestment accountAccount amountdecisions for theAccount(Equity range)account?Rosenthal --$ 6,000$ 66,600yesJoyce KovnerCargill -- Joyce Kovner115,000140,000noCargill -- MNA50,0001 59,400yesTotal171,000266,000899 DISCUSSIONThe sole issue for decision is whether petitioner is a "commodities dealer in the trading of commodities" within the meaning of section 108(b) of the Deficit Reduction Act of 1984, as amended by the Tax Reform Act of 1986.1. BackgroundIn 1981, Congress was concerned about the rapid growth in use of commodities spreads and straddles73 as a tax shelter. The Ways and Means Committee Report for the Tax Incentive Act of 1981, which was their report for the bill that later became the Economic Recovery Tax Act of 1981 (ERTA), states in pertinent part:The committee is concerned about the rapidly increasing use of transactions in commodity-related property to shelter unrelated income from taxation. Such shelters, usually structured as straddles or spreads, have been used by both individual and corporate taxpayers to defer income and frequently to convert ordinary income or short-term capital gain into long-term capital gain. These shelters have been widely publicized, promoted by brokerage firms and offered as limited partnership interests in domestic and off-shore syndicates. The growth of these shelters threatens to undermine the integrity of the United States' voluntary tax-assessment system and to create substantial revenue losses. [H. Rept. 97-201, at 198 (1981).]In a similar vein, the Senate Finance Committee Report for ERTA states that:In the last ten to fifteen years, the use of * * tax shelters in commodity futures has extended beyond investment professionals to significant numbers of taxpayers, individual74 and corporate, throughout the economy. The tax advantages of spread transactions, especially those structured in commodity futures contracts, have been touted in commodity manuals, tax services and financial journals. Brokerage firms have promoted tax spreads or straddles to their clients. Domestic and offshore syndicates have advertised tax straddle shelters for which purchasers pay a fee in an amount equal to a percentage of their desired tax loss. [S. Rept. 97-144, at 146 (1981).]As a result of these concerns, Title V of ERTA, Pub. L. 97-34, 95 Stat. 172, contained provisions to prevent the deferral of income and conversion of ordinary income and short-term capital gain into long-term capital gain through commodities transactions.900 The 1981 commodities straddles provisions did not provide rules for disposition of pre-ERTA straddles cases then before the Internal Revenue Service. In 1984, the Senate Finance Committee believed that there were too many of these cases still remaining at the Internal Revenue Service. Its version of the Deficit Reduction Act of 1984 included a provision to require the Secretary of the Treasury to report to the tax-writing committees of75 Congress on the status of those cases. H. Rept. 98-861 (Conf.), at 917 (1984), 1984-3 C.B. (Vol. 2) 171. The conference agreement substituted a provision intended to reduce the number of remaining pre-1982 cases. Sec. 108; H. Rept. 98-861 (Conf.), supra.2. Deficit Reduction Act of 1984 -- Section 108Section 108(a) of the Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 630, generally permitted the deductibility of losses incurred on the disposition of one or more positions entered into before 1982 and which form part of a straddle, if the position was part of a transaction entered into for profit. Section 108(b) of the Deficit Reduction Act of 1984, as applied to commodities dealers and persons regularly engaged in investing in regulated futures contracts, created a rebuttable presumption that the transaction was entered into for profit.For the text of section 108(a), (b), and (f), and the related text of the Conference Report to the Deficit Reduction Act of 1984, H. Rept. 98-861 (Conf.)(1984), 1984-1 C.B. (Vol. 2) 1, see appendices A and B.3. Tax Reform Act of 1986The Tax Reform Act of 1986 made76 technical corrections to section 108. Sec. 1808(d) of the Tax Reform Act of 1986, Pub. L. 99-514. The 1986 amendments limited section 108(b) to commodities dealers in the trading of commodities. The 1986 act also eliminated the rebuttable presumption and substituted a per se rule that any loss incurred by a commodities dealer in the trading of commodities shall be treated as a loss incurred in a trade or business. For the text of the Tax Reform Act of 1986 amendments to section 108(a) and (b), see appendix C.901 It appears that the intent in amending section 108 in 1986 continued to be to provide a rule to reduce the number of pre-ERTA straddles cases at the Internal Revenue Service. The Conference Report for the Tax Reform Act of 1986 states that:the conferees clarify their intent that the Internal Revenue Service bring all outstanding pre-ERTA straddle litigation to a speedy resolution, so that the large docket of cases on this issue may be cleared in a manner consistent with this legislation. [H. Rept. 99-841 (Conf.) at II-845 (1986), 1986-3 C.B. (Vol. 4) 845.]For the text of the House Ways and Means Committee Report, H. Rept. 99-42677 (1985), 1986-3 C.B. (Vol. 2) 1, and the Conference Report to the Tax Reform Act of 1986, H. Rept. 99-841 (Conf.) (1986), 1986-3 C.B. (Vol. 4) 1, see appendix D.The 1984 and 1986 versions of section 108(a) and (b) are compared below:Deficit ReductionTax Reform Actof 1984of 1986SECTION 108(a) any loss from such disposition shall be allowed for the taxable year ofthe disposition * * * * * * if such position * * * if such loss isis part of a transactionincurred in a trade orentered into for profitbusiness, or if such loss isincurred in a transaction enteredinto for profit though notconnected with a trade orbusiness.(b) Presumption That(b) Loss Incurred in aTransaction --Entered Into for Profit --Trade or Business --For purposes fo subsection (a),For purposes of subsection (a),any position held by aany loss incurred by acommodities dealer or any personcommodities dealer in the tradingregularly engaged in investing inof commodities shall be treated asregulated futures contracts shalla loss incurred in a trade orbe rebuttably presumed to be partbusiness.of a transaction entered into forprofit.78 902 4. Commodities Dealer in the Trading of CommoditiesAs stated, the 1986 act limited section 108(b) to a "commodities dealer in the trading of commodities." We will next discuss the definition of commodities dealer for purposes of section 108.Section 108(f) refers to a definition of commodities dealer used for the self-employment tax provisions. Sec. 1402(i)(2)(B).Under section 1402(i)(2)(B), a commodities dealer is any person who is (a) actively engaged in trading section 1256 contracts, and (b) registered with a domestic board of trade designated as a contract market by the Commodities Futures Trading Commission. Sec. 1402(i)(2)(B). Section 1256 contracts include "any regulated futures contract." Secs. 1402(i)(2)(C), 1256(b)(1). To be eligible under section 108(b), petitioner must satisfy both tests. 279 a. Actively Engaged in Trading Section 1256 ContractsRespondent's position is that petitioner's activities as a commodities broker and investor do not constitute the "trading" of section 1256 contracts. Respondent contends that petitioner was not actively engaged in trading futures contracts because he was not a floor trader, floor broker, or member of an exchange, and he did not execute trades on the floor of a domestic exchange designated as a contract 903 market by the CFTC. Respondent argues that petitioner should only be deemed to be trading futures contracts if he is a member of, or owns a seat on, the exchange on which such contracts are traded.Petitioner concedes that he was not a floor trader, floor broker, or member of a commodities exchange, but he maintains that he was actively engaged in "trading" regulated futures contracts (RFC's) in 1980 and 1981 as an investor and for customers.This is a case of first impression in that we have not previously decided whether an associated person qualifies as a "commodities dealer in the trading of commodities" under section 108(b), as amended. But we note that in two other cases in which we considered the applicability80 of section 108(b) of the Deficit Reduction Act of 1984, the parties agreed that the taxpayer, who was a member of a domestic exchange, was a commodities dealer. King v. Commissioner, 87 T.C. 1213">87 T.C. 1213 (1986); Perlin v. Commissioner, 86 T.C. 388">86 T.C. 388 (1986).In King v. Commissioner, supra at 1218-1219, the taxpayer was a member of the CME and its division, the International Monetary Market. We held that the taxpayer was eligible for section 108(b).In Perlin v. Commissioner, supra, the taxpayer was a member of the CBOT who traded commodities futures contracts as a floor trader. In discussing Perlin's status as a member of the exchange, this Court distinguished professional traders who are members of an exchange from investors who are not members of an exchange and who invest through a broker. We said, "In this opinion, we will be using the term 'trader' to refer to a professional commodities trader who is a member of the CBOT. In contrast, we will use the term 'investor' to refer to a person who is not a member of the CBOT, but invests in commodity futures through 81 the use of a broker." Perlin v. Commissioner, supra at 390 n. 5. Our decision here is consistent with the cited terminology from King and Perlin. 382 904 Even where the statutory language appears clear on its face, a court may seek out any reliable evidence as to legislative purpose. United States v. American Trucking Associations, 310 U.S. 534">310 U.S. 534, 543-544 (1940); see United States v. Dickerson, 310 U.S. 554">310 U.S. 554, 562 (1940); Huntsberry v. Commissioner, 83 T.C. 742">83 T.C. 742, 747 (1984); Carasso v. Commissioner, 34 T.C. 1139">34 T.C. 1139, 1142 (1960), affd. 292 F.2d 367">292 F.2d 367 (2d Cir. 1961).We next turn to an examination of the legislative history of section 108(b).We recognize that petitioner was engaged full-time in commodities transactions. However, this does not necessarily make him eligible to deduct losses under section 108(b).In its report for what became the Tax Reform Act of 1986, the House Ways and Means Committee stated that the deductibility of losses by a commodities dealer eligible for section 108(b) is not interchangeable with the deductibility of losses in a trade or business under section 162. The report stated that the treatment of an individual as a commodities dealer as defined in section83 108(b) is only for purposes of section 108(a), and "no inference should be drawn that a loss is incurred in a trade or business for any other purpose, such as for purposes of section 162." H. Rept. 99-426, at 911 (1985), 1986-3 C.B. (Vol. 2) 911.The Conference Report for the Deficit Reduction Act of 1984 states: "A commodity dealer is any person registered with a domestic board of trade designated as a contract market by the CFTC who buys or sells options or RFC's subject to the rules of such board." H. Rept. 98-861 (Conf.), at 910 (1984), 1984-3 C.B. (Vol. 2) 164.We believe this language was intended to exclude associated persons (such as petitioner) from the definition of commodities dealer. Associated persons solicit and accept customer orders, 17 C.F.R. sec. 1.3(aa) (1981); in contrast, floor brokers buy and sell commodities subject to the rules of the exchange, 17 C.F.R. sec. 1.3(n) (1981); and floor 905 traders are exchange members by or for whom futures trades are executed, 17 C.F.R. sec. 1.3(x) (1982).The House Report to the Tax Reform Act of 1986 provides that section 108(b) will not apply in cases "where the84 trades were * * otherwise in violation of the rules of the exchange in which the dealer is a member." H. Rept. 99-426, at 911 (1985), 1986-3 C.B. (Vol. 2) 911. The Conference Report similarly states that if a person qualifies as a commodities dealer, section 108(b) treatment will apply to any position disposed of by such person whether or not such position "was traded on an exchange on which the dealer was a member." H. Rept. 99-841 (Conf.), at II-845 (1986), 1986-3 C.B. (Vol. 4) 845. This language from both the House and Conference Reports presumes that a person eligible for section 108(b) is a member of an exchange, unlike petitioner.As originally enacted in 1984, section 108(b) applied to commodities dealers and to any person regularly engaged in investing in regulated futures contracts. Eligible persons were given a presumption of profit motive. The 1986 act changed the presumption to provide a per se rule that losses incurred by a commodities dealer on trades entered in compliance with the rules of the exchange are treated as losses incurred in a trade or business. See King v. Commissioner, 87 T.C. 1213">87 T.C. 1213, 1218-1219 (1986).85 This avoids the need to determine profit motive to resolve eligibility for section 108(b). At the same time, eligibility for section 108(b) was narrowed to commodities dealers in the trading of commodities. We believe petitioners' position on this issue fails to recognize -- and could largely negate -- the narrowing of eligibility for section 108(b) under the 1986 amendments.The Conference Report to the Tax Reform Act of 1986 states that "if an individual owns a seat on a commodities exchange, such individual will be treated as a 'commodities dealer.'" H. Rept. 99-841 (Conf.), at II-845 (1986), 1986-3 C.B. (Vol. 4) 845.This language establishes that an individual who owns a seat on (i.e., is a member of) an exchange is a commodities dealer under section 108(b). However, beyond that, the parties dispute its meaning. Respondent reads it to limit section 108(b) to members of an exchange. Petitioners read 906 it to merely make a category of persons automatically eligible for section 108(b). Even if we agreed with petitioners' view, the cited language itself does not go as far as petitioners need; it does not purport to extend section 108(b) to86 brokers or investors, and we do not see support for that position elsewhere in the statute or legislative history. Deductions are a matter of legislative grace and are construed narrowly. Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U.S. 134">417 U.S. 134, 148-149 (1974); Deputy v. duPont, 308 U.S. 488">308 U.S. 488, 493 (1940); New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 440 (1934).In view of the foregoing, we hold that, under the 1986 amendments, section 108(b) excludes brokers and investors who are not floor traders, floor brokers, or members of an exchange. Petitioner, as a commodities investor and broker, and as an AP or registered commodity representative (RCR), is not a "commodities dealer in the trading of commodities" for purposes of section 108(b) since he does not buy and sell commodities futures on the floor of, and subject to the rules of, an exchange. In so deciding, we do not necessarily limit eligibility for section 108(b) to owners of seats on an exchange; however, we do decide that AP's are excluded from section 108(b).b. Registered With a Domestic Board of TradeSection87 1402(i)(2)(B) requires that a commodities dealer be "registered" with a domestic board of trade designated as a contract market by the CFTC. Petitioner contends that because he was registered both as an AP under the CFTC regulations and an RCR with the Chicago Board of Trade he comes within section 108(b). In contrast, respondent argues that petitioner was not registered during 1980 since he was not registered as a member of an exchange.Neither the statute nor the rules of the CBOT defines "registered." The CFTC regulations, however, acknowledge several types of registration. 17 C.F.R. secs. 1.3(aa)-(cc), (mm) (1985). For example, several types of persons are required to register with the CFTC: an associated person, commodity trading adviser, commodity pool operator, and an introducing broker. Several types of persons are required to be registered with the CBOT as well: members, membership 907 interest holders, RCR's, floor clerks, and broker's assistants.Having held above that petitioner was not actively engaged in trading section 1256 contracts, resolution of this issue will not affect petitioner's eligibility for section 108(b), and so we do not reach it.This opinion88 decides petitioner's eligibility for section 108(b). Further proceedings will be required to dispose of other open issues in the case.To reflect the foregoing,An appropriate order will be issued.APPENDIX ADEFICIT REDUCTION ACT OF 1984 -- STATUTORY PROVISIONSSection 108(a), (b), and (f) of the Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 630-631, provides --SEC. 108. Treatment of Certain Losses on Straddles Entered into Before Effective Date of Economic Recovery Act of 1981.(a) General Rule. -- For purposes of the Internal Revenue Code of 1954, in the case of any disposition of 1 or more positions --(1) which were entered into before 1982 and form part of a straddle, and(2) to which the amendments made by title V of the Economic Recovery Tax Act of 1981 do not apply,any loss from such disposition shall be allowed for the taxable year of the disposition if such position is part of a transaction entered into for profit.(b) Presumption That Transaction Entered Into for Profit. -- For purposes of subsection (a), any position held by a commodities dealer or any person regularly engaged in investing in regulated futures contracts shall be rebuttably presumed89 to be part of a transaction entered into for profit. * * *908 (f) Commodities Dealer. -- For purposes of this section, the term "commodities dealer" has the meaning given to such term by section 1402(i)(2)(B) of the Internal Revenue Code of 1954 (as added by this subtitle).APPENDIX BDEFICIT REDUCTION ACT OF 1984 -- COMMITTEE REPORTSThe House version of the Deficit Reduction Act of 1984 (H.R. 4170, H. Rept. 98-432 and 98-432, Pt. 2) contained no provisions regarding the treatment of losses from pre-1982 straddles. The Senate amendment required the Secretary to report to the Senate Finance and House Ways and Means Committees with respect to progress made in reducing the backlog of cases involving the pre-ERTA treatment of RFC's. S. Prt. 98-169 (Vol. II), sec. 839 (1984).In lieu of the Senate amendment's requirement of a report, the conference agreement included section 108 of the 1984 act, a noncode provision which specifically addressed pre-1982 straddles.The Conference Report to the Deficit Reduction Act of 1984, H. Rept. 98-861 (Conf.), at 917 (1984), 1984-3 C.B. (Vol. 2) 171, states:In the case of commodity dealers and persons actively90 engaged in investing in RFCs, the provision is to be applied by presuming that the position is held as part of a transaction entered into for profit unless the Internal Revenue Service establishes to the contrary. In determining whether a taxpayer is actively engaged in trading in RFCs with an intent to make a profit, a significant factor will be the extent of transaction costs. If they are sufficiently high relatively to the scope of the taxpayer's activities that there is no reasonable possibility of a profit, the presumption will be unavailable. RFCs for purposes of applying the presumption are regulated futures contracts as defined in section 1256(b) before its amendment by the bill.For purposes of the provision, the term "commodities dealer" has the same meaning as such term in the amendments by the bill providing for application the self-employment income tax to such persons.As defined in the 1984 Conference Report, H. Rept. 98-861 (Conf.), at 910 (1984), 1984-3 C.B. (Vol. 2) 164:909 A commodity dealer is any person registered with a domestic board of trade designated as a contract market by the CFTC who buys or sells options or RFCs 91 subject to the rules of such board. * * * The conferees intend that no inference be made as to whether options dealers and commodity dealers be viewed as engaged in a trade or business in connection with their transactions in section 1256 contracts as a result of the application of self-employment taxes to such persons.APPENDIX CTAX REFORM ACT OF 1986 -- STATUTORY PROVISIONSAs amended by section 1808(d) of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2817, section 108(a) and (b) provides:SEC. 108. Treatment of Certain Losses on Straddles Entered into Before Effective Date of Economic Recovery Act of 1981.(a) General Rule. -- For purposes of the Internal Revenue Code of 1954, in the case of any disposition of 1 or more positions --(1) which were entered into before 1982 and form part of a straddle, and(2) to which the amendments made by title V of the Economic Recovery Tax Act of 1981 do not apply,any loss from such disposition shall be allowed for the taxable year of the disposition if such loss is incurred in a trade or business, or if such loss is incurred in a transaction entered into for profit though not connected with a trade or business.(b) Loss Incurred92 in a Trade or Business. -- For purposes of subsection (a), any loss incurred by a commodities dealer in the trading of commodities shall be treated as a loss incurred in a trade or business. * * (f) Commodities Dealer. -- For purposes of this section, the term "commodities dealer" means any taxpayer who --(1) at any time before January 1, 1982, was an individual described in section 1402(i)(2)(B) of the Internal Revenue Code of 1954 (as added by this subtitle), or(2) was a member of the family (within the meaning of section 704(e)(3) of such Code) of an individual described in paragraph (1) to the extent such member engaged in commodities trading through an organization the members of which consisted solely of --(A) 1 or more individuals described in paragraph (1), and910 (B) 1 or more members of the families (as so defined) of such individuals.APPENDIX DTAX REFORM ACT OF 1986 -- COMMITTEE REPORTSRegarding the treatment of losses from pre-ERTA straddles, the House Ways and Means Committee Report, H. Rept. 99-426, at 910-911 (1985), 1986-3 C.B. (Vol. 2) 910-911, for the bill that became the Tax Reform Act of 1986, states:Present Law93 Unlike taxpayers who conducted isolated straddle transactions prior to the effective date of ERTA solely for tax purposes, taxpayers in the trade or business of trading commodities conducted numerous straddle transactions in the normal course of their business. Section 108 was intended to clarify the treatment of losses claimed with respect to straddle positions entered into and disposed of prior to 1982 by taxpayers in the trade or business of trading commodities. It provided a profit-motive presumption in section 108(b) for such taxpayers because of the inherent difficulty in distinguishing tax-motivated straddle transactions from profit-motivated straddle transactions when the taxpayer was in the trade or business of trading in commodities.Explanation of ProvisionThe bill makes clear that [sec. 108] subsection (b) treatment is limited to those taxpayers in the business of trading commodities. The determination of whether a taxpayer is in the business of trading commodities is based upon all the relevant facts and circumstances. Under the statute as clarified by the technical correction, generally a taxpayer engaged in the business of investment banking who regularly trades94 in commodities as a part of that business would be considered in the trade or business of trading commodities. If a person qualifies as a commodities dealer, the subsection (b) treatment applies with respect to any position disposed of by such person. It would, for example, apply without regard to whether the position was in a commodity regularly traded by the person, whether it was traded on an exchange on which the dealer was a member, or whether an identical position was re-established on the same trading day or subsequently.* * * A taxpayer who does not satisfy the indicia of trade or business status, such as the taxpayer in Miller v. Commissioner (84 T.C. No. 55">84 T.C. No. 55 (1985)), would not be considered in the trade or business of trading commodities. Further, the presumption would not be available in any cases where the 911 trades were fictitious, prearranged, or otherwise in violation of the rules of the exchange in which the dealer is a member. The subsection (b) treatment is only for purposes of subsection (a), and no inference should be drawn that a loss is incurred in a trade or business for any other purpose, such as for purposes of95 section 162, 163(d) or 172.The Senate version of the Tax Reform Act of 1986 did not amend section 108.The Conference Report to the Tax Reform Act of 1986, H. Rept. 99-841 (Conf.), at II-845 (1986), 1986-3 C.B. (Vol. 4) 845, states:The conference agreement follows the House bill. Under the statute as clarified by the technical correction, generally a taxpayer engaged in the business of investment banking who regularly trades in commodities as a part of that business would be considered in the trade or business of trading commodities. If a person qualifies as a commodities dealer, the subsection (b) treatment applies with respect to any position disposed of by such person. It would, for example, apply without regard to whether the position was in a commodity regularly traded by the person, whether it was traded on an exchange on which the dealer was a member, or whether an identical position was re-established on the same trading day or subsequently. The conferees also wish to clarify that if an individual owns a seat on a commodities exchange, such individual will be treated as a "commodities dealer." Further, if a trading firm also regularly trades96 commodities in connection with its business, then the commodities trading will be deemed to be part of its trade or business. The latter rule applies only to the securities trading firm itself; it does not apply to separate individual trading of its partners, principals, or employees, nor to partnerships or other organizations formed for the principal purpose of marketing tax straddles.* * * Further, the conferees clarify their intent that the Internal Revenue Service bring all outstanding pre-ERTA straddle litigation to a speedy resolution, so that the large docket of cases on this issue may be cleared, in a manner consistent with this legislation. WHALENWhalen, J., dissenting: We are again confronted with section 108 of the Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 630 (hereinafter section 108). In this case, we are called upon to decide whether petitioner qualifies as a "commodities dealer" within the meaning of section 108(b) 912 as amended by section 1808(d), Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2817.The majority construes the term "commodities dealer" to exclude everyone other than floor traders, floor brokers, and members of an exchange. 97 In my view, there is no basis for such limitation in the statute or its legislative history. The majority arrives at this narrow construction by focusing on section 108(b), a provision of limited applicability intended to allow a deduction for certain pre-1982 straddle losses. The majority appears to overlook or dismiss as having "little or no practical effect" the impact of its opinion on the application of the self-employment tax to commodities traders and on their ability to contribute to qualified self-employment plans. (Majority op. at 902 note 2.) By limiting the term "commodities dealers" to floor traders, floor brokers, and members of an exchange, the majority limits the application of self-employment taxes to the same group. Other commodities traders escape self-employment tax on the gains and losses realized from their trading of section 1256 contracts. Similarly, they are not entitled to treat such gains and losses as "earned income" under the rules governing contributions to self-employment plans. See sec. 401(c)(2). I cannot accept the majority's view that Congress intended this anomalous result or that we should disregard it as having "little or no practical 98 effect."In general, section 108(b) treats losses from certain pre-1982 straddles as "incurred in a trade or business" and, thus, as losses deductible under section 108(a). The losses which qualify for such treatment are those incurred by a "commodities dealer in the trading of commodities."For purposes of section 108(b), the term "commodities dealer" is defined by section 108(f) to mean "an individual described in section 1402(i)(2)(B)" and certain members of his family. Section 1402(i)(2)(B) provides as follows:(B) Commodities dealer. -- The term "commodities dealer" means a person who is actively engaged in trading section 1256 contracts and is registered with a domestic board of trade which is designated as a contract market by the Commodity Futures Trading Commission.Respondent's position is that the above definition prescribes a two-part test. First, he contends that "the term 'registered' as used in section 1402(i)(2)(B) was intended to 913 mean registered as a member." (Emphasis supplied.) Second, he contends, "In determining whether the petitioner 'actively engaged in trading section 1256 contracts,' the Court must look only to the trades personally executed99 by him on the floor of a domestic exchange designated as a contract market by the CFTC." (Emphasis supplied.) Respondent's position is that only a member of an exchange who personally executes sufficient trades on the floor of a domestic exchange (or, alternatively, has them executed for his own account) is a "commodities dealer," as that term is used in section 108(b). Respondent argues, "Congress intended section 108(b) to give preferential treatment only to professional traders that operated on the floor of an exchange."The majority accepts respondent's construction of the "actively engaged" requirement. It construes the phrase "actively engaged in trading section 1256 contracts" to exclude persons "who are not floor traders, floor brokers or members of an exchange." (Majority op. at 906.) As I read its opinion, if a taxpayer does not fall into one of those narrow categories, he is not a "commodities dealer," regardless of the manner in which he engages in commodities trading or the volume of such activity. Petitioner concededly does not fall within those categories. Therefore, the majority holds that petitioner is not a "commodities dealer" because "he does not buy and sell100 commodities futures on the floor of, and subject to the rules of, an exchange." (Majority op. at 906.) In view of that holding, the majority does not construe the term "registered" or reach respondent's contention that such term in section 1402(i)(2)(B) means membership on an exchange.Unlike the majority, I believe that qualification under the words "actively engaged in trading section 1256 contracts" was intended to be determined using the facts and circumstances analysis which we have traditionally employed in such cases. See, e.g., King v. Commissioner, 89 T.C. 445">89 T.C. 445 (1987); Liang v. Commissioner, 23 T.C. 1040 (1955); Polacheck v. Commissioner, 22 T.C. 858">22 T.C. 858 (1954); Kemon v. Commissioner, 16 T.C. 1026">16 T.C. 1026 (1951). Under that analysis, the location at which a person buys and sells securities or commodities contracts, and his membership on an exchange, 914 are factors which may be taken into account, but they are not determinative of the taxpayer's status as a trader, broker, or investor. For example, in King v. Commissioner, supra 457 et seq., we distinguished101 traders from dealers and investors by the nature and extent of their activities. In that case, the Court noted that persons who regularly buy and sell on an exchange may be either dealers or traders. The difference between the two is that dealers have customers, whereas traders do not. Accordingly, the stocks or commodity contracts held by a trader in his business may qualify as capital assets under the definition in section 1221. King v. Commissioner, supra at 457. Thus, traders occupy an unusual position under the tax law because they may engage in a trade or business which produces capital gains and losses, rather than ordinary income and losses. King v. Commissioner, supra at 457. Traders are distinguished from investors by the nature of the activity in which they are engaged. Traders seek to profit from short-term market swings and receive income principally from selling rather than from dividends, interest, or long-term appreciation. Trading, as compared to investing, implies more frequent and substantial purchases and sales. King v. Commissioner, supra at 458.Significantly, 102 the Deficit Reduction Act of 1984 added section 1256(f)(3) to provide that, with the exception of certain hedging transactions, gains and losses "from trading of section 1256 contracts" are to be treated as capital gains and losses. The conference report accompanying the act notes that Congress merely intended to codify prior law "with respect to professional commodity traders." H. Rept. 98-861 (Conf.), at 903 (1984), 1984-3 C.B. (Vol. 2) 157. The conference report in effect recognized that traders occupy a special position under the tax law, as summarized above.Congress also enacted section 1402(i) in the Deficit Reduction Act of 1984 and further recognized that the capital gains and losses realized by a commodities trader "in the normal course of the taxpayer's activity of * * * trading section 1256 contracts" are, in reality, business income which should be subject to self-employment tax and taken into account in making contributions to self-employment plans. Congress defined the term "commodities 915 dealers" in section 1402(i)(2)(B) to describe the group who would be treated as professional commodities traders and subject to self-employment103 tax on their gains and losses from trading. That is, persons who are "actively engaged in trading section 1256 contracts" and who are "registered with a domestic board of trade."The words "actively engaged in trading" are meant to identify "traders," as determined under the facts and circumstances analysis described above. Thus, in my view, the definition of commodities dealer in section 1402(i)(2)(B) is intended to include traders who, like petitioner, are registered with a domestic exchange. The definition was intended to exclude investors and traders who, unlike petitioner, are not registered with a domestic exchange.In any event, there is nothing to suggest that Congress intended the term "commodities dealer" to refer only to floor traders, floor brokers, or members of an exchange. If Congress had wanted to limit the definition of commodities dealer to floor brokers, floor traders, and members of an exchange, it could have simply used those words, rather than the phrase "actively engaged in trading section 1256 contracts." It has done so in other similar provisions. For example, in section 1236(d)(2) Congress specifically defined the term "floor specialist" as follows: 104 (2) Floor specialist. -- The term "floor specialist" means a person who is -- (A) a member of a national securities exchange,(B) is registered as a specialist with the exchange, and(C) meets the requirements for specialists established by the Securities and Exchange Commission.Although the majority sets forth its view that Congress intended to limit the definition of "commodities dealer" to floor traders, floor brokers, and members of an exchange, it never explains how the words "actively engaged in trading section 1256 contracts" convey that intent. Implicit in the majority opinion is the proposition that only floor traders, floor brokers, and members engage in "trading" commodities futures contracts. Also implicit is the proposition that only floor traders, floor brokers, and members can be "actively engaged" in such activity. I cannot accept either proposition.916 Indeed, respondent's own regulation defining the term "commodities dealer" in section 1402(i)(2)(B) does not limit it to floor traders, floor brokers, and members of an exchange. That regulation states as follows:Q-7. Who qualifies as a commodities dealer or as a person regularly engaged in investing105 in regulated futures contracts for purposes of the profit presumption?A-7. For purposes of this section, the term "commodities dealer" has the meaning given to such term by section 1402(i)(2)(B) of the Code. Section 1402(i)(2)(B) defines a commodities dealer as a person who is actively engaged in trading section 1256 contracts (which includes regulated futures contracts as defined in Q&A-6) and is registered with a domestic board of trade which is designated as a contract market by the Commodity Futures Trading Commission. To determine if a person is regularly engaged in investing in regulated futures contracts all the facts and circumstances should be considered including, but not limited to, the following factors: (1) regularity of trading at all times throughout the year; (2) the level of transaction costs; (3) substantial volume and economic consequences of trading at all times through the year; (4) percentage of time dedicated to commodity trading activities as compared to other activities; and (5) the person's knowledge of the regulated futures contract market. [Sec. 1.165-13T, Temporary Income Tax Regs., 49 Fed. Reg. 33445 (Aug. 23, 1984).]The106 majority appears to base its narrow construction of the term "commodities dealer" solely on the legislative history of section 108. Although the majority admits that the "actively engaged in trading" requirement "appears clear on its face," it nevertheless undertakes an examination of the legislative history of section 108(b) on the ground that the Court "may seek out any reliable evidence as to legislative purpose." (Majority op. at 904.) While I agree that the Court can look to clear legislative history to construe the terms of an ambiguous statute, the majority appears to do the opposite. The legislative history cited by the majority is anything but clear, and thus the majority appears to rely upon ambiguous legislative history to vary the terms of a clear statute. Moreover, the majority appears to focus on the legislative history of section 108(b) and, in the process, loses sight of the broader implications of the term "commodities dealers" contained in section 1402(i).My principal objection is that the majority's narrow definition of the term "commodities dealer" for purposes of section 108 does not comport with the intended use of that 917 term for self-employment 107 tax purposes. In fact, as mentioned above, the definition at issue here is drawn from a self-employment tax provision, section 1402(i)(2)(B). It was enacted by the Deficit Reduction Act of 1984 as part of a special rule to prescribe how commodities dealers are to compute "net earnings from self-employment" for purposes of the self-employment income tax under section 1401. Generally, taxpayers other than commodities dealers exclude capital gains and losses in determining net earnings from self-employment. Sec. 1402(a)(3)(A). Commodities dealers, on the other hand, are required by the special rule to take into account gains or losses "from section 1256 contracts or property related to such contracts." Sec. 1402(i)(1).In enacting this provision, Congress also intended that commodities dealers would thereby be entitled to treat gains and losses from their trading activity as "earned income" for purposes of section 401(c)(2) and the rules governing contributions to self-employment plans. H. Rept. 98-861, at 910 (1984), 1984-3 C.B. (Vol. 2) 164. Congress made a similar change to the Social Security Act. See sec. 102(c)(2), Deficit Reduction Act of 1984, 108 98 Stat. 622.The definition of "commodities dealer" is the same under section 108 as it is under section 1402(i)(2)(B). Congress intended it to be the same:For purposes of the provision [section 108], the term "commodities dealer" has the same meaning as such term in the amendments by the bill providing for application [of] the self-employment income tax to such persons. [H. Rept. 98-861, at 917 (1984), 1984-3 C.B. (Vol. 2) 171.]Thus, the majority's construction of the term for purposes of section 108 governs for self-employment tax purposes. If, as the majority holds, only floor traders, floor brokers, or members of an exchange are "commodities dealers" for purposes of section 108, then only such persons are commodities dealers for purposes of section 1402(i)(2)(B). Other commodities traders are not "commodities dealers," and are not subject to the special rule of section 1402(i). They need not include their gains and losses realized from trading futures contracts and underlying property in computing net earnings from self-employment. Sec. 1402(a)(3)(A). Therefore, under the majority's construction of 918 the "actively engaged" requirement109 of section 1402(i)(2)(B), only floor traders, floor brokers, and members of an exchange are subject to self-employment tax on their business income.I see no reasonable basis to suppose that Congress intended to impose self-employment taxes on floor traders, floor brokers, and members of an exchange, but to allow other professional commodities traders to escape self-employment taxes. In defining the term "commodities dealer," section 1402(i)(2)(B) says nothing about the physical location at which a taxpayer conducts his trading activity or whether the person is a member of an exchange. The gains and losses which he realizes from his trading activity are the same whether he conducts his activity on the floor of the exchange or elsewhere. They receive the same characterization, as capital or ordinary, regardless whether the trading takes place on or off the floor of an exchange. See, e.g., sec. 1256(f)(3).Similarly, the legislative history of section 1402(i)(2)(B) says nothing about the physical location of a taxpayer's trading. Congress described its definition of "commodities dealer" in section 1402(i)(2)(B) as follows:Under the conference agreement, gains and losses derived110 in the ordinary course of trading in section 1256 contracts and property related to such contracts (e.g., stock used to hedge options) are defined as earnings from self-employment for purposes of applying the tax on self-employment income and the rules relating to contributions to self-employment plans. This treatment is extended only to options dealers, and commodity dealers, as defined in the bill. A commodity dealer is any person registered with a domestic board of trade designated as a contract market by the CFTC who buys or sells options or RFCs subject to the rules of such board. This treatment applies to taxable years beginning after the date of enactment except that for options dealers electing 60/40 and mark-to-market rules for the taxable year which includes the date of enactment, it applies for such taxable year. The conferees intend that no inference be made as to whether options dealers and commodity dealers be viewed as engaged in a trade or business in connection with their transactions in section 1256 contracts as a result of the application of self-employment taxes to such persons. [H. Rept. 98-861, at 910 (1984), 1984-3 C.B. (Vol. 2) 164.]111 The majority's narrow construction of "commodities dealer" creates the anomalous result that only floor traders, floor brokers, and members of an exchange are subject to 919 self-employment tax on gains and losses from trading section 1256 contracts. This problem cannot be dismissed, as the majority attempts to do in footnote 2 of its opinion, on the ground that its opinion deals with "associated persons" and has "little or no practical effect for self-employment tax purposes because AP's are usually employees." (Majority op. at 902 note 2.) The majority's holding is not limited to associated persons and investors. Its opinion states "we hold that, under the 1986 amendments, section 108(b) excludes brokers and investors who are not floor traders, floor brokers, or members of an exchange." (Majority opinion at 906.) Under that holding, every commodities trader who is not a floor trader, floor broker, or member of the exchange is excluded from the term "commodities dealer."By disregarding the overall purpose of the term "commodities dealer" as enacted by the Deficit Reduction Act of 1984, the majority drastically limits the application of self-employment taxes to commodities*112 traders and unfairly curtails the ability of certain commodities traders to make contributions to their self-employment plans. Accordingly, I respectfully dissent. Footnotes1. It has been said that "Memberships are broadly held both occupationally and geographically. Bankers, investment bankers, mortgage bankers, money market dealers, commercial manufacturing firms, brokers, futures commission merchants, and individuals such as lawyers, dentists, farmers, and shopkeepers own memberships." M. Powers and D. Vogel, Inside the Financial Futures Market 18 (1st ed. 1981).↩1. This amount was derived by subtracting the amounts invested in the first and second accounts from the total funds invested.↩2. This opinion decides whether an individual who is an associated person (AP) and investor is eligible per se to deduct commodities losses under sec. 108(b). As noted, sec. 108 refers to the definition of commodities dealer used for the self-employment tax provisions, sec. 1402(i)(2)(B).The sec. 1402(i)(2)(B) definition of commodities dealer was made part of the Internal Revenue Code by the Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 102(c), 98 Stat. 622. Its role in the self-employment tax scheme is as follows: Secs. 1401-1403 impose a tax on self-employment income. The tax on self-employment income applies to net earnings from an individual's trade or business. Sec. 1402(a). However, it generally does not apply to gain or loss from the sale or exchange of a capital asset. Sec. 1402(a)(3)(A).Sec. 1402(i) is an exception to sec. 1402(a)(3)(A) for certain dealings by commodities and options dealers. It provides that, in determining net self-employment earnings of an options or commodities dealer, "any gain or loss (in the normal course of the taxpayer's activity of dealing in or trading section 1256 contracts) from section 1256 contracts" or related property shall not be excluded. Sec. 1402(i). Sec. 1402(i)(2)(B) defines commodities dealer.Thus, under sec. 1402(i), commodities dealers take into account gains or losses for self-employment tax purposes that would otherwise be disregarded by sec. 1402(a)(3)(A).We note that an opinion dealing with AP's has little or no practical effect for self-employment tax purposes because AP's are usually employees, 7 U.S.C. sec. 6k (1982), 17 C.F.R. secs. 1.3(aa) and 3.12(a)-(c) (1982); 1 P. Johnson, Commodities Regulation, 118, 122 (1st ed. 1982), and, thus, would not usually come within the self-employment tax. In contrast, floor brokers historically have been self-employed. P. Johnson, supra↩ at 123.3. We note that CFTC regulations appear to use the term "traders" to include investors. For purposes of the CFTC's reportable position regulations, 17 C.F.R. secs. 15 through 19.10, a trader is a person who, for his own account or for an account which he controls, makes transactions in commodity futures or options, or has such transactions made. 17 C.F.R. sec. 15.00(e). Investors appear to meet this definition, but were specifically excluded from the definition of commodities dealer by the 1986 TRA amendments to sec. 108(b).There is also apparently use in the commodities field of the term "trader" to include investors. See, e.g., M. Powers, Getting Started in Commodity Futures Trading 1-14 (4th ed. 1983); and M. Powers and D. Vogel, supra↩ at 22. In light of the deletion of investors from sec. 108(b) by the 1986 TRA, it is clear that all those that may be popularly referred to as commodities traders are not eligible for sec. 108(b).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621339/	Alexander L. Allen v. Commissioner.Allen v. CommissionerDocket No. 42858.United States Tax CourtT.C. Memo 1956-88; 1956 Tax Ct. Memo LEXIS 205; 15 T.C.M. (CCH) 464; T.C.M. (RIA) 56088; April 17, 1956205 1. Petitioner's gross receipts determined by the bank deposit method. 2. Petitioner purchased three buildings in Chattanooga, Tennessee, to be used in his practice. Two of the buildings at 522 and 909 Vine Street required extensive remodeling and replacements to render them suitable for petitioner's purpose. The building at 502 Forrest Avenue was already being used as a clinic when acquired by petitioner and required only incidental repairs. During 1947, petitioner spent about $22,000 in rehabilitating and improving the three buildings, and claimed part of the aggregate cost thereof as an ordinary and necessary business expense. Held, that all of the work done on the Vine Street properties was part of an over-all plan of permanent betterment increasing the usefulness and the life of such buildings, and no part of the expense thereof is deductible as repair expense. Held further, that part of the cost of work done on 502 Forrest Avenue to keep the premises in an ordinarily efficient, operating condition is deductible as repair expense, but that expenditures for other work on said building are disallowed as deductions, in part, because capital in nature and, in part, because of failure206 to meet the burden of proving that such expenditures were for repairs. 3. Deduction allowed for salaries paid in addition to amount deducted on income tax return. 4. In 1947, petitioner sold his office premises in Cincinnati, Ohio, which he occupied under a lease-purchase agreement, and claimed a deduction for an alleged loss on the sale of such property. Held, that petitioner realized neither gain nor loss for the year 1947. K. Harlan Dodson, Jr., Esq., for the petitioner. Frederick T. Carney, Esq., and J. Frost Walker, Esq., for the respondent. FISHERMemorandum Findings of Fact and Opinion Respondent determined a deficiency in petitioner's income tax for the calendar year 1947 in the amount of $4,975.98. The determination was based upon the bank deposit method, 207 gross receipts being determined on the basis of deposits in a bank in Chattanooga, Tennessee. At the hearing, it developed that petitioner also had a bank account in Cincinnati, Ohio. Respondent filed an amended answer under section 272(e) of the Internal Revenue Code of 1939, claiming an increased deficiency in the amount of $6,469.87, based upon deposits in the Cincinnati bank. Petitioner filed a motion to strike that part of respondent's answer relating to the claim for an increased deficiency. We denied the motion, but granted petitioner 60 days to file a further motion to reopen the proceedings to permit him to take testimony relating to the increased deficiency. No motion to reopen was filed. The issues before us are: (1) to determine the correct amount of petitioner's gross receipts for 1947 by the bank deposit method; (2) whether certain business expenditures were ordinary and necessary expenses or capital in nature; (3) whether certain salaries were paid to employees in 1947 in addition to the amount deducted as payroll expense in petitioner's return, and (4) what amount of gain or loss resulted from the sale by petitioner of certain real property located in Cincinnati, 208 Ohio. Findings of Fact Some of the facts were stipulated, and, to the extent so stipulated, are included herein by this reference. Alexander L. Allen, hereinafter sometimes referred to as the petitioner, during the taxable year 1947 was a resident of Chattanooga, Tennessee, and filed his individual Federal income tax return for 1947 with the collector of internal revenue for the district of Tennessee. The petitioner is a naturopath and physiotherapist who has practiced as such for about 50 years. He practiced in Cincinnati, Ohio, before moving to Chattanooga, Tennessee, early in 1947. Near the end of 1947, petitioner was enjoined by authorities of the State of Tennessee from practicing any branch of the healing arts in Tennessee, and he is now located in Rossville, Georgia, just across the State line from Chattanooga, Tennessee. In his income tax return for 1947, petitioner reported gross receipts of $25,452. During the year in question, petitioner deposited $44,033.60 in his account with the Hamilton National Bank in Chattanooga, Tennessee, (hereinafter sometimes referred to as the Chattanooga bank). During the same year, petitioner deposited $12,034.36 in his account with209 the Columbia Bank and Trust Co., Cincinnati, Ohio, (hereinafter referred to as the Cincinnati bank). The parties have stipulated, inter alia, that during the taxable year in question the petitioner borrowed $5,050 from his sister Lydia DeWitt and deposited said amount in his bank account in the Hamilton National Bank, Chattanooga, Tennessee; that he borrowed $1,750 from Nancy B. Gerrish and deposited in his Chattanooga bank account $1,200 of said amount; that checks totaling $1,540 received from Dr. Peter Wehner were deposited in said bank account and were later charged back to such account by the bank upon nonpayment; and that the amount of the deposits referred to in this paragraph, totaling $7,790, should be eliminated from petitioner's deposits in the Chattanooga bank and from gross income as determined by respondent in the statutory notice of deficiency. Respondent, on brief, also conceded that petitioner's income as determined should be further reduced by the amount of $5,000 which was withdrawn from petitioner's account in the Cincinnati bank and redeposited in the Chattanooga bank. The sum of $175 deposited on May 31, 1947, in petitioner's bank account in Chattanooga210 represented the proceeds of the sale of a neon sign owned by petitioner for more than six months prior to such sale. The adjusted basis for such sign was not established. We find as an ultimate fact that $1000 of the deposits made in the Chattanooga bank account in 1947 represented checks cashed for patients and workmen, and said amount is not includible in gross receipts for the purpose of determining petitioner's income. While practicing in Cincinnati, Ohio, petitioner occupied two buildings, one of which was a three-story structure located at 110 East Eighth Street. The building was used as an office and for the treatment of patients. On May 12, 1944, petitioner entered into a lease-purchase agreement for the purchase of said property. The agreement provided, among other things, that petitioner was to pay to the seller $21,000 with 5 1/2 per cent interest in 120 equal monthly payments of $228.06; that after all payments had been made the lessor would deliver a general warranty deed to the lessee; and that the lessee had the right to assign the lease or sublet the premises without himself being released. On December 26, 1946, the petitioner entered into a contract with Dr. 211 Peter Wehner for the sale of his interest in the 110 East Eighth Street property. The pertinent provisions of the sales contract are as follows: "Whereas Alexander L. Allen is the owner of a lease with privilege of purchase on the premises known as 110 East Eight Str., Cincinnati, O. * * on which 32 monthly payments have been made in accordance with its terms, and * * "Whereas Dr. Peter Wehner desires to acquire said lease and property, therefor I Peter Wehner hereby agree to purchase said lease, assuming all of the terms, conditions, and obligations of said lease, paying to Alexander L. Allen a total purchase price of $32,000.00 plus 5 1/2 per cent interest on unpaid balances as follow: A. Wheras [Whereas] Alexander L. Allen is indebted to Dr. Peter Wehner in the sum of $950.00 for services rendered by the said Peter Wehner Alexander L. Allen is hereby given a receipt in full for this $950.00 indebtednes [indebtedness] and paid an additional sum of Fifty Dollars in cash making a total of $1,000.00 to be credited on the purchase price. B. Dr. Peter Wehner agrees to pay Alexander L. Allen, as soon as possible but not later than January 25th 1947 another payment of212 $1,000.00 and $1,000 on the 25th day of June, September & December 1947, together with interest at the rate of 5 1/2% * * "It is further agreed that if Alexander L. Allen, his heirs or assigns should be unable to deliver to Dr. Peter Wehner a legal assignment or sublet of the lease and a marketable title, then all moneys paid by Dr. Peter Wehner to Alexander L. Allen shall be refunded with 5 1/2% interest by Alexander L. Allen. * " Wehner paid to petitioner, in January of 1947, the sum of $1,000 in two checks, one for $800 and the other for $200, both of which were deposited in petitioner's Cincinnati bank account. Said sum of $1,000 was a return of capital from which no gain or income was realized. Early in 1947, Wehner also delivered to petitioner several checks (consisting of the checks payable to Dr. Wehner and endorsed over to petitioner) totaling $1,540, referred to above, which were deposited in petitioner's bank account in Chattanooga but were not honored by the drawee upon presentation for payment and were charged back to petitioner's account. Petitioner had also occupied another three-story building at 19 East Eighth Street, Cincinnati, under a lease arrangement. 213 During the course of petitioner's tenancy the building was damaged by fire. The owner of said property, Katherine Hagen, carried fire insurance on the building, but the proceeds of the insurance policy were about $1,000 less than the estimated amount required to rehabilitate the premises. The owner, an elderly widow, did not wish to undertake the extensive repairs occasioned by the fire. On April 13, 1944, petitioner and Katherine Hagen executed a 10-year lease agreement, including an option to purchase said building at the termination of the lease, April 14, 1954. The pertinent provisions of the lease are as follows: "It is understood and agreed between the lessor and lessee, their heirs and assigns, that the lessee shall have permission to make the following structural changes in the improvements on the above described premises, provided said improvements are made pursuant to permit duly obtained from the Building Commissioner of the City of Cincinnati and are duly carried out under the supervision of said Commissioner and in accordance with the Building Code of the City of Cincinnati. The lessee, his heirs and assigns hereby agrees and covenants to make the following improvements214 in such manner and under such supervision provided the lessee, his heirs and assigns, should undertake to make the same. "(A) Install a new front to said building on the sidewalk level and at the lot line, dropping first floor to the sidewalk level so as to improve the first floor for retail store purposes. Also, to install separate entrance, stairway, elevator, etc., to the upper floors in substitution of the means of ingress and egress now existing. "(B) Change the heating system of the building, gas, water and electric installations, etc., so as to provide for separate services to the individual floors of the budiling. "(C) Install additional metal windows in west wall of building where same abuts areaway in the rear of the premises adjoining on the west. "It is understood and agreed that all improvements made by the lessee shall be paid for by him, his heirs and assigns, as rapidly as made, and that all of said improvements as soon as made shall become the property of the lessor, her heirs and assigns, except that special plumbing, bath, steam and toilet facilities installed by the lessee shall remain his property and may be removed by him upon the expiration of this lease, 215 * * * "All payments, agreements and covenants provided for in this lease having been faithfully kept by the lessee, his heirs and assigns, the lessee shall have the privilege of purchasing said premises at the termination of this lease for Twenty Five Thousand Dollars ($25,000.) less all payments made by lessee to credit of principal of said purchase price. Yielding and paying therefor, during the said term a sum of money annually as rent equal to six per cent (6%) on the unpaid balance of said purchase price, payable in quarterly installments beginning July 15, 1944; and in addition thereto the sum of One Thousand Dollars ($1000.) annually to apply on the principal of said purchase price; said interest payments to be ratably reduced at the end of each year in proportion as the unpaid balance of the purchase price is reduced. * * "It is understood and agreed that payments of principal under the terms of this lease may not be anticipated and that in the event of default by the lessee, his heirs and assigns, in making any payment under this lease or in keeping any of the other covenants provided for in this lease required by the lessee to be kept, all payments made by the216 lessee, his heirs and assigns, whether of principal or interest, shall be deemed and considered as rent to be retained by the lessor and not as payments of principal to the credit of the lessee. * * "It is understood and agreed that the lessee shall make all repairs at his own expense made necessary or desirable by reason of the recent fire in said premises. It is further understood and agreed that the lessee shall make all repairs, inside and outside of said premises, during the term of this lease in order to keep said premises in as good or better condition than they were prior to the event of said recent fire in said premises." The parties also agreed that the proceeds of the insurance policy on said building, estimated to be $3,637.51, were to be paid to Katherine Hagen. Petitioner spent about $4,637.51 in repairing the damage resulting from the fire. He also installed a central heating plant and had the building remodeled into 13 efficiency apartments at a cost of $5,652. Late in 1946, petitioner arranged to sell the 19 East Eighth Street property to the Jack Malloy Post No. 35 of the American Legion in Cincinnati, Ohio, for $40,000, of which amount the purchasers217 withheld $1,500 as a guarantee that petitioner would make certain restorations and give possession at the time agreed. The said $1,500 has not been paid to petitioner. The transaction was consummated on January 2, 1947. Petitioner had previously made two principal payments of $1,000 each to Mrs. Hagen. The First National Bank of Cincinnati, which had granted a mortgage loan of $39,000 to the Malloy Post, handled the escrow settlement and disbursed the $39,000 by checks as follows: AmountEndorsed2nd Endorsement$27,000.00Katherine Hagen8,021.25A. L. Allen, M.D.328.75A. L. Allen, M.D.Katherine Hagen1,850.00A. L. Allen, M.D.Reliable RealtyCo.1,443.82Blank356.18BlankThe item of $328.75 represents interest paid by petitioner to the owner. That of $1,850 represents real estate commissions paid by petitioner. The checks for the remaining two items were turned over to the Malloy Post. The following items are includible in the computation of petitioner's adjusted cost basis: $ 2,000.00Principal payments to Mrs.Hagen prior to sale to Mal-loy Post27,000.00Additional payments to Mrs.Hagen at time of settlementwith Malloy Post4,637.51Payments by petitioner result-ing from fire damage5,652.00Improvements made by peti-tioner$39,289.51Less 288.00Depreciation$39,001.51Adjusted basis218 The amount of $8,021.25 distributed to petitioner in cash at the settlement with the Malloy Post and deposited by him in his Cincinnati bank account represented a return of capital and is not includible in petitioner's income for 1947. Our previous Findings of Fact have covered $9,021.25 of the total of $12,034.36 deposited in 1947 in petitioner's bank account in Cincinnati. Of the remaining $3,013.11, we find as an ultimate fact that $2,513.00 represented ordinary income from petitioner's business and practice. In November 1946, preparatory to moving his practice from Cincinnati, Ohio, petitioner purchased two old residence-type buildings at 822 and 909 Vine Street, Chattanooga, Tennessee. In February 1947, he purchased a third residence-type building in the same city at 502 Forrest Avenue. At the time of purchase, the house at 822 Vine Street was being operated as a rest home, the house at 909 Vine Street had been closed and unoccupied for two years, and the house at 502 Forrest Avenue was being used as a doctor's clinic. Neither of the Vine Street buildings was suitable for the petitioner's purpose until numerous alterations and improvements had been accomplished. Petitioner219 installed one or two bath rooms in each of the Vine Street houses and also installed concrete walks around the buildings. At 909 Vine Street, Alexander Allen found that much of the wood around the basement windows was rotted; that water pipes in the walls had corroded; that it was necessary to rebuild some of the foundation with concrete building blocks; and that it was necessary to replace the wood framed windows with steel framed windows and install an outside steel fire escape. Alterations were also made to the interior of this building. At 822 Vine Street, the entire basement was rebuilt and special hydrotherapeutic equipment was installed for treating patients. The clinic building at 502 Forrest Avenue did not require as extensive renovation and remodeling as the other two buildings. At 502 Forrest Avenue, during 1947, petitioner made expenditures, among other things, for carpentry, refrigerator repairs, sanding floors, repairing windows, replacing electric light bulbs and fittings, painting and wallpapering, repairs to the heating system, the installation of metal brackets into the walls, and building supplies. During the year 1947, Allen spent approximately $22,000 in reconditioning, 220 remodeling and making incidental repairs to the three aforementioned buildings. In petitioner's tax return for 1947, he reported in Schedule C - "profit (or loss) from business or profession" - a loss of $2,727.28 with a notation "see schedule attached." On the attached schedule he reported "Receipts - fees from Patients $25,452.00" and under the heading "Disbursements" listed 21 categories of expenses totaling $28,179.38. Respondent disallowed as a business expense an item deducted as "Building Repairs $2,390.10," but allowed all other expense items claimed by petitioner. All of the expenditures with respect to 522 and 909 Vine Street which petitioner claims as a basis for deduction for repairs were part of an over-all plan for the general rehabilitation and permanent improvement of said buildings which added to their value and useful life. The following expenditures with respect to 502 Forrest Avenue were ordinary and necessary expenses for repairs: Nature of WorkAmountPaper and paint$ 73.40Floor finish50.81Repairing windows (allocatedfrom total of $128 spent on allthree buildings)43.00Electric light bulbs and fittings97.13Carpentry47.73Heating19.50Refrigerator33.00Total$364.57221 The remaining items of expenditures claimed as repairs with respect to 502 Forrest Avenue were capital expenditures or nonsegregable therefrom. Included in the item of "Building Repairs" deducted on petitioner's return was the amount of $1,320.87 for salaries which he paid to employees. This amount was paid in addition to the sum of $1,559 which petitioner deducted as payroll expense. The item of $1,320.87 was an ordinary and necessary expense. Opinion FISHER, Judge: Petitioner does not question the propriety of respondent's use of the bank deposit method in reconstructing petitioner's gross receipts for the year before. The major areas of dispute revolve around the issue of whether and to what extent the method was correctly used. Petitioner likewise does not dispute the amount of the deposits in both the Cincinnati and Chattanooga bank accounts, but questions respondent's failure to exclude numerous items therefrom in calculating the amount of taxable income. We consider first the items relating to the Cincinnati bank account and the sale of interests in Cincinnati properties. The total deposits in 1947 in said account were $12,034.36. We think it is clear that we must222 eliminate the amount of $1,000 representing the deposits of checks of $800 and $200 from Wehner. We have found as a fact that this amount represents a return of capital. The evidence supports the view that it was a payment on account of the principal sum due by Wehner in purchasing petitioner's interest in 110 East Eighth Street. The payment was made at approximately the time when a principal payment was due under the contract, and too early to represent interest. The recitals in the contract with Wehner convincingly support the view that petitioner had previously paid substantially more than $1,000 of principal in obtaining his interest therein, so that he had not as yet recovered his basis. Thus, no capital gain resulted from Wehner's payment, and it is clear that it did not represent ordinary income. We likewise exclude, as a return of capital, the amount of $8,021.25 which petitioner received and deposited at the time of consummation of the sale of the 19 East Eighth Street Building. Although respondent disallowed petitioner's claim for loss on the sale of the property, there was no determination in the statutory notice (nor claim in the amended answer) that petitioner had realized223 a gain. We add that we think such a determination or claim would have been unavailing, because, although the selling price reported in petitioner's return ($40,000) exceeded petitioner's adjusted basis by $998.49, some $1,500 of the purchase price was withheld, and was not paid to petitioner in 1947, if at all. Respondent further suggests that petitioner's basis be reduced to the extent of $3,637.51, the approximate amount of insurance proceeds paid to Mrs. Hagen. We find no merit in this contention because the evidence is clear that petitioner's obligation to her (as used in determining adjusted basis) was not reduced by the above amount. On the other hand, we must sustain respondent in disallowing the loss claimed by petitioner on his return growing out of the sale of 19 East Eighth Street. Since the sale price exceeded basis, the withholding of $1,500 did not change what might ultimately have been a gain into a loss. The purchaser remained liable for the $1,500 and while the evidence shows that it was not paid, there is nothing to indicate whether, and if so, when the liability was released, discharged or became worthless. We have found as an ultimate fact that, of the remaining224 $3,013.11 deposited in the Cincinnati bank account, $2,513.11 represented ordinary income from petitioner's business and practice. Here, the burden of proof is upon respondent, who first raised the issue relating to Cincinnati bank deposits in his amended answer. No determination relating thereto was made in the statutory notice. We think, upon the whole record, that respondent has sustained his burden to the extent indicated by our ultimate finding. The fact of the deposit is admitted. Petitioner testified that he continued to treat patients in Cincinnati during the early months of 1947. Such patients had come in and paid for one or two months treatment and petitioner stayed and finished up the treatments. Wehner came into only partpossession in January, and did not take over completely until March of 1947. The only apparent source of at least the greater part of deposits in the Cincinnati bank which have not already been accounted for was petitioner's remaining practice in Cincinnati. His property transactions have been accounted for and he suggests no others. There is likewise no suggestion of loan, gift, or inheritance as a source of such deposits. Petitioner asserts, however, 225 that the money in the Cincinnati bank was redeposited in the Chattanooga bank, and should not be duplicated in determining his income. We think it is better to consider this issue in our analysis infra of the deposits in the Chattanooga bank. Petitioner also asserts that some part of the remaining deposits in the Cincinnati bank represents checks of out-of-town patients which he cashed for their use and which did not represent income to him. He does not suggest the amount of such items. Under the above circumstances, we are faced with the proposition, on the one hand, that at least some part of such remaining deposits in the Cincinnati bank represented income while some part represented checks which were cashed. The record does not disclose the precise amount of either. We think the larger part represents income from practice. We recognize that the burden is upon respondent. We must resolve the issue according to our judgment based upon what tangible evidence we find in the record. We hold, therefore, that $2,513.11 is to be deemed ordinary income, and that $500 is to be excluded in determining income. See Cohan v. Commissioner (C.A. 2, 1930) 39 Fed. (2d) 540. We226 next turn to our analysis of the issues relating to deposits in the Chattanooga bank. It is admitted that the total of Chattanooga deposits in 1947 was $44,033.60. Petitioner reported gross receipts in the amount of $25,452 in his income tax return. Respondent, in his statutory notice, included the difference of $18,561.60 in petitioner's gross income. Of the above amount of $18,561.60, $7,790 has been eliminated by stipulation. This is the total of the following items: $5,050 representing a loan from Lydia DeWitt; $1,200 representing part of a loan from Nancy B. Gerrish; and $1,540 representing checks received from Wehner which were charged back to petitioner's account upon nonpayment. Respondent concedes, on brief, that an additional amount of $5,000 is to be eliminated. This amount represented part of the return of capital arising out of the sale of petitioner's interest in the property at 19 East Eighth Street, Cincinnati. The $5,000 was withdrawn from the Cincinnati bank and redeposited in the Chattanooga bank. On the basis of the foregoing, the amount in issue is reduced from $18,561.60 to $5,791.60. Petitioner contends that $550 of his deposits made during 1947 in the227 Chattanooga bank constituted a loan and should be excluded from gross income for that year. The parties stipulated that petitioner borrowed $1,750 from Nancy Gerrish and that on March 5, 1947, $1,200 of this amount was deposited to his bank account. We have already eliminated the $1,200 from gross income. Petitioner testified that he obtained the additional $550 in two or three payments, one of which was $250 in cash received when he was still practicing in Cincinnati, and that he ultimately deposited the $550 to his bank account in Chattanooga. Respondent takes the view that the deposit of the $550 is not substantiated. Respondent's determination is prima facie correct, and the burden of proof is upon petitioner. Here petitioner relies only upon vague recollection dating back to a period many years prior to the hearing. He does not recall whether the $550 was turned over to him in two or three payments. He asserts the payments were in cash. His own testimony is to the effect that he regularly carried with him cash in substantial amounts which he used for various outlays. It is at least possible that the $550 item was mingled with such funds. Petitioner does not claim that he remembers228 the date of the deposit or even the circumstances. It is stipulated that the $1,200 was deposited on March 5, 1947. The total deposit on that date was $1,491.05, so that it could not have included the $550. Analysis of the bank statement discloses numerous deposits during 1947, but there is nothing to identify them with the item in question or any part of it. We realize the handicap which petitioner faces in his effort to establish the fact that the $550 was actually deposited, but we cannot supply his proof for him, and must hold that he has failed to meet the burden of proving that the item in question was in fact deposited. See Burnet v. Houston, 283 U.S. 223">283 U.S. 223 (1931). We have already eliminated from income the sum of $1,540 which was deposited in the Chattanooga bank, representing a payment by Wehner, which was charged back to petitioner's account upon nonpayment. Petitioner claims that Wehner repaid the said $1,540, and that it was again deposited. Petitioner takes the position that it should be excluded from gross income on the theory that it was a payment on an executory contract contingent upon future passing of title. We do not think it necessary to consider229 petitioner's theory. We have carefully examined the confused testimony on this issue and fail to find acceptable evidence establishing either that Wehner repaid the sum of $1,540, or, if he did, that it was deposited in petitioner's Chattanooga bank account. We hold, therefore, that petitioner has failed to meet his burden of proof on this issue. See John J. Hoefle v. Commissioner (C.A. 6, 1940) 114 Fed. (2d) 713, 714, affirming a Memorandum Opinion of this Court [CCH]. We have eliminated from income attributable to deposits in the Cincinnati bank the sum of $1,000 paid by Wehner to petitioner because the amount so paid represented return of capital. Petitioner claims, however, that this amount was withdrawn from the Cincinnati bank and redeposited in the Chattanooga bank, and should therefore be eliminated from the gross receipts attributed to deposits in the Chattanooga bank. Petitioner also claims specifically that items totaling $3,000 (alleged to be part of the total of $8,021.25 which we have eliminated in relation to the Cincinnati bank account as a return of capital) was withdrawn and redeposited in the Chattanooga bank, and generally that all funds in the230 Cincinnati bank account were withdrawn and redeposited in the Chattanooga bank account. Again we are presented with broad, general and confused testimony which is not supported by any correlation with or between the records of deposits and withdrawals covering the Cincinnati and Chattanooga bank accounts. Under the circumstances, except for the amount of $5,000 conceded by respondent to be a duplication (referred to supra), we cannot accept the general and uncorroborated statements of petitioner as sufficient to meet his burden of proof of duplications. Petitioner claims that he cashed checks during 1947 for patients and workmen which checks were deposited in the Chattanooga bank account. (These are in addition to those discussed supra in relation to the Cincinnati account.) We think it reasonable to believe that petitioner did so. The record does not disclose the amount of such checks, but we feel justified, under the rule of Cohan v. Commissioner, supra, in making an estimate which will necessarily bear against petitioner under the circumstances. We, therefore, eliminate from gross receipts attributable to deposits in the Chattanooga bank the amount of $1,000 to231 reflect the cashing of checks which did not give rise to income. Petitioner sold a neon light for $175. He had held it for more than six months. He failed to establish an adjusted basis, so that the entire amount, which was deposited in the Chattanooga bank, must be recognized as gain, but is to be treated as lon-term capital gain and not as ordinary income. Petitioner has failed to meet the burden of proving that, subject to the adjustments called for, supra, the remaining deposits in the Chattanooga bank represented other than ordinary income, and to that extent we sustain respondent's determination. During the taxable year 1947, petitioner spent approximately $22,000 for labor and materials on three buildings which he had then recently purchased in Chattanooga, Tennessee, for his practice of naturopathy. On his tax return for that year, petitioner treated $2,390.10 of the total expenditures as deductible expense for repairs of said property. Respondent disallowed the entire deduction on the ground that such expenditures represent capital improvements. Petitioner contends that about $1,069.23 of the $2,390.10 is deductible under section 23(a)(1)(A) of the Internal Revenue232 Code of 1939 as the cost of ordinary and necessary repairs, and that the remainder in issue amounting to $1,320.87 is deductible as salary expense (for janitorial work relating to the buildings), which he failed to include as deductions in his 1947 return. In the alternative, petitioner contends that the building at 502 Forrest Avenue required no alterations or remodeling, and that $455.72 of the $2,390.10 in controversy is currently deductible since that amount was spent only for minor repairs on said property, with no part of the benefit being allocable to the other buildings. Respondent, on the other hand, contends that all of the so-called repairs represent part of a general plan of permanent betterment of the three buildings in question and that under section 24(a) of the Code the expense thereof is not so deductible. The authorities are to the effect that where the general plan under which the work is performed is one of rehabilitation and permanent betterment, expenditures incident to such general plan which might ordinarily constitute deductible expenses for repairs will be disallowed as deductions in the current year even though they may be segregated. Home News Publishing Co., 18 B.T.A. 1008">18 B.T.A. 1008, 1010 (1930);233 California Casket Co., 19 T.C. 32">19 T.C. 32 (1952); Ethyl M. Cox, 17 T.C. 1287">17 T.C. 1287 (1952). We hold that the rationale in the above cases is applicable to all of the expenditures relating to the Vine Street properties, which expenditures were made not for incidental repairs, but as an integral part of the over-all plan for the general rehabilitation, remodeling and improvement of the two residence-type buildings. It is clear that much that was done in renovating the Vine Street properties was in the nature of permanent betterments. Petitioner, among other things, installed new bathrooms in each of the Vine Street buildings, and constructed cement walks around the grounds. At 909 Vine Street, he erected an outside steel fire escape, replaced part of the foundation, and installed steel framed windows. At 822 Vine Street, the entire basement was rebuilt for the accommodation of hydrotherapeutic equipment. It is our view that the foregoing structural alterations and the remaining work incidental to the over-all plan materially added to the value of the said buildings and gave them an extended useful life for petitioner's purpose. J. [I.] M. Cowell, 18 B.T.A. 997">18 B.T.A. 997, 1002 (1930),234 Joseph Merrick Jones, 24 T.C. 563">24 T.C. 563, 568 (1955). From the record before us, it is evident from the nature and cost of the expenditures made on 502 Forrest Avenue (which was already being used as a clinic or hospital when acquired by Allen) that they were not made pursuant to the general plan of rehabilitation and permanent betterment contemplated for the Vine Street property, but rather (for the most part) were incurred to keept the building in an ordinarily efficient operating condition. In our opinion, except for a few questionable items, the expenditures on 502 Forrest Avenue were incidental repairs which neither materially added to the value of the property nor appreciably prolonged its life. Based upon consideration of all the evidence, we hold that the total sum of $364.57 expended on 502 Forrest Avenue as itemized in our Findings is deductible for ordinary and necessary expenses. Petitioner also claimed that he spent $204.46 out of a total of $1,587.06 on "builders' supplies" for 502 Forrest Avenue. It may be that some part or all such expenditure represents an item or items currently deductible. In order that we may allow a deduction on account thereof, however, 235 the nature of the item must be made clear to us. Henry F. Cochrane, 23 B.T.A. 202">23 B.T.A. 202, 210 (1931); George A. Manos v. Commissioner, (C.A. 6, 1951) 187 Fed. (2d) 734, affirming a Memorandum Opinion of this Court [8 TCM 1025;]. Obviously, the general term used to designate the item "builders' supplies" is too vague for us to determine whether the materials were used for repairs or for capital improvements. Petitioner has therefore failed to meet the burden of proof with respect to this item. Petitioner also testified that he spent $76.50 for metal wall brackets, especially designed to hold certain examination tables steady. We regard the cost thereof as a capital expenditure and not a deductible expense. The installation of the metal brackets in the walls did not represent a repair but was a betterment designed to render the building more suitable for the use of petitioner in his practice. Accordingly, petitioner has failed to establish the right to deduct the cost of such installation as an ordinary and necessary repair expense. Petitioner likewise argues that several other items of expense, such as plumbing and lead sheets for the showers, *236 are repairs. He did not, however, indicate on which of the buildings such expenditures were made, and we are unable to determine their function with respect to other work performed on the properties in question. Accordingly, we must hold that such unsegregated items are not currently deductible. Henry F. Cochrane, supra. Petitioner contends that salaries amounting to $1,320.87 paid to two employees, who performed janitorial and gardening duties on the grounds of the three buildings, had been mistakenly charged to the "repair" expenditures in issue and are currently deductible in addition to the "payroll" deduction of $1,559.30 taken in his return. After a careful examination of the somewhat vague testimony, we are satisfied that the salary item of $1,320.87 is not a duplication of the deduction taken on the return, and that it was in fact expended for services rendered by employees under circumstances which did not render it capital in nature. We hold, therefore, that petitioner is entitled to a deduction for the $1,320.87 item in addition to the payroll deduction taken on his return. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621342/	MYRNA LABOW, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; RONALD LABOW, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentLa Bow v. CommissionerDocket Nos. 5061-79, 15869-79.United States Tax CourtT.C. Memo 1987-191; 1987 Tax Ct. Memo LEXIS 195; 53 T.C.M. (CCH) 576; T.C.M. (RIA) 87191; April 13, 1987. 195 M sued her husband R for divorce and obtained an order awarding her alimony pendente lite. R's appeal automatically stayed execution of the order. Held, the order for alimony pendente lite, although stayed, remained effective for purposes of sections 71 and 215, I.R.C. 1954, and R's support payments to M made while they were living separately were alimony. Myrna LaBow, pro se in docket No. 5061-79. Ronald LaBow, pro se in docket No. 15869-79. Vincent J. Guiliano and Paulette Segal, for the respondent. NIMSMEMORANDUM FINDINGS OF FACT AND OPINION NIMS, Judge: These cases are before the Court on remand from the Court of Appeals for the Second Circuit. LaBow v. Commissioner,763 F.2d 125">763 F.2d 125 (2d Cir. 1985), affg., revg. and remanding T.C. Memo 1983-417">T.C. Memo. 1983-417. The issues for decision are: (1) whether for purposes of sections 71(a)(3)1 and 215 an order for support remains effective while it is stayed pending appeal; (2) whether Ronald LaBow lived in the co-op in 1975 or moved out in 1974; (3) how much, if anything, Ronald LaBow paid in alimony during 1975; and (4) whether Myrna LaBow double counted $1,000 when she admitted that she received $4,240 directly from Ronald and $3,775 from Ronald197 through the New York Family Court in 1976.FINDINGS OF FACT After the receipt of the mandate of remand pursuant to LaBow v. Commissioner,763 F.2d 125">763 F.2d 125 (2d Cir. 1985), affg., revg. and remanding T.C. Memo. 1983-417, a further trial was held at which testimony was heard and additional exhibits were admitted into the record. Other exhibits submitted after trial have also been admitted into the record. Rather than make supplemental findings, we have recast and here set forth all findings essential to the disposition of the case under the legal standards enunciated by the court of appeals. Myrna LaBow (hereinafter referred to as Myrna) has two addresses, one in New York, New York, and the other in Weston, Connecticut. Ronald LaBow (hereinafter referred to as Ronald) is a resident of New York, New York. At the time the petitions were filed in this case, both Myrna and Ronald resided in New York, New York. Petitioners were married on July 28, 1960. 198 They had three children who were born on June 30, 1961, November 7, 1967, and April 9, 1970, respectively. Before the years in issue, petitioners resided in a cooperative apartment (hereinafter referred to as the co-op) in New York, New York, that they purchased in 1967. They also spent time in Weston, Connecticut, where they owned property containing two houses (hereinafter referred to as the Connecticut property). In July, 1974, Myrna filed a complaint in the Connecticut court seeking a dissolution of the marriage. Ronald appeared "specially" to challenge the Connecticut court's jurisdiction. On February 25, 1975, the Superior Court of Fairfield County, Connecticut, entered an order for alimony pendente lite (hereinafter referred to as the February 25, 1975, order). The February 25, 1975, order was retroactive to November 1, 1974, and required Ronald to pay Myrna $300 per week and all current bills for maintenance of the co-op and the Connecticut property. Ronald was also required to pay all medical and dental expenses for Myrna and the children, to pay for the education of the minor children and to furnish Myrna with the use of a car. On March 11, 1975, Ronald appealed199 to the Supreme Court of Connecticut from the February 25, 1975, order. Ronald's appeal automatically stayed the execution of the February 25, 1975, order. Conn. S. Ct. R. section 661 (1968). On June 5, 1975, the Superior Court issued an order terminating the stay of execution resulting from Ronald's appeal from the February 25, 1975, order. On July 16, 1975, the Chief Justice of the Supreme Court of Connecticut signed an order granting Ronald's motion for review of the trial court's order terminating the stay and directing the trial court to set forth its reasons for terminating the stay of the February 25, 1975, order. On December 10, 1975, the Supreme Court of Connecticut vacated the order of the Superior Court terminating the stay of execution of the February 25, 1975, order. On August 17, 1976, the Supreme Court of Connecticut held that the February 25, 1975, order was valid. On February 22, 1977, the Superior Court found Ronald in contempt of the February 25, 1975, order, ordered him to pay $36,032 in arrearages for the period from November 1, 1974, to August 31, 1976, and credited him with the payment of $17,635 to Myrna for the same period. Ronald appealed the February 22, 1977, decision200 to the Supreme Court of Connecticut. On April 29, 1977, the Superior Court terminated the stay resulting from Ronald's appeal of its February 22, 1977, decision. On May 17, 1977, the Supreme Court of Connecticut upheld the trial court's decision to terminate the stay. Unable to collect the full amount required by the February 25, 1975, order, Myrna filed a claim in the Connecticut Court of Common Pleas. On February 23, 1976, the Connecticut Court of Common Pleas -- Bureau of Support entered a temporary support order requiring Ronald to pay Myrna $750 a week for support. In September, 1975, Ronald sued Myrna for divorce in the Supreme Court of New York. On August 3, 1976, the Family Court of the State of New York entered a temporary support order requiring Ronald to pay the court $2,580 a month for support of Myrna and the children. None of the orders issued February 25, 1975, February 23, 1976, and August 3, 1976, designated any amount of the ordered payments as child support. During the years in issue, Myrna and the three children alternated their residences between the co-op in New York and the Connecticut property. From January 1, 1975, through May 29, 1975, Myrna and201 the three children resided at the co-op. From May 30, 1975, through September 15, 1976, they resided at the Connecticut property. From September 16, 1976, through December 31, 1976, Myrna and the three children resided at the co-op and made only occasional trips to the Connecticut property. Myrna and Ronald battled over access to the co-op. On October 15, 1975, Ronald was locked out. He sued the 1050 Tenants Corporation and obtained an order from the Supreme Court of New York permitting him to enter the co-op. On April 2, 1976, the Supreme Court of New York issued an order permitting both Ronald and Myrna access to the co-op. Ronald originally claimed to have paid the following amounts as alimony to Myrna: 19751976Checks to Myrna$9,000.00$4,735.54Payments through the0 6,855.00New York court systemCooperative maintenance8,832.000 expensesMedical expenses302.500 Cable television (Teleprompter)46.000 New York Telephone465.750 Consolidated Edison984.200 Repairs80.080 Connecticut Light & Power126.130 Southern New England Telephone320.090 Fuel - Connecticut363.340 Repair - Tractor48.520 Tuition expenses9,294.501,583.50TOTAL$29,863.11$13,174.04202 The following cancelled checks found in the possession of the clerk of the Superior Court of Connecticut correspond with Ronald's alleged alimony payments to Myrna in 1975: 1/1/75 to5/30/75 to5/29/752/31/75Checks to Myrna$3,130.00$2,000.00($5,130.00 total)Cooperative maintenance4,350.521,087.63expenses ($5,438.15 total)Medical expenses234.50233.00($467.50 total)Cable television (Teleprompter)46.000 ($46.00 total)New York Telephone351.83292.90($644.73 total)Consolidated Edison680.65384.67($1,065.32 total)Connecticut Light & Power80.6791.40($172.07 total)Southern New England Telephone50.00219.82($269.82 total)Fuel - Connecticut472.8843.00($515.88 total)Tuition expenses3,372.503,075.19($6,447.69 total)TOTAL$12,769.55$7,427.61Other cancelled checks in the possession of the Superior Court do not correspond with Ronald's testimony concerning the alleged alimony payments to Myrna in 1975. All the cancelled checks found in the possession of the Superior Court were from Ronald's personal checking account. The address printed on the cancelled checks203 was "230 Park Avenue, New York, N.Y. 10017." This is not the address of the co-op. OPINION Sections 71 and 215 were amended by the Tax Reform Act of 1984, Pub. L. 98-369, 98 Stat. 494 and further amended by the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085. The 1984 amendments generally apply to divorce or separation instruments executed after 1984. H. Rept. No. 98-861, 1984-3 C.B. (Vol. 2) 371. The 1986 amendments generally apply to instruments executed after December 31, 1986. Section 1843(c)(2)(A), Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2854. Because the years in issue are 1975 and 1976, neither the 1984 amendments nor the 1986 amendments apply in this case. Section 71 as in effect during the years in issue provides in pertinent part: SEC. 71. ALIMONY AND SEPARATE MAINTENANCE PAYMENTS. (a) GENERAL RULE. -- * * * (3) DECREE FOR SUPPORT. -- If a wife is separated from her husband, the wife's gross income includes periodic payments (whether or not made at regular intervals) received by her after the date of the enactment of this title from her husband under a decree entered after March 1, 1954, requiring the husband to make the204 payments for her support or maintenance. This paragraph shall not apply if the husband and wife make a single return jointly. (b) PAYMENTS TO SUPPORT MINOR CHILDREN. -- Subsection (a) shall not apply to that part of any payment which the terms of the decree, instrument, or agreement fix, in terms of an amount of money or a part of the payment, as a sum which is payable for the support of minor children of the husband. For purposes of the preceding sentence, if any payment is less than the amount specified in the decree, instrument, or agreement, then so much of such payment as does not exceed the sum payable for support shall be considered a payment for such support. Section 215 as in effect during the years in issue provides in pertinent part: SEC. 215. ALIMONY, ETC., PAYMENTS. (a) GENERAL RULE. -- In the case of a husband described in section 71, there shall be allowed as a deduction amounts includible under section 71 in the gross income of his wife, payment of which is made within the husband's taxable year. * * Section 71(a)(3) sets forth certain requirements that must be met before a husband can deduct under section 215 his payments to his wife pursuant to a decree205 of support and before the wife must include those payments in her gross income. At issue in this case are the requirements under section 71(a)(3) that: (1) the husband's payments must be made pursuant to a decree requiring him to make payments for the support or maintenance of his wife; and (2) the husband and wife must be separated. Myrna contends that these two requirements have not been met because (1) Ronald's payments to her were not made pursuant to an effective decree; and (2) she and Ronald were not separated when the payments were made. In this case three different courts each issued orders requiring Ronald to make support payments to Myrna. Myrna argues that Ronald's support payments made before August, 1976, did not constitute alimony because there was no order for support in effect until that time. Myrna made this same argument when we first heard this case. At that time she failed to produce sufficient proof that the February 25, 1975, order was stayed pending Ronald's appeal. Upon reconsideration and a review of certain documents Myrna submitted after trial and which we have been directed to consider in this proceeding, we now conclude that the February 25, 1975, order206 was stayed. Section 661 of the Rules for the Supreme Court of Connecticut provides: In actions not criminal, proceedings to enforce or carry out the judgment shall be stayed for twenty days; if the time in which to take an appeal is extended, as provided in Sec. 665, such proceedings shall be stayed until the time to take an appeal has expired; if an appeal is filed, such proceedings shall be stayed until the final determination of the cause; and if the case goes to judgment in this court, until ten days after the decision is announced; but if the judge who tried the case is of the opinion that the extension is sought, the notice is filed or the appeal is taken only for delay or that the due administration of justice requires him to do so, he may at any time, upon motion and hearing, order that the stay be terminated. (P.B. 1951, Sec. 411; 1963.) (Amended May 28, 1968, to take effect Sept. 3, 1968; amended June 9, 1976, to take effect Oct. 1, 1976.) [Conn. S. Ct. R. section 661 (1968).] Under section 661 of the Rules for the Supreme Court of Errors, Ronald's filing of an appeal effected a stay of execution of the February 25, 1975, order until 10 days after August 17, 1976, the207 date of the final decision of the Supreme Court of Connecticut affirming that order. 2208 In our earlier opinion we determined that if the February 25, 1975, order had been rendered ineffective by a stay, Ronald's payments to Myrna pursuant to that order would be nondeductible voluntary payments rather than deductible alimony payments, citing Daine v. Commissioner,168 F.2d 449">168 F.2d 449 (2d Cir. 1948). Respondent argues that even though the February 25, 1975, order was stayed, it remained effective for purposes of section 71(a)(3). We agree with respondent. In Daine v. Commissioner, the husband made maintenance payments to his wife under a voluntary separation agreement terminable by him on one month's notice. The husband and wife were divorced four years later, and incident to the decree of divorce, the Supreme Court of New York entered a nunc pro tunc order declaring that the judgment and decree "shall have the same force and effect" as if entered on the date of the voluntary separation agreement. The Second Circuit held that, notwithstanding the nunc pro tunc order, at the time the payments were made there was no decree of divorce or of separate maintenance in effect as required by sections 22(k) and 23(u) of the Internal Revenue Code of 1939, in effect209 during the years in issue in that case. Sections 22(k) and 23(u) of the Internal Revenue Code of 1939 were the forerunners of sections 71(a)(1) and 215 as in effect during the years in issue in this case. Both section 22(k) of the Internal Revenue Code of 1939 and section 71(a)(1) require the inclusion in a wife's income of payments by a husband under a decree of divorce or separate maintenance. There were no provisions in the Internal Revenue Code of 1939 for the inclusion in a wife's income of payments by a husband under a written separation agreement as required by section 71(a)(2) or under a decree for support as required by section 71(a)(3). The decree requirement in section 71(a)(3) is analogous to the same requirement in section 71(a)(1). Under Daine v. Commissioner,supra, there must be an effective decree in existence at the time the maintenance payments are made before the wife is required to include the payments in her gross income. In this case there was a decree, the February 25, 1975 order, in existence at the time that Ronald made support payments to Myrna. Myrna maintains that the automatic stay invalidated the February 25, 1975, order210 and that therefore any payments made pursuant to that order and before August, 1976, when the Supreme Court affirmed the order, were voluntary payments by Ronald not includible in her gross income. Myrna's understanding of the effect of the stay is incorrect. Under Connecticut law, a stay does not render a judgment ineffective. Continental National American Group v. Majeske,30 Conn. 567">30 Conn. 567, 305 A.2d 291">305 A.2d 291 (1973). The Superior Court of Connecticut recognized the validity of the February 25, 1975, order when it held Ronald in contempt of that order, ordered him to pay arrearages totaling $36,032 for the period from November 1, 1974, to August 31, 1976, and credited him with the payment to Myrna of $17,635 for the same period. Myrna has also submitted exhibits showing that Ronald and his attorney did not believe that he was obligated to make payments under the February 25, 1975, order while it was stayed. Whether Ronald believed that he made the payments pursuant to a decree is irrelevant in this case. Section 71 does not require that either party intend or believe that the payments were made pursuant to a decree. In Daine v. Commissioner,supra,211 the taxpayer's wife had originally included the amounts received from her husband pursuant to their maintenance agreement as taxable income on her income tax returns. Later she filed claims for refund of alleged overpayments of tax. The wife's original perception concerning the nature of the payments was irrelevant to the determination of the case. See also Wondsel v. Commissioner,350 F.2d 339">350 F.2d 339, 341 (2d Cir. 1965). Myrna has also argued that the order for support issued by the Connecticut Court of Common Pleas -- Bureau for Support on February 23, 1976, was ineffective. Because we have determined that the February 25, 1975, order was effective and that Ronald's payments to Myrna were made pursuant to the February 25, 1975, order, it is unnecessary to address this issue. Separated and Living ApartSection 71(a)(3) also provides that the husband and wife must be separated and living apart when the support payments are made before the payments will be considered alimony includible in the wife's gross income and deductible by the husband. Section 1.71-1(b)(3)(i), Income Tax Regs. To satisfy the "separated and living apart" requirement of section 71(a)(3), 212 the husband and wife must live in separate residences. Lyddan v. United States,721 F.2d 873">721 F.2d 873 (2d Cir. 1983), cert. denied 467 U.S. 1214">467 U.S. 1214 (1984); Washington v. Commissioner,77 T.C. 601">77 T.C. 601 (1981); contra Sydnes v. Commissioner,577 F.2d 60">577 F.2d 60 (8th Cir. 1978), revg. as to this issue 68 T.C. 170">68 T.C. 170 (1977). Accordingly, even though Ronald and Myrna used separate bedrooms when they both lived at the co-op, they were not separated during those times for purposes of section 71(a)(3). While it has been established where Myrna and the children resided during 1975 and 1976, there are conflicting statements by both Ronald and Myrna concerning Ronald's residence during this period. New evidence, although contradictory, has been presented concerning Ronald's residence during the years in issue. Upon consideration of all the evidence, we conclude that Ronald and Myrna lived together at the co-op from January 1, 1975, through May 29, 1975, and from October 1, 1976, through December 31, 1976. The parties agree that Myrna and the three children resided at the co-op from January 1, 1975, through May 29, 1975; at the Connecticut213 property from May 30, 1975, through September 15, 1976; and at the co-op from September 16, 1976, through December 31, 1976. They also agree that Myrna and Ronald lived in separate residences from May 30, 1975, when Myrna moved to Connecticut, until September 16, 1976, when Myrna moved back to the co-op. Finally, it has been established that Ronald and Myrna resided together at the co-op from October 1, 1976, through December 31, 1976, and that Ronald did not return to the co-op after he was locked out on October 15, 1975, until October, 1976. LaBow v. Commissioner,763 F.2d 125">763 F.2d 125, 131 (2d Cir. 1985), affg., revg. and remanding T.C. Memo. 1983-417. Myrna and Ronald disagree, however, about Ronald's residence during the period from January through May, 1975. At the first trial in this Court, Myrna testified that Ronald lived with her at the co-op from January until May, 1975. Ronald's statements in two affidavits submitted to the Supreme Court of New York during his battle with Myrna over access to the co-op support this testimony. However, in an affidavit submitted to the Supreme Court of New York during the fight over access to the co-op, Myrna stated: 214 "The plaintiff [Ronald] had abandoned me and my children sometime in the spring of 1974 in that he stopped sleeping at the apartment at 1050 Park Avenue [the co-op]." At the first trial in this Court, Ronald contradicted the statements in his affidavits by testifying that he moved out of the co-op in December, 1974, or January, 1975, and did not return until the last third of 1976. We find that all the statements submitted by both petitioners were self-serving at the time they were made, but we have concluded that Myrna's testimony at the trial and Ronald's statements in the affidavits to the Supreme Court of New York are more credible than their other contradictory statements. Accordingly, Ronald's support payments made to Myrna during the time they were living separately from May 30, 1975, through October 1, 1976, were alimony, includible in Myrna's gross income and deductible by Ronald. The Amount of Alimony Paid in 1975Ronald originally claimed that he paid Myrna alimony totaling $29,863.11 in 1975. Later he conceded that tuition expenses for the children that he had originally claimed as alimony were not deductible by him and not to be included in Myrna's gross215 income. At the first trial in this Court, however, Ronald was unable to produce any evidence of actual payment. Respondent has now produced cancelled checks that were in the possession of the Superior Court of Connecticut showing payments by Ronald in 1975 to Myrna or for her benefit. Of these cancelled checks, only $20,197.24 corresponded with Ronald's alleged alimony payments to Myrna in 1975. None of the parties have argued that the checks not corresponding with Ronald's alleged alimony payments should be considered alimony. Because there is no issue concerning those checks, we shall only determine whether the cancelled checks corresponding with Ronald's alleged alimony payments were includible in Myrna's gross income and deductible by Ronald in 1975. Because we have concluded that Ronald and Myrna lived together from January 1, 1975, through May 29, 1975, only those checks dated after May 29, 1975, can be considered alimony payments. Of the checks dated after May 29, 1975, $7,427.61 corresponded to Ronald's alleged alimony payments. However, Ronald has conceded that his payments for tuition for the children were not alimony. Accordingly, $3,075.19 in tuition checks dated216 after May 29, 1975, must be subtracted from the $7,427.61 total. We conclude, therefore, that Ronald made alimony payments to Myrna totaling $4,352.42 in 1975, includible in Myrna's gross income and deductible by Ronald in 1975. Although most of the cancelled checks represent payments by Ronald to third parties on Myrna's behalf, they are nevertheless alimony. Isaacson v. Commissioner,58 T.C. 659">58 T.C. 659 (1972). Included in Ronald's payments to third parties after May 29, 1975, were checks totaling $1,087.63 in cooperative expenses. Respondent has determined that these payments were not made to support Ronald's ownership interest in the co-op but were for Myrna's benefit, and neither Ronald nor Myrna has questioned this conclusion. We therefore accept respondent's determination as to the nature of the cooperative expenses. The Amount of Alimony Paid in 1976Myrna originally admitted that she received checks totaling $4,240 directly from Ronald and $3,775 from Ronald through the Family Court of New York in 1976. None of the court orders directing these payments fixed any specific amounts as child support, and therefore the entire amount paid by Ronald to Myrna217 in 1976 was alimony. Commissioner v. Lester,366 U.S. 299">366 U.S. 299 (1961). At the trial in this Court after remand, Myrna testified that she received checks directly from Ronald totaling only $3,240 in 1976 and that she double counted the receipt of $1,000 from Ronald in August, 1976. Ronald did not attempt to refute her testimony, and respondent has conceded this issue. Accordingly, we find that Myrna double counted $1,000 of the $8,015 that she originally had admitted she had received from Ronald in 1976. Myrna has also submitted evidence that she received $3,775 from Ronald through the Family Court of New York during the period from March 1, 1976, through August 1, 1976. It has been established that Ronald and Myrna were not separated for purposes of section 71(a)(3) during the last three months (October through December) of 1976, and therefore amounts Ronald paid to Myrna during that time cannot be considered alimony. Accordingly, we conclude that three-fourths of the $3,240 that Ronald paid directly to Myrna in 1976 and all of the $3,775 paid through the Family Court of New York in 1976 was alimony. Myrna must include $6,205 in her gross income and Ronald may deduct218 that amount in 1976. Decisions will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect during the years in issue. All rule references are to the Tax Court Rules of Practice and Procedure.↩2. Respondent argues that the February 25, 1975, order was not stayed until March 11, 1975, when Ronald filed his appeal. Under section 661 of the Rules for the Supreme Court of Connecticut, the February 25, 1975, order was automatically stayed for twenty days. Ronald's filing of his appeal within the twenty-day period kept the stay effective until ten days after the Supreme Court of Connecticut entered its final decision affirming the order. Respondent also argues that the stay was lifted from June 5, 1975, when the trial court issued an order terminating the stay, until July 16, 1975, when the Chief Justice of the Supreme Court of Connecticut granted Ronald's motion for review of the trial court's order terminating the stay or until December 10, 1975, when the Supreme Court of Connecticut vacated the order of the Superior Court terminating the stay. The Rules for the Supreme Court of Connecticut as in effect during the years in issue do not clearly indicate what effect Ronald's motion for review had on the trial court's order terminating the stay. If Ronald's motion was an appeal of the order, it stayed the order under Conn. S. Ct. R. section 661 (1968). The Rules for the Supreme Court of Connecticut were revised in 1978 to provide that a motion for review of an order terminating a stay, in turn, stays the order keeping the original stay alive until the Supreme Court of Connecticut rules otherwise. Conn. S. Ct. R. section 3067 (1978). However, because we have determined that the February 25, 1975, order remained effective despite the existence of the stay, see infra,↩ we need not address the issue concerning the duration of the stay.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621344/	KERMIT M. OTNESS AND ANGELA J. OTNESS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentOTNESS v. COMMISSIONERDocket No. 3296-75.United States Tax CourtT.C. Memo 1978-481; 1978 Tax Ct. Memo LEXIS 38; 37 T.C.M. (CCH) 1849-44; November 29, 1978, Filed 38 Petitioner was employed through his union by M-K on a construction project during which period he maintained two homes. Held, petitioner's position with M-K was temporary and expenses incurred at the construction project are deductible as away-from-home expenses. Paul A. Kief, for the petitioners. James C. Lanning, for the respondent. IRWINMEMORANDUM FINDINGS OF FACT AND OPINION IRWIN, Judge: Respondent determined a deficiency of $771.91 in petitioners' income tax for the taxable year 1971. Due to a concession by respondent, the only issue remaining for our consideration is whether petitioners are entitled to deduct amounts expended by Kermit39 Otness for meals and lodging as traveling expenses incurred in his trade or business while away from home. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts, together with the exhibit attached thereto, are incorporated herein by this reference. Petitioners, Kermit M. Otness and Angela J. Otness, husband and wife, filed a joint income tax return for the taxable year 1971. Although it is not stated in the record where the return was filed, petitioners' legal residence during 1971 was Bemidji, Minnesota. At the time they filed their petition herein, petitioners still resided in Bemidji, Minnesota. Because Angela J. Otness is a petitioner herein solely by reason of her filing a joint return, hereafter references to petitioner are to Kermit Otness. Since September 1968, petitioner has belonged to the Minneapolis-St. Paul local of the operating engineers union. The local also had offices at Bagley, Minnesota and Grand Forks, North Dakota. Petitioner obtained work through his union hall from which he was dispatched to jobs. Operating engineers' work typically is seasonal, usually lasting from May through November, and petitioner often had40 several employers during a single season. Petitioner was dispatched by his union hall at Grand Forks in April 1970, and started employment as an oilergreaser on April 25, 1970 with the Morrison-Knudsen Construction Company (hereafter M-K) on a missile construction project in Concrete, North Dakota. The project was scheduled to be completed in June 1973. Petitioner worked on an hourly basis under the supervision of M-K's permanent employees, had no guarantee as to the duration of his job, and was subject to discharge by M-K at any time. M-K hired all its union help from local union halls. Petitioner had no employment contract with M-K other than that obtained through the local unions. M-K provided no housing for union employees on the project and petitioner lived in a small trailer house not large enough to accommodate his family while in Concrete. His family continued to reside in Bemidji throughout his employment with M-K. During the summer and fall of 1970, petitioner worked as an oiler-greaser servicing equipment in the field. During the summer and fall of 1970, there were four other employees holding identical positions. At the end of the fall season, when outside41 work was discontinued, three of these employees were laid off. Petitioner, however, was retained by M-K in November to do indoor repair and maintenance work as an oiler-greaser during the winter of 1970-1971. From April 1971 through November 1971, petitioner once again performed equipment service work but by the end of fall 1971, petitioner was performing repair and maintenance work similar to that which he had done during the previous winter. In spring 1972, petitioner again returned to field work at which he remained until his job was terminated due to a union dispute on August 28, 1972. At this time, petitioner returned to his family in Minnesota. Three days later, however, petitioner was rehired and worked for M-K until December 1, 1972, when he was laid off due to a reduction in M-K's work force. OPINION Under section 162(a)(2) 1 a taxpayer may deduct expenses of meals and lodging incurred in one's trade or business while away from home. The dispute in this case centers on whether petitioner was away from home while assigned to the missile construction site in Concrete. In order to answer this question, we must determine where petitioner's tax home was during 1971: 42 if his tax home was Bemidji, expenses incurred in Concrete would qualify as away-from-home expenses; on the other hand, if petitioner's tax home was Concrete, expenses incurred would not qualify under section 162(a)(2). This Court has consistently held that a taxpayer's "home" for purposes of section 162(a)(2) is his principal place of business regardless of where his family resides. Coombs v. Commissioner,67 T.C. 426">67 T.C. 426, 478 (1976), on appeal to the Ninth Circuit Feb. 14, 1977; Michaels v. Commissioner,53 T.C. 269">53 T.C. 269 (1969). However, where a taxpayer's employment is only temporary rather than indefinite a deduction will be allowed. 2Bochner v. Commissioner,67 T.C. 824">67 T.C. 824, 827 (1977); Montgomery v. Commissioner,64 T.C. 175">64 T.C. 175 (1975), affd. 532 F.2d 1088">532 F.2d 1088 (6th Cir. 1976); Dean v. Commissioner,54 T.C. 663">54 T.C. 663 (1970). In addition, if the employment while away from home, even if temporary at its inception, later becomes indefinite or indeterminate in duration, the situs of such43 employment becomes the taxpayer's tax home. Norwood v. Commissioner,66 T.C. 467">66 T.C. 467 (1976); Kroll v. Commissioner,49 T.C. 557">49 T.C. 557, 562 (1968); Verner v. Commissioner,39 T.C. 749">39 T.C. 749 (1963); Garlock v. Commissioner,34 T.C. 611">34 T.C. 611, 615 (1960). The Eighth Circuit, to which appeal in this case would lie, has adopted a similar position: Where it appears probable that a taxpayer's employment outside the area of his regular abode will be for a 'temporary' or 'short' period of time, then his travel expenses are held to be deductible; conversely, if the prospects are that his work will continue for an 'indefinite' or 'intermediate' or 'substantially long' period, then the deduction is disallowed. Cockrell v. Commissioner,321 F.2d 504">321 F.2d 504, 507 (8th Cir. 1963). See also Jenkins v. Commissioner,418 F. 2d 1292 (8th Cir. 1969),44 affg. T.C. Memo 1969-257">T.C. Memo. 1969-257; Ney v. Commissioner,171 F.2d 449">171 F.2d 449 (8th Cir. 1948), cert. denied 336 U.S. 967">336 U.S. 967 (1949). We agree with petitioner that the evidence shows that construction workers doing work similar to petitioner often accept seasonal employment on a single project basis which lasts no longer than the project. Because petitioner was not regularly or continuously employed by any single concern, apparently usually worked in the Bemidji area, was a member of the local union for his trade, and maintained his family residence in Bemidji, respondent appears to concede that Bemidji was petitioner's tax home prior to obtaining the job with M-K and that if petitioner expected to remain on the project less than one year, the expenses would be deductible. 3 Similarly, petitioner recognizes the issue here is whether, in accepting employment on this particular project, he could have expected to have been only temporarily employed, i.e., not for a substantial or indefinite period. 45 Petitioner agrees with respondent that if he had expected to be employed the entire 31 months (April 25, 1970 through December 1, 1972) that he worked for M-K at the time he was first employed, the work would have been for a sufficiently long period to deny him a deduction. It is his position, however, that when he was first hired in April 1970, he did not know he would be employed for a whole season and definitely expected to be laid off in the fall when inclement weather would force construction to halt; that he did not expect to be retained to do service and maintenance work during the winter; and that the same was true of the summer and fall of 1971 and 1972. Petitioner maintains that under these conditions it would be unreasonable to expect him to move his family and he is thereby entitled to deduct away-from-home expenses. Tucker v. Commissioner,55 T.C. 783">55 T.C. 783 (1971). Respondent contends that petitioner's job at its inception was for an indefinite or substantially long period of time. In the alternative, respondent contends that at some point on or prior to December 31, 1970, petitioner's job became indefinite, thus losing its temporary status. We believe46 that throughout 1970 and 1971, it was likely that petitioner's employment, from any given time, would last only a short time. 4 The actual work performed by petitioner during the winter was different than it was during the summer and fall. Three of the five oiler-greasers who were working on the project during the summer and fall of 1970 were laid off during the winter when outside work was discontinued. Petitioner had no reason to expect that he would be one of the two oiler-greasers that would be retained by M-K during the winter months until he was asked to work in November. In addition, his work was typically seasonal, usually lasting only from May through November. 547 On these facts, although a close case, we hold that petitioner was away-from-home while working in Concrete and, therefore, entitled to deduct his meals and lodging expenses incurred there. 6Decision will be entered for the petitioners. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect for the taxable year in issue.↩2. Employment which merely lacks permanence is indefinite rather than temporary unless termination is foreseeable within a short period of time. Boone v. United States,482 F.2d 417">482 F.2d 417 (5th Cir. 1973); Albert v. Commissioner,13 T.C. 129">13 T.C. 129↩ (1949).3. Petitioner relies on a letter ruling, denoted as Letter-Ruling 5-4-56, which provides identical conditions to Rev. Rul. 60-189, 1 C.B. 60">1960-1 C.B. 60. Although petitioner cannot, of course, rely on a private ruling issued to another taxpayer even where that taxpayer is similarly situated, McLane v. Commissioner,46 T.C. 140">46 T.C. 140 (1966), affd. 377 F.2d 557">377 F.2d 557 (9th Cir. 1967), cert. denied 389 U.S. 1038">389 U.S. 1038, (1968), a careful reading of the revenue ruling shows that petitioner cannot fall within its confines unless he can show that the anticipated and actual duration of employment was for less than one year. The precise issue in this case is whether petitioner can show he anticipated working only a short period of time. It is apparently conceded that the other facts necessary to bring petitioner within its scope are all met: the tax-payer is not regularly or continuously employed by any single concern; is a member of the local union for his trade in a particular city and maintains his regular place of abode there; usually works in and around that city but at times takes employment elsewhere; and the location and duration of his employments elsewhere require him to obtain lodging near such projects. Moreover, we believe respondent would not contest a situation in which a taxpayer took a job for an expected seven-month period and then at the end of that period was hired for an additional seven or eight months such that the second position could be considered a new job if all other conditions of the ruling were met. Cf. Barkley v. Commissioner, T.C. Memo. 1976-159; LaRocca v. Commissioner, T.C. Memo. 1973-185; Brown v. Commissioner, T.C. Memo. 1971-7↩.4. When petitioner was told in November 1970 that he would be retained through the winter, we believe he should reasonably have expected to be retained during the summer and fall of 1971, since additional oiler-greasers would be hired. But he could not reasonably expect to be rehired the following winter; therefore, at no time through 1971 could he expect to be on the job for longer than an additional year. We agree with respondent that the actual duration of petitioner's employment indicates its indefiniteness and is a factor weighing against petitioner. Boone v. United States,482 F.2d 417">482 F.2d 417 (5th Cir. 1973); McCallister v. Commissioner,70 T.C. 505">70 T.C. 505, 510 (1978); Garlock v. Commissioner,supra.Since the test is whether petitioner could anticipate the length of his employment, however, this is only a fact to be considered and is not dispositive. See Frederick v. United States,↩ an unreported case (D.C.N.D. 1978, 78-2 U.S.T.C. par 9774).5. Petitioner also relies on the fact that he had no guarantee as to the duration of his job and was subject to discharge at any time. We do not believe these facts are dispositive. McCallister v. Commissioner,70 T.C. 505">70 T.C. 505, 510 (1978). Although petitioner's employment may have lacked real permanence, this does not necessarily imply that degree of temporariness which would prevent his principal place of employment from becoming Concrete. Garlock v. Commissioner,supra↩.6. Cf. Frederick v. United States, an unreported case (D.C.N.D. 1978, 78-2 U.S.T.C. par 9774); Holter v. Commissioner,T.C. Memo. 1978-411↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621345/	C. J. Reuter v. Commissioner. F. N. Reuter v. Commissioner.Reuter v. CommissionerDocket Nos. 22658, 23838.United States Tax Court1951 Tax Ct. Memo LEXIS 274; 10 T.C.M. (CCH) 292; T.C.M. (RIA) 51089; March 30, 1951274 C. J. Reuter, for the petitioners. E. C. Adams, Esq., for the respondent. JOHNSON Memorandum Findings of Fact and Opinion JOHNSON, Judge: In these consolidated proceedings respondent determined income tax deficiencies against each of the petitioners for the clendar year 1943 as follows: Docket No. 22658C. J. Reuter$816.96Docket No. 23838F. N. Reuter898.24The only question presented is whether petitioners are entitled to a bad debt deduction amounting to $16,430 in the year 1943 under section 23 (k) (1) of the Internal Revenue Code. Findings of Fact Petitioners are individual taxpayers, C. J. Reuter residing at Alexandria, Minnesota, and F. N. Reuter at Carlos, Minnesota. They are brothers and also comprise a mercantile partnership under the firm name of Reuter Bros., and have places of business both at Carlos, Minnesota, and Alexandria, Minnesota, and they each filed income tax returns and also a partnership return for the calendar year 1943 with the collector of internal revenue at St. Paul, Minnesota. Petitioners have been in business, under the firm name of Reuter Bros., continuously since 1904, each275 being an equal partner therein. They first established a business at Carlos, Minnesota, and later, in 1923, established another at Alexandria, Minnesota, both of which they have continued to operate, including 1943 and thereafter. In 1919 petitioners formed another and different partnership with C. G. Dickey, a brother-in-law of petitioner, C. J. Reuter, under the firm name of Reuter Bros. & Dickey, for the purpose of operating an automobile dealership, at Morris, Minnesota. Dickey was in charge of the management of the business at Morris, but petitioners furnished most of the capital therefor. On January 4, 1928, the Reuter Bros. & Dickey firm was indebted to the firm of Reuter Bros., and on that date a promissory note was executed and signed by "Reuter Bros. & Dickey, by C. G. Dickey", wherein they promised to pay Reuter Bros. $14,130. No due date was stated in the note. Another promissory note was executed by Reuter Bros. & Dickey, dated January 4, (no year given) whereby Reuter Bros. & Dickey promised to pay to Reuter Bros., on January 4, 1930, $3,170. The back of this note contains a credit notice of $870 "paid on 12/27/ - " (no year given). The partnership of Reuter Bros. 276 & Dickey was operated continuously from 1919 to 1933, but in 1933 it was dissolved and thereafter C. G. Dickey alone carried on the automobile business at Morris, Minnesota, as its sole owner, and petitioners no longer owned an interest therein. Upon the dissolution of this partnership in 1933, in the settlement of the interest of the three partners growing out of said business, C. G. Dickey personally assumed an promised to pay to petitioners an indebtedness based upon the notes above described. This indebtedness by C. G. Dickey to petitioners remained due and unpaid in the amount of $16,430 on January 1, 1943. Petitioners had not unduly pressed Dickey for payment since he had had "a lot of sickness" both of himself and his family, and petitioners thought that he would "work it out" and eventually pay them. Dickey at all times recognized his liability for the debt and continued in business at Morris, Minnesota. In 1943, due to financial reverses, Dickey lost the equity which he owned in the building in which he was carrying on his automobile business, and also lost possession thereof, and petitioners then, for the first time, concluded that Dickey would not be able to pay them and277 that the debt due them by Dickey was worthless, and they charged it off in that year as a bad debt deduction in their income tax returns, which the Commissioner disallowed. The debt of $16,430 due petitioners by C. G. Dickey did in fact become worthless in the year 1943. Opinion The parties agree that here there was a business debt and that it became worthless. The only question in dispute is whether it became worthless in 1943. Petitioners assert that it did, while respondent contends that it became worthless prior thereto. We think the evidence sustains petitioners' contention that the debt in question became worthless in 1943, the year that petitioners charged it off and claimed it as a deduction. From 1933, when the debt in question was created, up to and including 1943, Dickey, the debtor, was continuously engaged in and carrying on a business of his own, and so long as he was so engaged and recognized his obligation to petitioners, the debt could not be deemed worthless. In 1943, however, the conditions affecting the collectability of the debt and Dickey's ability to pay same were materially changed when, by reason of financial reverses, Dickey lost the equity which he278 owned in the building in which he was carrying on his business, and also lost possession of same and was unable to continue in business. Such an identifiable event, we think, warrants the conclusion that the debt then became worthless. Respondent's brief, in commenting upon petitioners' forbearance in pushing the collection of the debt, due to the illness of Dickey and members of his family, states: "Indeed the action of these two petitioners in their dealings with Mr. Dickey are highly commendable, but income tax is a matter of statute and bad debt loss is allowable only in the year in which it actually becomes a bad debt. Meltzer v. Commissioner, (C.A. 2, 1946) 154 Fed. (2d) 776." [Italics supplied.] Meltzer v. Commissioner, supra, is the only case cited by respondent. There the debt in question was created from 1928 to 1932. The taxpayer, who was the creditor, at times made demands of the debtor for payment without avail, and in 1941 claimed the debt then became worthless on the ground "that the entrance of the United States into war with Germany and Japan in December, 1941, was an identifiable event which made the debt worthless". There the debtor279 in 1935 lost all of his property, both real and personal, and another creditor of the debtor in that year foreclosed a lien upon valuable property in which the debtor had an equity. And subsequent to 1935 the debtor was able to earn no more than his living expenses. The Tax Court [4 TCM 638,], the Court of Appeals for the Second Circuit affirming, held that the debt became worthless prior to 1941, and there was no happening in that year which made the debt worthless. Evidently, if the taxpayer had claimed deductibility on the ground of worthlessness in 1935, the year that the debtor lost his property and his ability to earn income, the Court would have sustained the taxpayer's claimed deduction. The holding in the Meltzer case, when applied to the facts of the instant case, sustains the petitioners rather than the respondent. Petitioners' forbearance in the collection of the debt did not affect their right to claim its deductibility on the ground of worthlessness. Smyth v. Barneson, 181 Fed. (2d) 143, (C.A. 9, 1950). Respondent in his brief states that under the law of Minnesota the statute of limitations for the collection of the debt "had tolled*280 sometime in 1936 (six years from 1933), and recovery after that date would be impossible, except at the will of the debtor sued". He does not contend, however, that this fact of itself rendered the debt worthless prior to 1943, and as we understand he merely suggests it was a plea that could have been interposed if suit had been brought. And under Smyth v. Barneson, supra, limitation of itself would not have rendered the claim worthless prior to 1943, the debtor recognizing the existence of liability, as the facts show. Decisions will be entered for the petitioners.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621348/	South Lake Farms, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent. South Lake Farms, Petitioner, v. Commissioner of Internal Revenue, RespondentSouth Lake Farms, Inc. v. CommissionerDocket Nos. 82944, 82945United States Tax Court36 T.C. 1027; 1961 U.S. Tax Ct. LEXIS 75; September 15, 1961, Filed 75 Decisions will be entered under Rule 50. 1. Late in September 1956 purchasing corporation purchased all of the capital stock of old corporation for the purpose of dissolving it and immediately taking over its assets. Early in October 1956 and pursuant to a plan of dissolution and complete liquidation the old corporation distributed and transferred all of its assets to purchasing corporation without receiving any payment therefor and thereby was rendered without any assets. Held, that the market value of an unharvested cotton crop and certain land preparation included in the assets distributed and transferred is not includible in the income of the old corporation. Elsie SoRelle, 22 T.C. 459">22 T.C. 459 (1954), followed.2. Held, that the income of old corporation may not be increased by amount of expenses incurred by old corporation in producing unharvested cotton crop and in making land preparation where the amount of such expenses is not distributed, allocated, or apportioned to purchasing corporation as required by section 482, I.R.C. 1954. Chicago & North Western Railway Co., 29 T.C. 989">29 T.C. 989 (1958), followed. H. D. Costigan, Esq., and Gordon M. Weber, Esq., for the petitioners.John O. Hargrove, Esq., for the respondent. Withey, Judge. WITHEY1028 The respondent has determined deficiencies in the income tax of petitioner South Lake Farms, Inc., of $ 35,029.52, $ 37,791.98, and $ 853,731.09 for the fiscal years ended April 30, 1955, and April 30, 1956, and the period beginning May 1 and ending October 3, 1956, respectively. The respondent has determined that petitioner South Lake Farms is liable as transferee of the assets of South Lake Farms, Inc., for the foregoing deficiencies in the income tax of the latter corporation.The issues for determination in the case of South Lake Farms, Inc., are the correctness of the respondent's action (1) in determining that the taxable income of the petitioner for the period May 1 through October 3, 1956, should be increased by the amount of $ 1,808,679.94 as representing the value of petitioner's growing crops at the time of petitioner's79 distribution in complete liquidation of all of its assets to its parent corporation, South Lake Farms, (2) in determining, in the alternative, in the event the preceding issue is decided adversely to him, that the taxable income of the petitioner for the period May 1 through October 3, 1956, should be increased by the amount of $ 847,632.58 as representing the expenses determined by respondent to have been incurred by petitioner in connection with its growing crops to the time of its liquidation, (3) in determining that the petitioner did not sustain a net operating loss of $ 150,618.26 for the period May 1 through October 3, 1956, and accordingly did not have a net operating loss carryback of $ 77,941.38 to the fiscal year ended April 30, 1955, and a net operating loss carryback of $ 72,676.88 to the fiscal year ended April 30, 1956.In addition to the foregoing issues presented in the case of South Lake Farms, Inc., the case of South Lake Farms also presents as an issue the correctness of the respondent's action in determining that South Lake Farms is liable as transferee of the assets of South Lake Farms, Inc., for the deficiencies in income tax of the latter corporation involved80 herein.FINDINGS OF FACT.Some of the facts have been stipulated and are found accordingly.South Lake Farms, Inc., sometimes hereinafter referred to as the old corporation, was organized under the laws of California in May 1946, has its principal office at Fresno, California, and filed its Federal income tax returns for the fiscal years ended April 30, 1955, and April 30, 1956, and the period May 1 through October 3, 1956, with the district director in San Francisco, California.1029 South Lake Farms, sometimes hereinafter referred to as the purchasing corporation, is a California corporation with its principal office at Fresno, California. Its Federal income tax returns for the periods here involved were filed with the district director in San Francisco, California. The purchasing corporation originally was organized under the name of Ross Mercantile Company in May 1954 to conduct a general merchandising business. On January 3, 1956, its charter was suspended for failure to pay its annual license fee. The charter was revived on September 26, 1956, and the name of the corporation was changed to South Valley Farms. Thereafter, on October 8, 1956, the corporation's name 81 was further changed to its present name, South Lake Farms.From the time of its organization in May 1946 until October 3, 1956, the old corporation was engaged in the farming business in Tulare, Kings, and Kern Counties, California. Its principal products were cotton, barley, cover crops, and cattle and sheep and their by-products. During the summer of 1956 its farming activities were conducted on approximately 33,424 acres of land owned by it and 43,470 acres of additional land leased by it.At all times material herein the old corporation regularly kept its books and filed its income tax returns on the basis of an accrual method of accounting and on the basis of a fiscal year beginning on May 1 and ending on April 30, except for its final fiscal period which began May 1 and ended October 3, 1956. Crops unharvested at the end of each fiscal year were not inventoried or otherwise included in gross income until the following year when they were harvested. Crops harvested and on hand at the end of each fiscal year were included in inventories at the lower of estimated cost or actual market value.On September 29, 1956, and for about a year prior thereto the stock of the old corporation82 was owned by approximately 30 individuals, most of whom were members of the Hill family.On or about September 7, 1956, Carl Quandt and Kenneth Quandt made an offer to the owners of all of the capital stock of the old corporation and to two affiliated partnerships for the purchase by them, or by a corporation to which their rights might be assigned, of all of the capital stock of the old corporation and all of the interests in two partnerships for $ 5 million. The offer was conditioned upon the accomplishment of transactions necessary to the dissolution of the old corporation on or before October 5, 1956, in order that its assets could be transferred to a successor corporation by that date. The offer was accepted by all of the parties to whom it was addressed, including all of the shareholders of the old corporation, on or about September 19, 1956. On September 28, 1956, amendments not material herein were added to the contract of purchase and sale.1030 Both the offerors and the offerees expected that the harvest of the old corporation's 1956 cotton crop would commence on or shortly after October 5, 1956. The estimated value of the old corporation's unharvested crops was83 taken into account by the parties in fixing the purchase price of the old corporation's stock. The possibility of substantial refunds of Federal income tax to the old corporation as the result of an anticipated net operating loss sustained by the old corporation during its last or final taxable period also was taken into account by the parties in fixing the purchase price of the stock of the old corporation.On September 26, 1956, the charter of the purchasing corporation, which had been suspended since January 3, 1956, because of failure to pay its annual license fee, was revived at the request, by telegram, of Producers Cotton Oil Company, Carl Quandt, Kenneth Quandt, and David S. Davis. On the same day, September 26, 1956, the foregoing persons purchased the capital stock of the purchasing corporation in the following indicated percentages:StockholderPercentageProducers Cotton Oil Company40Carl Quandt20Kenneth Quandt20David S. Davis20Immediately following the foregoing purchases A. T. Mann, an officer of Producers Cotton Oil Company, the Quandts, and Davis became directors of the purchasing corporation. On October 2, 1956, the Quandts executed a stock-voting84 proxy to the Producers Cotton, Oil Company and thereafter, at all times material herein, that company controlled the purchasing corporation.The principal business activity of Producers Cotton Oil Company is, and at all times material herein has been, the ginning of cotton, including cotton purchased, ginned, and sold by it, the purchase of cottonseed, and the manufacture and sale of cottonseed products. During 1956 Producers Cotton Oil Company held the controlling stock of Calflax Company and Sunset Farms, Inc., two corporations engaged in the business of farming, including the growing of cotton for sale to Producers for its ginning and manufacturing operations.On or about September 27, 1956, the directors of the purchasing corporation authorized the acquisition by the corporation of the rights and the assumption by it of the obligations of the Quandts under the contract of September 7, 1956, as subsequently amended. Such contract was then assigned to the purchasing corporation which on September 29, 1956, purchased all the outstanding shares of the old corporation's stock.1031 The purpose of the purchasing corporation in purchasing the capital stock of the old corporation85 was to dissolve it immediately and take over its assets.In order to finance the initial payment of $ 1 million for the stock of the old corporation and for working capital needs, the purchasing corporation obtained a bank loan of $ 1,750,000 on the security of a crop mortgage and the guarantee of repayment by Producers Cotton Oil Company.Subsequently and on October 2, 1956, a plan of dissolution and complete liquidation of the old corporation was adopted by its then sole shareholder, the purchasing corporation, at a meeting of the shareholders of the old corporation held on that date. The plan, which was never modified or rescinded, was as follows:PLAN OF DISSOLUTION AND COMPLETE LIQUIDATION OF SOUTH LAKE FARMS, INC.Dated: October 2nd, 1956SOUTH LAKE FARMS, INC. (hereinafter called the Subsidiary) is a corporation organized and existing under and by virtue of the laws of the State of California and has outstanding a total of 2,250 shares of stock, all of which shares are common stock.SOUTH-VALLEY FARMS (hereinafter called the Parent) is a corporation organized and existing under and by virtue of the laws of the State of California and is the owner beneficially and of record86 of all of said issued and outstanding shares of the Subsidiary.The separate existence of the Subsidiary is no longer necessary or advisable, and it is to the best interests of the Subsidiary and the Parent that the Subsidiary be wound up, dissolved and completely liquidated, and that the Parent, as the sole shareholder of the Subsidiary, receive all of the property, assets and franchises of the Subsidiary, to be distributed to the Parent in complete liquidation of the Subsidiary and in complete cancellation and redemption of all of the stock of the Subsidiary, in the manner hereinafter in this Plan provided.In order to effect these purposes the following steps shall be taken:(1) The Parent, as sole shareholder of the Subsidiary, will cause a special meeting of the shareholders of the Subsidiary to be held on written waiver of notice and consent to the holding of the meeting signed by the Parent.(2) At said special meeting of the shareholders of the Subsidiary, the Parent, as sole shareholder of the Subsidiary, will cause all of the issued and outstanding shares of the Subsidiary to be voted in favor of resolutions (a) electing to wind up and voluntarily dissolve the Subsidiary, 87 (b) adopting this Plan and authorizing, approving, ratifying and confirming this Plan in all respects, and (c) authorizing the complete liquidation of the Subsidiary and the distribution of all of its property, assets and franchises to the Parent, as sole shareholder of the Subsidiary, subject to the debts and liabilities of the Subsidiary, in complete cancellation and redemption of all of the stock of the Subsidiary.(3) A special meeting or meetings of the Board of Directors of the Subsidiary will be held and, at said meeting or meetings, there will be adopted resolutions (a) authorizing compliance with Section 4605 of the Corporations Code of the State of California and (b) determining that all known debts and liabilities 1032 of the Subsidiary have been fully paid or adequately provided for within the meaning of Section 5000 of the Corporations Code of the State of California.(4) The Subsidiary will take all necessary further steps to cause its complete liquidation and the distribution of all of its property, assets and franchises to the Parent, as sole shareholder of the Subsidiary, subject to the debts and liabilities of the Subsidiary, in complete cancellation and redemption88 of all of the stock of the Subsidiary, and the Parent will take all necessary further steps to the same end and to assume all debts and liabilities of the Subsidiary.(5) The Subsidiary will take all necessary further steps to accomplish its winding up and voluntary dissolution in the manner provided by Section 4600 et seq. of the Corporations Code of the State of California.(6) Upon the distribution of assets all outstanding shares of the Subsidiary will be automatically cancelled and extinguished and all certificates representing outstanding shares of the Subsidiary shall be surrendered to it for cancellation and shall be cancelled; provided, however, that the surrender and cancellation of such certificates shall not be a condition precedent to the automatic cancellation and extinguishment of the shares of the Subsidiary represented thereby.(7) This Plan shall be completed as soon as possible and in any event on or before December 31, 1956.Thereafter and on October 2 and 3, 1956, all steps necessary under California law were taken for the dissolution and liquidation of the old corporation and the distribution of all its assets to the purchasing corporation. On October 3, 1956, 89 and pursuant to the plan of dissolution and complete liquidation all of the assets of the old corporation were distributed and transferred to the purchasing corporation without any payment to the old corporation by the purchasing corporation. Immediately after the foregoing transfer of its assets to the purchasing corporation the old corporation had no assets.The assets so distributed to the purchasing corporation by the old corporation consisted, among others, of the latter's land, leaseholds, the unharvested 1956 cotton crop of the old corporation, and the preparation it had made of land for later planting in 1956 of a barley crop for harvesting in 1957, sometimes hereinafter referred to as the land preparation.The cotton crop was on approximately 5,100 acres of land, approximately 3,925 acres of which the old corporation had leased. All of the crop had been planted on or before April 30, 1956, and expenses in the amount of $ 497,641.93 had been incurred in connection with its planting and growth. Of the $ 497,641.93, the amount of $ 254,566.91, which included depreciation in the amount of $ 22,721.24, represented expenses incurred during the period May 1 through October 3, 90 1956, and was included in the deductions taken by the old corporation in its Federal income tax return for that period in accordance with its accrual method of accounting. The remainder of the expenses, $ 243,075.02, which included depreciation in the amount of $ 9,087.86, was incurred during the old corporation's fiscal year ended April 30, 1956, and was included in the deductions taken in the old corporation's 1033 Federal income tax return for that year in accordance with that corporation's accrual method of accounting.The cotton crop which produced 11,010 bales, or an average yield per acre of 2.16 bales, was harvested by the purchasing corporation at a total cost of $ 271,505.56 during the fall of 1956 as follows:1956BalesOct. 4-14790Oct. 15-211,504Oct. 22-282,877Oct. 29-Nov. 41,707Nov. 5-111,642Nov. 12-18986Nov. 19-25302Nov. 26-Dec. 2314Dec. 3-9455Dec. 10-16313Dec. 17120Total11,010The cotton was ginned by Producers Cotton Oil Company and sold by the purchasing corporation for gross proceeds of $ 1,855,518.68. Of the foregoing amount $ 1,670,887.04 was received from Producers for cotton and cottonseed sold to it91 and $ 184,631.64 was received for cotton sold to others.Following the distribution of the assets of the old corporation to it, the purchasing corporation under the provisions of section 334(b)(2) of the Internal Revenue Code of 1954 allocated its adjusted basis of the stock of the old corporation to the various assets. The portion of the adjusted basis of the stock allocated to the cotton crop was $ 1,616,667.73. In making the foregoing allocations the purchasing corporation made estimates of the fair market values as of the date of liquidation of the old corporation of the assets of that corporation and in doing so estimated the fair market value of the cotton crop at that date, which was prior to the incurring of harvesting costs, to be $ 1,593,619.44.In determining its gross and taxable income for its fiscal year July 1, 1956, through June 30, 1957, the purchasing corporation included in its gross receipts the proceeds from the sale of the cotton and cottonseed, $ 1,855,518.68, and against its gross receipts offset the costs of harvesting the cotton, $ 271,505.56, and the portion of its adjusted basis of the stock of the old corporation which it had allocated to the cotton 92 crop, $ 1,616,667.73.Included in the land and the leaseholds distributed and transferred by the old corporation to the purchasing corporation were approximately 13,000 acres of land of which approximately 1,000 acres were leased, which the old corporation had prepared for the planting of a 1956-1957 barley crop. The barley crop was planted by the purchasing corporation at an undisclosed cost between November 5 and December 15, 1956. Expenses incurred by the old corporation for the land preparation totaled $ 215,060.50. Of the foregoing amount, $ 170,223.91 was incurred during the period from May 1 through October 3, 1956, and was included in the deductions taken in the Federal 1034 income tax return of the old corporation for that period in accordance with its accrual method of accounting. The remainder, $ 44,836.59, was incurred during the fiscal year ended April 30, 1956, of the old corporation and was included in the deductions taken by the old corporation in its Federal income tax return for that year in accordance with its accrual method of accounting.The portion of its adjusted basis of the stock of the old corporation allocated by the purchasing corporation to the93 land preparation was $ 218,156.73. The purchasing corporation estimated the fair market value of such preparation at the time of the liquidation of the old corporation to be $ 215,060.50, the total amount incurred by the old corporation for such preparation.The barley crop was harvested at an undisclosed cost by the purchasing corporation during the period May 26, 1957, through July 10, 1957, and sold by that corporation for an undisclosed amount. In determining its gross and taxable income the purchasing corporation included in its gross receipts the proceeds from the sale of the barley and against its gross receipts offset its costs of planting, growing, and harvesting the barley and the portion of its adjusted basis of the stock of the old corporation which it had allocated to the land preparation, $ 218,156.73.In its Federal income tax return for the fiscal year beginning July 1, 1956, and ending June 30, 1957, the purchasing corporation reported a net loss of $ 1,440,363.08 from its operations during that year.In its Federal income tax return for the period May 1 through October 3, 1956, the old corporation reported a net operating loss of $ 150,618.26. After filing its94 return for the foregoing period the old corporation filed with respondent an application for a carryback of the loss to its fiscal years ended April 30, 1955, and April 30, 1956, in the amounts of $ 77,941.38 and $ 72,676.88, respectively, which the respondent allowed.In determining the deficiency in the old corporation's income tax for the period May 1 through October 3, 1956, the respondent determined that the corporation's taxable income should be increased by $ 1,808,679.94, accordingly included that amount in the corporation's income, offset against that amount a net loss of $ 150,618.26 reported in the corporation's return, and determined $ 1,658,061.68 as the amount of the corporation's taxable net income for the period. In the notice of deficiency the respondent explained his action as follows:Growing crops [cotton crop and land preparation] valued at $ 1,808.679.94 were distributed by South Lake Farms, Inc. when the corporation was liquidated on or about October 3, 1956. Costs and expenses allocable to those growing crops were deducted by South Lake Farms, Inc. in computing its taxable income for the period May 1, to October 3, 1956. The value of those crops at the95 date of distribution was not included in the taxable income for the taxable period mentioned, 1035 nor were the proceeds ultimately received upon sale of the crops when harvested.It is held that the method of accounting employed in computing the taxable income of South Lake Farms, Inc. for the taxable period does not properly reflect income under the provisions of the Internal Revenue Code of 1954, including sections 268, 441, 446, and 482 thereof. Accordingly, taxable income has been increased $ 1,808,679.94, the value of the growing crops at the date of liquidation.In the alternative, in the event it is finally determined that the value of the crops is not includible in the taxable income of South Lake Farms, Inc. for such taxable period, it is held that taxable income for such period is to be increased by the amount of $ 847,632.58, representing the determined expenses attributable to such crops and incurred as of the date of liquidation.Having determined that the old corporation had no net operating loss for the period May 1 through October 3, 1956, the respondent disallowed the net loss carrybacks by the old corporation from that period to its fiscal years ended April96 30, 1955, and April 30, 1956, which previously had been allowed and, accordingly, determined the deficiencies involved herein for those years.OPINION.In view of the respondent's reference to section 441 of the Code in the explanation of his action as set out in the notice of deficiency, it is observed at this point there is no controversy between the parties respecting the period May 1 through October 3, 1956, constituting a proper taxable period for the old corporation within the contemplation of that section.The primary issue for determination is the correctness of the respondent's action in increasing the taxable income of the old corporation for the period May 1 through October 3, 1956, by $ 1,808,679.94 as representing the value of the cotton crop in the amount of $ 1,593,619.44 and the value of the land preparation in the amount of $ 215,060.50 on October 3, 1956, the date of the liquidation of the old corporation.In support of his action respondent contends that the old corporation, in accordance with its accrual method of accounting, took deductions of $ 712,702.43 for expenses incurred in connection with producing the cotton crop and making the land preparation for planting97 a barley crop, that since these were distributed in liquidation to the purchasing corporation before the crops were harvested, the old corporation was in the position of being able to take the deductions arising from its crop-growing business without reporting the income resulting from the operation and thereby reported a large operating loss of its last taxable period, May 1 through October 3, 1956. The respondent also contends that irrespective of whether the accrual method employed by the old corporation was proper for its earlier taxable periods when it sold the crops it produced, the method did not clearly reflect 1036 its taxable income for its last taxable period and that he properly invoked and correctly applied the provisions of section 446(b) of the 1954 Code. 1 As further support for his action the respondent relies on Lucas v. Earl, 281 U.S. 111">281 U.S. 111 (1930), affirming 10 B.T.A. 723">10 B.T.A. 723 (1928); Helvering v. Horst, 311 U.S. 112">311 U.S. 112 (1940), affirming 39 B.T.A. 757">39 B.T.A. 757 (1939); and Helvering v. Eubank, 311 U.S. 122 (1940), affirming98 39 B.T.A. 583">39 B.T.A. 583 (1939), and other cases stemming from the foregoing cases.The petitioners take the position that section 446(b) and the cases relied on by the respondent are inapplicable here and that the inclusion by the respondent of the value of the cotton crop and land preparation99 as determined by him is not only unwarranted under section 446(b) but is an attempt by respondent to disregard the provisions of section 336 of the Code, 2 which prohibit the recognition of any gain or loss to the old corporation on the distribution of its property to the purchasing corporation in complete liquidation.Section 446(a) and (c) of the Code provides that the taxable income of a taxpayer shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books and recognizes an accrual method as being a permissible method. Section 446(b) provides that if the method used by the taxpayer does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the100 Secretary or his delegate, does clearly reflect income. Section 336 provides that except as to installment obligations, none of which are involved herein, no gain or loss shall be recognized to a corporation on the distribution of property in partial or complete liquidation.The respondent and the petitioners are in agreement that the old corporation was not required to include in its inventory, either on May 1, 1956, or October 3, 1956, any amount as the value of the cotton crop or the land preparation in computing its taxable income for its last taxable period which ended October 3, 1956, and respondent contends that his action is not to be equated as the inclusion of those items in the old corporation's inventory as of the close of October 3, 1956. In disclaiming any attempt to disregard the provisions of section 336 the 1037 respondent states on brief that he has not determined and is not here contending that the old corporation realized any gain upon the distribution of its property to the purchasing corporation, that any gain was scarcely possible since the purchasing corporation paid the old corporation nothing for its property, and urges that consideration of the applicability101 of section 336 to the distribution by the old corporation to the purchasing corporation is not essential to a determination of the correctness of his exercise of his powers under section 446.The respondent admits, as the petitioners contend, that the factual situations involved in the cases relied on by him are substantially different from those in the instant situation. However, he urges that the rule of those cases is applicable here.In Lucas v. Earl, supra, it was held that despite an agreement between a husband and wife that any property acquired by either should be held by them as joint tenants, the husband was subject to income tax on the entire amount of salary and legal fees earned by him. The holding in Helvering v. Horst, supra, was that the gift during the donor's taxable year of interest coupons detached from bonds owned by him, delivered to the donee, and later in the year paid at maturity constituted the realization of income taxable to the donor. In Helvering v. Eubank, supra, a general life insurance agent after termination of his agency contracts for services102 as agent made assignments of renewal commissions to become payable subsequently, without other apparent purpose than to confer on assignees the power to collect commissions, which they did during the taxable year involved. It was there held that the commissions were taxable as income of the assignor for the year in which paid. Pearce v. Commissioner, 315 U.S. 543">315 U.S. 543 (1942), affirming 42 B.T.A. 91">42 B.T.A. 91 (1940), involved an annuity contract purchased by the divorced husband for the divorced wife pursuant to their agreement made prior to the divorce. The question presented was whether the income arising from the annuity subsequent to the divorce decree was taxable to the wife who received it or to the husband who provided it. In holding that the income was taxable to the wife, the Supreme Court said:Such cases as Helvering v. Horst, 311 U.S. 112">311 U.S. 112, Helvering v. Eubank, 311 U.S. 122">311 U.S. 122, and Harrison v. Schaffner, supra, are not opposed to this result. Those cases dealt with situations where the taxpayer had made assignments of income from property. He was103 held taxable on the income assigned by reason of the principle "that the power to dispose of income is the equivalent of ownership of it and that the exercise of the power to procure its payment to another, whether to pay a debt or to make a gift, is within the reach" of the federal income tax law. Harrison v. Schaffner, supra, p. 580. But in those cases the donor or grantor had "parted with no substantial interest in property other than the specified payments of income." Id. p. 583. Here he has parted with the corpus. And "the tax is upon income as to which, in the general application of the revenue acts, the tax liability attaches to ownership." Blair v. Commissioner, 300 U.S. 5">300 U.S. 5, 12. * * *1038 To the time of the dissolution of the old corporation, no income had been received by or accrued to it with respect to the cotton crop or the land preparation. Although through expenditures incurred by it the old corporation owned a valuable unharvested cotton crop and owned and held under lease land which was more valuable because it had been prepared for the planting of a barley crop, neither of these items represented taxable income104 to the old corporation either earned, realized, received, or accrued. At most, they merely represented property being held by the old corporation for future disposition or utilization. Despite the foregoing and although the respondent does not contend that the old corporation realized any income on its distribution in complete liquidation of the cotton crop and land preparation to the purchasing corporation and although the purchasing corporation upon distribution became not only the owner of those items but also of the land and the leases on land with which those items were involved, the respondent asks us to sustain his action in including the value of the cotton crop and the land preparation at the time of their distribution in the income of the old corporation.In Elsie SoRelle, 22 T.C. 459">22 T.C. 459 (1954), a father who had four children discussed with his accountant in May 1946 the matter of gifts of land which he contemplated making to each of his children. By the fall of 1946 he had decided upon the parcels of land which he would give to the respective children and, upon advice from his accountant that a conveyance of the parcels would carry with them105 a transfer of any wheat growing thereon, proceeded to plant wheat on each parcel. In December 1946 the father told each child of the specific parcel which he intended to give it, that he had planted the parcel in wheat, and that the wheat crop also would be its (the child's). Thereafter, and following a warning from his accountant that unless he completed the gifts prior to the harvesting of the wheat he would be subject to income tax thereon, the father, on June 23, 1947, just prior to the harvesting (which terminated on July 4 or 5 of that year), executed warranty deeds conveying the four parcels of land upon which there were matured wheat crops to his four children. The fair market value of the matured wheat crops on the four parcels was $ 53,259.50. There were no restrictions or conditions placed by the father on the children's ownership of the land, the wheat, or the proceeds to be received from the sale of the wheat, but there was an understanding that the children would lend him the proceeds of sale. Two of the children attended to the harvesting of the wheat on their parcels. The father supervised the harvesting of the wheat on the parcels of the other two children which106 was done with machinery and employees of the father. At the time the gifts were made no arrangement had been made for the sale of the wheat and no immediate sale was contemplated. The wheat harvested from the four parcels was 1039 placed in the father's storage bins where it was held without charge to the children until the father deemed it advantageous to sell, and was then sold by the father with the children's consent sometime after the end of 1947. The proceeds of the sale (less an amount retained by the father for harvesting and selling expenses) were subsequently loaned by the children to their father. The four children paid income tax on the profit realized from the sale of the wheat. The father, whose basis for reporting income was an accrual basis, deducted in his income tax returns for 1946 and 1947 the cost to him of planting, raising, and harvesting the wheat. The respondent there contended that the father realized and was taxable on income in 1947 equal to the fair market value of the wheat crop on the four parcels of land on the date of the gifts. Upon concluding that the conveyance of the parcels of land effected a conveyance of the wheat crop thereon and107 relying on the above-quoted portion of the opinion in Pearce v. Commissioner, supra, we held that the wheat became the property of the four children to whom the land was given and that "when the wheat was harvested and later sold the income resulting therefrom belonged to the children and was taxable to them and not to petitioner [father]."In the instant case, the ownership of the land and the leaseholds on the land on which the unharvested cotton crop stood and on which the land preparation had been made was transferred by the old corporation to the purchasing corporation when the former distributed its property in complete liquidation to the latter and by the same distribution the ownership of the cotton crop and the land preparation likewise was transferred. Since in the SoRelle case the transfer of the ownership of the land and a mature but unharvested wheat crop thereon was held to prevent the inclusion in the income of the father of the fair market value of the wheat crop at the time of the transfer, we think for a like reason the value of the cotton crop and the land preparation here involved is not properly includible in the taxable108 income of the old corporation.In reaching the foregoing conclusion we are aware that in the SoRelle case the respondent sought to include the value of the wheat at the date of gifts in the income of the father on the ground that under the rule of Helvering v. Horst, supra, the father had realized taxable income equal to such fair market value whereas here the respondent seeks under section 446 to include the value of the cotton crop and land preparation in the gross income of the old corporation on the ground that such inclusion is necessary in order to properly reflect the income of the old corporation because it deducted in its income tax returns the amounts of expenditures it had incurred in connection with the land preparation and in connection with the planting and raising of the cotton crop. In the SoRelle case the father, whose basis 1040 for reporting income was an accrual basis, deducted in his income tax return the cost of planting and raising the wheat crop there involved but that fact did not preclude the holding that the income resulting from the sale of the wheat belonged to the children and was taxable to them and not109 to the father. The petitioners are sustained as to this issue.Since we have not sustained the respondent on the foregoing issue, it becomes necessary to consider his alternative determination, namely, that the taxable income of the old corporation for the period May 1 through October 3, 1956, is to be increased by the amount of $ 847,632.58, representing the expenses determined by respondent as attributable to the cotton crop and land preparation and incurred as of the date of the old corporation's liquidation.The notice of deficiency does not show how the respondent computed the foregoing amount of $ 847,632.58 nor does the record otherwise show how the amount was arrived at. However, the parties have stipulated in detail as to the expenses incurred by the old corporation with respect to the cotton crop and the land preparation and we have made findings accordingly. The total of such expenses as shown by the stipulation of the parties is $ 712,702.43 and the respondent on brief accepts that amount as the amount in controversy in this issue.The respondent takes the position that in making his alternative determination --that taxable income [of the old corporation] for such110 period [May 1 through October 3, 1956] is to be increased by the amount of $ 847,632.58 [$ 712,702.43], representing the determined expenses attributable to such crops [cotton crop and land preparation] and incurred as of the date of liquidation [Oct. 3, 1956] --he exercised his discretion under section 482 of the Code 3111 by allocating the deductions taken by the old corporation for such expenses to the purchasing corporation in the form of basis. The petitioners point out that there is nothing in the notice of deficiency to indicate any allocation of any deduction to the purchasing corporation and that the stipulation of facts filed by the parties shows that the respondent has done nothing other than follow section 334(b)(2) of the Code 41041 prescribing the basis of the cotton crop and land preparation in the hands of the new corporation.112 Section 482 provides that in the case of any two or more organizations, trades, or businesses, whether or not incorporated and whether or not affiliated, owned, or controlled directly or indirectly by the same interests, the Secretary or his delegate may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.Section 334(b)(2) provides that if property is received by a corporation in a distribution in complete liquidation of another in a factual situation of the kind presented here, then the basis of the property in the hands of the distributee shall be the adjusted basis of the stock with respect to which the distribution was made.Respecting allocation, the stipulation of facts filed herein by the parties contains the following:The Commissioner's action with respect to allocation of gross income from any other taxpayer to the Old Company and with respect to allowance or disallowance to any113 taxpayer of the deduction for crop expenses here involved, in the alleged amount of $ 847,632.58, is contained in the deficiency notices attached as Exhibits A to the petitions in the above entitled cases, and also in the Commissioner's action in accepting the Purchasing Corporation's allocation of basis to the cotton and barley crops here involved.As stipulated by the parties and set out in our findings, the purchasing corporation, following the distribution to it of the assets of the old corporation and acting under section 334(b)(2), allocated its adjusted basis of the stock of the old corporation to the various assets and of its adjusted basis of the stock allocated $ 1,616,667.73 to the cotton crop and $ 218,156.73 to the land preparation. According to the above-quoted portion of the stipulation the respondent has accepted the foregoing amount as representing the correct basis of such items in the hands of the purchasing corporation as provided by section 334(b)(2). Such being the situation it would appear that if 1042 the expenses in the amount of $ 712,702.43 incurred by the old corporation with respect to such items had been allocated by the respondent to the purchasing114 corporation, either the basis of the cotton crop and that of the land preparation in the amounts of $ 1,616,667.73 and $ 218,156.73, respectively, would have been increased accordingly, or the expenses would have been allowed otherwise as deductions to the purchasing corporation. However, the respondent informs us on brief that neither has been done. He states that in accepting the basis for the cotton crop of $ 1,616,667.73 and the basis for the land preparation of $ 218,156.73 determined in accordance with the provisions of section 334(b)(2), he has allocated to the purchasing corporation a tax benefit corresponding to the expense deductions of the old corporation for the respective items and that the efficacy of such benefit is demonstrated by the large operating loss of $ 1,440,363.08 reported by the purchasing corporation for its fiscal year ended June 30, 1957. The respondent further states that obviously he could not have allowed the expense deductions in question to the purchasing corporation, in addition to accepting the above-mentioned amounts as the basis of the respective items, since the consequence of such a procedure would have been a shocking distortion of the taxable115 income of the purchasing corporation. Despite the foregoing the respondent contends that his action is in accord with the provisions of section 482.From what has been said above, we think it is clear that under his alternative determination the respondent has not made an allocation of the expenses of the old corporation here in question to the purchasing corporation but merely has allowed to the purchasing corporation only the basis for the cotton crop and the basis for the land improvement which it was entitled to under section 334(b)(2) irrespective of any allocation to it of expenses of the old corporation.The section of the Code of 1939 corresponding to section 482 of the Code of 1954 here involved is section 45. In considering section 45 in Chicago & North Western Railway Co., 29 T.C. 989">29 T.C. 989 (1958), it was held that the "distribution, apportionment or allocation" contemplated by the section implies an allowance somewhere else of the disallowed deduction, and that an allocation to a corporation of a deduction which the corporation already is entitled to under some other provision of the Code does not constitute an allocation within the contemplation116 of the section but in reality constitutes a mere disallowance of the deduction which the section does not permit. In our opinion the foregoing holding is applicable here and we accordingly conclude that respondent by his alternative determination has not made an allocation to the purchasing corporation of the expenses in question but merely has disallowed them to the old corporation which he may not do under section 482.1043 Having reached the foregoing conclusion and since the respondent states on brief that he does not rely on section 268 of the Code 5 in support of his alternative determination, we hold for the petitioners on this issue.117 In view of our holdings above it becomes unnecessary to consider the remaining issues which arose solely by reason of the respondent's primary determination heretofore considered.Decisions will be entered under Rule 50. Footnotes1. SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING.(a) General Rule. -- Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.(b) Exceptions. -- If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary or his delegate, does clearly reflect income.(c) Permissible Methods. -- Subject to the provisions of subsections (a) and (b), a taxpayer may compute taxable income under any of the following methods of accounting -- * * * (2) an accrual method:↩2. SEC. 336. GENERAL RULE.Except as provided in section 453(d)↩ (relating to disposition of installment obligations), no gain or loss shall be recognized to a corporation on the distribution of property in partial or complete liquidation.3. SEC. 482. ALLOCATION OF INCOME AND DEDUCTIONS AMONG TAXPAYERS.In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary or his delegate may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.↩4. SEC. 334. BASIS OF PROPERTY RECEIVED IN LIQUIDATIONS.(b) Liquidation of Subsidiary. -- * * (2) Exception. -- If property is received by a corporation in a distribution in complete liquidation of another corporation (within the meaning of section 332(b)), and if -- (A) the distribution is pursuant to a plan of liquidation adopted --(i) on or after June 22, 1954, and(ii) not more than 2 years after the date of the transaction described in subparagraph (B) (or, in the case of a series of transactions, the date of the last such transaction); and(B) stock of the distributing corporation possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote, and at least 80 percent of the total number of shares of all other classes of stock (except nonvoting stock which is limited and preferred as to dividends), was acquired by the distributee by purchase (as defined in paragraph (3)) during a period of not more than 12 months,then the basis of the property in the hands of the distributee shall be the adjusted basis of the stock with respect to which the distribution was made. * *↩5. SEC. 268. SALE OF LAND WITH UNHARVESTED CROP.Where an unharvested crop sold by the taxpayer is considered under the provisions of section 1231 as "property used in the trade or business", in computing taxable income no deduction (whether or not for the taxable year of the sale and whether for expenses, depreciation, or otherwise) attributable to the production of such crop shall be allowed.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621351/	MARIO G. De MENDOZA, III, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentDe Mendoza v. CommissionerDocket No. 11182-92United States Tax CourtT.C. Memo 1994-314; 1994 Tax Ct. Memo LEXIS 317; 68 T.C.M. (CCH) 42; July 7, 1994, Filed 317 Decision will be entered under Rule 155. For petitioner: Richard Paladino and Robert O. Rogers. For respondent: William B. McCarthy and John T. Lortie. COLVINCOLVINMEMORANDUM FINDINGS OF FACT AND OPINION COLVIN, Judge: Respondent determined deficiencies in petitioner's Federal income taxes for the years 1986, 1987, and 1988, in the following amounts: YearDeficiency1986$ 156,316.501987102,963.55198842,145.12The issue for decision is whether petitioner operated his polo activity with a profit objective. Petitioner contends that in deciding this issue, we should treat legal fees he received from clients he met through polo activities (polo clients) as polo-related income. We hold that petitioner's legal fees from his clients are not polo-related income, and that he did not operate his polo activity with a profit objective. Section references are to the Internal Revenue Code in effect for the years in issue. 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. 1. PetitionerPetitioner resided in Palm Beach, Florida, when he filed the petition. Petitioner318 was born and raised in Cuba. He immigrated to the United States in 1961. He attended the University of Miami and received an accounting degree from Kent State University. He later worked in the tax department of the accounting firm of Deloitte, Haskins & Sells in Philadelphia, Pennsylvania. In 1972, petitioner graduated from Dickinson School of Law. He began practicing law in Florida in 1972. Petitioner currently practices law as a real estate attorney in Palm Beach County, Florida, in the partnership of Mendoza, Callas & Schilling. Petitioner has always enjoyed polo. His family owned ranches in Cuba, and he has maintained and ridden horses since his early childhood. Petitioner attended polo matches when he was a child and in the United States while he attended college and law school. He attended polo matches in Florida during the late 1970s and the early 1980s. 2. Alamendares Farm Corp.Petitioner incorporated Alamendares Farm Corp. (AFC), a subchapter S corporation, on March 9, 1982, to buy and sell polo horses. Petitioner is the sole shareholder of AFC. Before he began to operate his polo activity through AFC, petitioner did not make a written budget, forecast319 of profitability, or break-even analysis. AFC used both purchased and leased property for its polo operations. AFC owned about 10 acres of land during the years in issue. By the time of trial, AFC had bought 30 acres of land for $ 557,500. The property included a barn, a bunkhouse where the horse grooms lived, and a built-in stone barbecue installed in 1985 at a cost of $ 3,653. Petitioner has never lived or slept at the farm. The board of directors of AFC held regular meetings. AFC maintained separate bank accounts, books, and records. A certified public accountant prepared AFC's books, annual financial statements, and corporate income tax returns. AFC kept separate files for each horse which contained information about the horse's teeth, shoes, vaccinations, and wormings. In addition to its polo activities, AFC invested in real estate partnerships. The gains and losses from those activities were segregated on AFC's financial statements and tax returns. 3. The Polo ActivityPetitioner bought horses and formed a polo team in 1982 and has maintained a team since then. A polo team has four players. Each player plays six periods called "chukkers". Each chukker 320 lasts 7-1/2 minutes. Generally, each player needs six horses per game. It costs about $ 60,000 to buy five or six polo horses and the required tack (i.e., saddles and bridles). It costs $ 15,000 to $ 25,000 per year to maintain and care for the horses. Polo players are ranked on a scale of -2 to 10 goals. There are about 10 to 15 10-goal players in the world. Petitioner is a two-goal player. Petitioner ranks in about the top one-fourth or one-third of U.S. polo players. Untrained polo horses are called "green". Trained polo horses are called "made". It takes 1 to 2 years to train a green horse so that it can be used to play polo. When petitioner began the polo activity, he bought made horses for resale. He later started buying green horses. He was buying semi-made horses at the time of trial because inexpensive semi-made horses were available from failed polo farms. Petitioner had not managed a horse farm before forming AFC. Petitioner has subscribed to various equine and polo magazines since 1982, and he is a member of the U.S. Polo Association. He hired people to teach him to play polo and to help him buy and train horses, and he hired players for AFC's polo team. 321 AFC did not advertise its polo horses, but sold them through personal contacts. Negotiations to buy a polo horse often occur at a polo practice or match. Interested buyers often go to polo matches to see the quality of the horses. The horses perform in polo matches in order that their skills are displayed to potential buyers. AFC showed its horses to potential buyers at polo matches in which its team played. AFC also organized small games and invited prospective buyers to try the horses. High-goal polo players did not buy horses from AFC in its early years because AFC had not yet established a meaningful reputation. From 1983 to 1991, petitioner employed Peter Rizzo (Rizzo) to assist him with the polo activity. Rizzo is a six-goal polo player who has made a living through polo. Rizzo has been a professional polo player since 1967. Rizzo bought and sold about 300 horses before working for AFC, most of which were polo horses. When Rizzo began working for AFC in 1983 there were two or three other employees who managed the farm and trained the horses. In 1984, Rizzo became the general manager of the farm and the polo team. Petitioner terminated Rizzo's employment in 1991. 322 At the time of trial, Rizzo was the manager of Royal Palm Polo Sports Club, one of the largest polo clubs in the world. 4. Petitioner's Involvement in AFCPetitioner went to the farm to work and play polo. During the years in issue, petitioner spent about 30 hours per week at the farm during the summer. During the rest of the year, he usually went to the farm on Saturdays and Sundays, and left the office two to three times per week to attend tournaments. Petitioner helped train many of AFC's horses and sometimes negotiated the sale of the horses. Petitioner played for AFC's team and other teams in polo tournaments. At the farm petitioner performed such tasks as cleaning stalls, mowing grass, painting fences, and sodding fields. Petitioner spoke by telephone with farm employees while he was at his law firm and did some recordkeeping there. Petitioner prepared a work list each weekend when he visited the farm if he was not going to be at the farm during the next week. The list included work to be done and the training schedule for each horse. 5. Income and Expenses From Polo ActivitiesAFC had gross receipts from its polo operations for each year from 1982323 to 1992. AFC received income from horse sales, tournament earnings, promotions, commissions, consulting, and instructing fees. Following are AFC's gross receipts and losses from 1982 to 1992 and the depreciation reported each year: YearGross ReceiptsProfit/(Loss)Depreciation1982$ 3,393($ 176,085)$ 27,824198349,976(335,661)44,9971984125,475(224,160)38,748198594,139(208,203)30,035198617,365(230,967)42,684198728,389(259,121)38,8391988140,200(150,179)37,491198952,792(335,591)44,2021990129,800(193,392)39,448199194,959(137,881)33,8321992120,408(114,350)29,349Total856,896(2,365,590)407,4496. AFC's HorsesA polo horse can become worthless quickly because of injuries or illness. It may be necessary to "put down" (i.e., "kill") a sick or injured horse from a business standpoint. More of AFC's horses have been killed than sold. Petitioner told buyers of two horses AFC sold in 1991 that he wanted to sell to generate cash to bolster his position in this case. AFC sold a horse named Nevada for $ 25,000 in 1992. Nevada was unsuitable for polo and was sold as a jumper horse. 324 AFC sold a horse named Mambe for $ 45,000 in April 1992. Mambe had a natural suitability for polo. Petitioner displayed Mambe by riding him in polo matches. Mambe was sold to Kerry Packer (Packer), who buys the best polo horses that he can to play in tournaments throughout the world. Packer sent one of the world's best polo players, Gonzales Pieres, to try Mambe. Mr. Pieres bought Mambe for Packer. This sale generated favorable publicity for petitioner. Mambe's sale price was the highest that AFC has received for one of its horses. AFC sold a horse for $ 10,000 to Guillermo Gracida's (Gracida) corporation in December 1992. Gracida is a 10-goal polo player. Rizzo prepared a valuation report of AFC's horses as of June 3, 1991, which was shortly after he left AFC. In June 1991, AFC had 45 horses that Rizzo valued at $ 471,000. Petitioner had purchased the horses for a total of $ 70,089. Before the time of the trial, 7 of the 45 horses had been destroyed. 7. Petitioner's Efforts To Reduce CostsPetitioner took steps to cut AFC's expenses. He persuaded one of his legal clients to sponsor AFC's polo team and a tournament organized by AFC. Petitioner used the advertising325 income to pay some of AFC's expenses. Petitioner switched from buying hay by the bale to buying it in bulk to save money. He learned to perform some veterinary and dentistry procedures himself, rather than to pay someone to do them. Petitioner traveled throughout the United States and abroad to buy inexpensive horses. AFC paid petitioner's travel expenses. Petitioner stopped insuring the horses because it was too expensive. He also bred horses but quit because it was too costly. Petitioner used to pay commissions to individuals to sell his horses, but then began selling the horses himself. Petitioner helped to train the horses. He used to have five employees on his farm but at the time of trial had two. He put down unsellable horses. Petitioner obtained an agricultural classification for AFC to decrease its real estate taxes. Instead of paying rent for the land AFC leased, petitioner mowed and fertilized the property and painted or built fences. 8. Petitioner's Other Business EndeavorsPetitioner's income from his legal practice was $ 445,209 in 1986, $ 616,590 in 1987, and $ 390,243 in 1988. Before the years in issue, petitioner tried to import leather goods326 through a corporation known as Polo de Argentina. This business failed after his business partner died. In 1985, petitioner sold 4.5 acres of farm land at a $ 121,548 loss. Before the years in issue, petitioner was involved in a yacht chartering business that incurred losses that were disallowed. OPINION 1. Activity Not Engaged In for ProfitThe issue for decision is whether petitioner operated his polo activity through AFC for profit in 1986, 1987, and 1988 for purposes of section 183. A taxpayer may deduct ordinary and necessary business expenses paid or incurred during the taxable year. Sec. 162. The test for deciding whether a taxpayer is carrying on a trade or business under section 162 is whether the taxpayer is engaged in the activity with an actual and honest profit objective. Dreicer v. Commissioner, 78 T.C. 642">78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205">702 F.2d 1205 (D.C. Cir. 1983); Engdahl v. Commissioner, 72 T.C. 659">72 T.C. 659, 666 (1979); Golanty v. Commissioner, 72 T.C. 411">72 T.C. 411, 426 (1979), affd. without published opinion 647 F.2d 170">647 F.2d 170 (9th Cir. 1981).327 Whether petitioner had the requisite profit objective is decided based on all the facts and circumstances. Golanty v. Commissioner, supra; sec. 1.183-2(b), Income Tax Regs. In this context, "profit" means economic profit, independent of tax savings. Herrick v. Commissioner, 85 T.C. 237 (1985); Seaman v. Commissioner, 84 T.C. 564">84 T.C. 564, 588 (1985); Surloff v. Commissioner, 81 T.C. 210">81 T.C. 210, 233 (1983). We give greater weight to the objective facts than to petitioner's statement of intent. Dreicer v. Commissioner, supra; sec. 1.183-2(a), Income Tax Regs. Petitioner bears the burden of proving that he had a profit objective. Rule 142(a); Surloff v. Commissioner, supra.Section 1.183-2(b), Income Tax Regs., lists some of the factors which may be considered in determining whether an activity is engaged in for profit. They are: (1) The manner in which the taxpayer carried on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying328 on the activity; (4) the expectation that the assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or loss with respect to the activity; (7) the amount of occasional profit, if any, which is earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved. No single factor is controlling. Abramson v. Commissioner, 86 T.C. 360">86 T.C. 360, 371 (1986); Golanty v. Commissioner, supra at 426; Dunn v. Commissioner, 70 T.C. 715">70 T.C. 715, 720 (1978), affd. 615 F.2d 578">615 F.2d 578 (2d Cir. 1980). a. The Manner in Which the Polo Activity Was ConductedMaintaining complete and accurate records and changing operating methods to increase profit prospects can indicate a profit motive. Elliott v. Commissioner, 90 T.C. 960">90 T.C. 960, 971-972 (1988), affd. without published opinion 899 F.2d 18">899 F.2d 18 (9th Cir. 1990); Ronnen v. Commissioner, 90 T.C. 74">90 T.C. 74, 93 (1988);329 sec. 1.183-2(b)(1), Income Tax Regs. Petitioner contends that this factor favors him because AFC kept detailed, separate records of the polo activities. Petitioner also argues that he changed AFC's operating methods to reduce costs. For example, petitioner sought the best sources for horses to train, decided not to breed horses when he learned he could not do so economically, and hired good staff for AFC. While petitioner kept good records of his polo activity, his attempts to reduce expenses were minor compared to his large losses. Petitioner did not formulate a formal business plan or make financial projections before he started the polo activity. We are not convinced that petitioner ever had a plausible plan to make AFC profitable. On balance, this factor favors respondent. b. Expertise of Petitioner or His AdvisersPreparing to enter an activity by studying its accepted business, economic, and scientific practices or by relying on expert assistance may indicate a profit motive. Sec. 1.183-2(b)(2), Income Tax Regs.Petitioner has been involved with polo since he was a child. He subscribes to polo magazines, belongs to a polo association, paid people to teach him330 how to play polo and to sell polo horses, and relied on experts such as Rizzo. He was not well versed in how to make AFC profitable, which counts against his claim of expertise. However, on balance, this factor favors petitioner. c. The Time and Effort Expended by PetitionerThe fact that a taxpayer devotes much personal time and effort to conduct an activity, or withdraws from another occupation to devote most of his time to an activity, may indicate a profit objective. Sec. 1.183-2(b)(3), Income Tax Regs. Petitioner's time at the farm was limited because he maintained his practice of law during the years in issue. We believe his legal practice detracted from his ability to make a profit. The fact that a taxpayer devotes a limited amount of time to an activity does not necessarily indicate a lack of profit objective where the taxpayer employs qualified persons to carry on the activity. Cornfeld v. Commissioner, 797 F.2d 1049">797 F.2d 1049, 1052 (D.C. Cir. 1986), revg. and remanding T.C. Memo. 1984-105; Arwood v. Commissioner, T.C. Memo. 1993-352; sec. 1.182-2(b)(3), Income Tax Regs. Because331 petitioner employed qualified staff to work at AFC, on balance, this factor favors petitioner. d. Expectation of Appreciation in ValueThe expectation that assets used in the activity will appreciate in value sufficiently to lead to an overall profit when netted against losses may indicate a profit motive. Sec. 1.183-2(b)(4), Income Tax Regs.Petitioner contends that he expected AFC's real estate to appreciate in value and that, based on Rizzo's appraisal, AFC's horse inventory had appreciated by $ 400,000 even after taking into account the fact that seven of the horses listed in Rizzo's report were later killed. We disagree. First, petitioner did not offer any projections of his expectation of real estate appreciation when he organized AFC. His expectation of appreciation was at best vague. Second, although we found Rizzo to be generally credible, we believe his appraisal of AFC's horses was overstated. Even the claimed $ 400,000 in appreciation by 1991 is dwarfed by the more than $ 2.3 million in losses AFC sustained from 1982 to 1992. See Tripi v. Commissioner, T.C. Memo 1983-483">T.C. Memo. 1983-483. This factor favors respondent. e. Petitioner's332 Success in Other ActivitiesThe fact that a taxpayer has previously engaged in successful activities may indicate a profit motive. Sec. 1.183-2(b)(5), Income Tax Regs. However, the lack of such experience does not necessarily indicate that the taxpayer lacked a profit objective. Pirnia v. Commissioner, T.C. Memo. 1989-627. Respondent contends that this factor hurts petitioner because: (a) Petitioner unsuccessfully attempted to run a yacht chartering business and an importing business, and (b) he lost money on the sale of farmland in 1985. Petitioner points out that his law firm is successful and the importing business failed because his partner died. Because petitioner has been involved in both successful and unsuccessful business endeavors, this factor is neutral. f. Petitioner's History of Income or LossesNeither start-up losses nor losses which result from unforeseen circumstances necessarily show the taxpayer lacked a profit objective. Engdahl v. Commissioner, 72 T.C. at 669; sec. 1.183-2(b)(6), Income Tax Regs. However, a record of substantial losses over many years, coupled with the unlikelihood333 of the activity's becoming profitable, indicates that the taxpayer lacks a profit objective. Golanty v. Commissioner, 72 T.C. at 427. In analyzing the profitability of petitioner's polo activity, both parties consider the losses incurred from 1982 to 1992. AFC has experienced large losses during each of those 11 years, totaling more than $ 2.3 million. Petitioner contends that AFC is still in its formative years, but that the sale of Mambe to a renowned polo player established AFC as a leading producer of quality polo horses and means AFC will become profitable in the near future. Petitioner further asserts that his polo losses were exacerbated because of circumstances beyond his control such as an economic recession and the need to kill horses unfit for polo. We believe that it is a matter of speculation whether AFC will have more sales like Nevada and Mambe. Nevada was sold as a jumper horse, so the high price was not necessarily due to petitioner's efforts. The sale of Mambe was due in part to Mambe's natural talent. In our view, these two sales say little about AFC's potential for future profitability. Start-up losses may be disregarded334 if they can be recouped by future profits. Bessenyey v. Commissioner, 45 T.C. 261">45 T.C. 261, 274 (1965), affd. 379 F.2d 252">379 F.2d 252 (2d Cir. 1967). However, we have seen nothing that leads us to expect AFC to recoup the prior losses of more than $ 2.3 million. We are not convinced that AFC was hurt by unforeseen circumstances that were beyond petitioner's control. The need to kill horses should not have been unforeseen, and we are not convinced that an economic downturn caused petitioner's losses. This factor favors respondent. g. The Amount of Occasional Profit, If AnySmall occasional profits with large continuous losses do not indicate a profit objective. Sec 1.183-2(b)(7), Income Tax Regs. Although petitioner testified that he believes that AFC will become profitable in the near future, he concedes that it is not profitable yet. The possibility of substantial future profits in a highly speculative venture may indicate that the activity is operated for profit even though it has generated only losses. Sec. 1.183-2(b)(7), Income Tax Regs. However, we do not believe it is realistic to expect AFC to generate substantial future335 profits. This factor favors respondent. h. Financial Status of PetitionerSubstantial income from sources other than the activity may indicate a lack of a profit objective when the losses from the activity produce significant tax benefits. Sec. 1.183-2(b)(8), Income Tax Regs. Petitioner had substantial income to absorb the losses. This factor favors respondent. i. Elements of Personal Pleasure or RecreationEnjoyment of one's work does not show a lack of profit objective if the activity is conducted for profit as shown by other factors. Jackson v. Commissioner, 59 T.C. 312">59 T.C. 312, 317 (1972); sec. 1.183-2(b)(9), Income Tax Regs. Petitioner argues that this factor does not weigh against him because he worked hard at the farm. Respondent contends that petitioner's motive in establishing a polo operation was to gain tax deductions from an activity that he enjoyed. Petitioner has enjoyed polo all his life. We do not believe that he would have continued his polo activities after incurring such large losses if his objective were to make a profit. This factor favors respondent. 2. Relationship Between Petitioner's Polo Activity and His336 Legal PracticePetitioner claims that one reason he began his polo activity was to meet clients for his law firm. He asks us to find that the profitability of the polo activity should be calculated based on both polo income and legal fees from polo clients. We will not consider the income from petitioner's law practice in deciding whether AFC was profitable. In deciding whether two or more undertakings may be classified as one activity, we consider all of the facts and circumstances, including the degree of organizational and economic interrelationship, the business purpose served by conducting the undertakings together or separately, and the similarity of the undertakings. Sec. 1.183-1(d)(1), Income Tax Regs. A taxpayer's characterization of an activity is generally accepted unless it is unreasonable. Sec. 1.183-1(d)(1), Income Tax Regs. If two undertakings are treated as two activities, the profit and losses of each are considered separately in deciding if each activity was conducted with a profit objective. Id.Petitioner relies on Campbell v. Commissioner, 833">868 F.2d 833 (6th Cir. 1989), affg. in part and revg. in part T.C. Memo. 1986-569,337 which held that a taxpayer/partner could deduct losses from a partnership formed to lease an airplane to a corporation controlled by the taxpayer and the other partners. He also cites Kuhn v. Commissioner, T.C. Memo. 1992-460, in which a taxpayer was held to have a profit objective with respect to the lease of property he owned to a corporation he controlled. The authority cited by petitioner is not controlling here. The opinions in Campbell and Kuhn did not consider whether the undertakings in question could be treated as one activity for purposes of section 183. Instead, the issue in both of those cases was whether a profit objective could exist for an undertaking that derived its income from a related corporation. Campbell v. Commissioner, supra at 836; Kuhn v. Commissioner, supra.In Campbell and Kuhn, the activity in question was formed solely to benefit the taxpayer's existing business. No such interrelationship exists between petitioner's polo activity and his law practice. AFC was formed and operated as a separate business and did not depend on the law338 firm to conduct its activities. Also, we believe that if the law firm derived any benefit from AFC, it was at most incidental. We have held that two closely related undertakings are one activity for purposes of section 183. See Keanini v. Commissioner, 94 T.C. 41">94 T.C. 41, 46 (1990) (dog grooming and kennel operations treated as one activity because of close organizational and economic relationship). However, we find more analogous to this case our decision in Schlafer v. Commissioner, T.C. Memo 1990-66">T.C. Memo. 1990-66. In Schlafer, we held that an automobile dealer could not count income from his dealership in deciding whether his car racing activity, through which he advertised his dealership, was operated for profit. The two undertakings here are less closely connected than those in Schlafer. AFC and petitioner's law firm are not similar, and there was no organizational interrelationship between them. Schlafer v. Commissioner, supra; sec. 1.183-1(d)(1), Income Tax Regs. We believe there is less of an economic relationship than petitioner claims. We are not convinced that petitioner began 339 the polo activity to generate legal business or that AFC materially benefited petitioner's law practice. At trial, petitioner produced three undated lists of 60 to 127 clients he purportedly met through polo. Petitioner formed AFC in 1982, but he did not keep a list of polo clients until 1987. By then, he may have felt the need for additional ways to argue he had a profit objective. Petitioner's reliance on the list of polo clients appeared to be more of an afterthought than part of a bona fide business plan. The legal fees petitioner argues he received from polo clients would not be sufficient to produce a profit for the polo activity even if we treated his polo activity and his legal practice as one activity. Petitioner contends that he has earned $ 550,000 in net income from his legal practice from polo clients. It is unclear how many polo clients petitioner had, because three different polo client lists were entered into evidence. Even if we use that estimate and assume AFC's real estate could be sold at its acquisition cost and the horses could be sold at petitioner's asserted value of $ 400,000, the polo operation would still have a large net loss even without considering340 depreciation. 3. ConclusionWe hold that petitioner did not engage in the polo activity for profit. To reflect concessions and the foregoing, Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621453/	ESTATE OF FRANCES HAMPTON CURREY, DECEASED, BROWNLEE O. CURREY, JR., AND MARGARET CURREY HENLEY, EXECUTORS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Currey v. CommissionerDocket No. 2219-78United States Tax CourtT.C. Memo 1981-40; 1981 Tax Ct. Memo LEXIS 700; 41 T.C.M. (CCH) 800; T.C.M. (RIA) 81040; February 2, 1981. William M. Waller, for the petitioner. Vallie C. Brooks, for the respondent. GOFFEMEMORANDUM OPINION GOFFE, Judge: This case is before us on petitioner's Motion for Summary Judgment pursuant to Rule 121, Tax Court Rules of Practice and Procedure.1 A hearing on the motion was held September 10, 1979, at Nashville, Tennessee. The Commissioner determined the following deficiencies in the Federal income tax of Frances Hampton Currey (hereinafter called decedent): 701 Taxable YearDeficiency1972$ 135,039.751973358,351.98The issues are: (1) whether decedent realized income either upon a donative transfer in trust subject to the condition that the trustee pay decedent's resultant gift tax liability or upon the trustee's payment of such liability; (2) the fair market value of 12,800 shares of American Express Company stock on December 17, 1968; (3) whether petitioner is entitled to recover attorney's fees. Some of the facts have been stipulated. The stipulation of facts, together with the Exhibits attached thereto, are incorporated herein by this reference. On the date the petition herein was filed, decedent resided in Nashville, Tennessee. She died on February 10, 1979, and her son, Brownlee O. Currey, Jr., and daughter, Margaret C. Henley, qualified as executors of her will. On or about December 28, 1972, decedent executed three trust agreements with a Nashville bank (the Bank) as trustee for the benefit of her three grandchildren. On December 28, 1972, she transferred to each trust 8,000 shares of the common stock of American Express Company. On January 3, 1973, she made a further gift of 8,000 shares702 of this stock to each trust. With the exception of the beneficiary, the provisions of each trust agreement were identical. Article I(d) of each trust instrument provided: This gift is on the express condition that the Trustee report and pay out of the trust estate all gift taxes, both state and federal, which may be imposed upon donor by virtue of this gift. The Trustee is authorized to borrow the money with which to pay said taxes, or any part thereof, and to repay said loan or loans by selling, from time to time, property comprising a part of the trust estate. The interest on said loan or loans may be paid out of the income of the trust or by selling property in the trust estate, in the sole discretion of the Trustee. Decedent's basis in the 48,000 shares transferred to the three trusts was $ 720. On or about February 5, 1973, decedent filed a Federal quarterly gift tax return for the fourth quarter of 1972 and first quarter of 1973, and a Tennessee state gift tax return for 1972 and 1973, in which she reported the gifts of stock made on December 28, 1972, and January 3, 1973. The gift tax liability reported on each of the returns was as follows: 19721973Federal Return$ 372,773$ 446,384.49State Return83,23484,655.00TOTAL GIFT TAXLIABILITY REPORTED$ 456,007$ 531,039.49703 The Federal and State gift tax liabilities reported on the returns were paid by the trustee of the three trusts in 1973 from funds obtained by loans from the Bank. These loans were repaid by the three trusts from proceeds of subsequent sales of some of the American Express stock which had been transferred to the trusts. Decedent did not report any income from the payment of the gift taxes made by the trustee on either her 1972 or 1973 Federal income tax returns. On December 18, 1968, decedent donated to Vanderbilt University 12,800 shares of American Express common stock in which she retained a life estate. The value of the remainder interest in this stock equaled 67.814 percent of its total fair market value at the time of donation, and qualified as a charitable contribution deductible under section 170(a)(1) of the Internal Revenue Code of 1954. 2In December 1968, the common stock of American Express Company was traded only in the over-the-counter market. The bid and asked price for American Express common stock was as follows at the close of business on the dates704 shown below: DateBidAskedDecember 17, 1968$ 77.75$ 78.25December 18, 1968HolidayHolidayDecember 19, 196877.7578.25Records of the actual sales of American Express Company stock traded in the over-the-counter market or otherwise on the above dates are not available. For purposes of computing the value of the remainder interest in the stock transferred to Vanderbilt in 1968, decedent used a value of $ 79.25 per share, arriving at the amount of the claimed contribution as follows: Shares contributed12,800Value per share used$ 79.25TOTAL VALUE OF SHARESCONTRIBUTED$ 1,014,400Remainder value.67814VALUE OF CONTRIBUTION$ 687,905A portion of this amount was carried over to decedent's 1972 and 1972 taxable years. The Commissioner determined that decedent realized and recognized in 1973, a long-term capital gain upon the payment by the trustee of the gift taxes resulting from her transfer of the American Express common stock in trust on December 28, 1972, and January 3, 1973. The amount of the gain was determined to be $ 986,326.49, which was the excess of the gift taxes paid over decedent's basis in the705 stock. Alternatively, the Commissioner determined that, upon the transfer of the stock in trust, she realized and recognized long-term capital gains in 1972 and 1973 of $ 455,647 and $ 530,679.49, respectively, the excess of the gift taxes applicable to the stock transferred in each year over her basis therein. The Commissioner further determined that the decedent should have used a value of $ 78 instead of $ 79.25 per share in computing the amount of the contribution to Vanderbilt University in 1968 and accordingly reduced he carryover to 1972. In the petition filed herein, petitioner prayed that this Court award attorney's fees to its counsel. Issue 1. Income Tax Consequences of Transfers in Trust Conditioned Upon Trustee's Payment of Donor's Gift Tax LiabilityIt is well-settled in this Court's jurisprudence that a donor does not realize a gain or loss under section 1001 upon a trustee's payment of taxes imposed upon the donor's gifts in trust. Davis v. Commissioner, 74 T.C. 881">74 T.C. 881, 907 (1980); Bradford v. Commissioner, 70 T.C. 584">70 T.C. 584 (1978), on appeal (6th Cir., Dec. 26, 1978); Estate of Henry v. Commissioner, 69 T.C. 665">69 T.C. 665 (1978),706 on appeal (6th Cir., May 5, 1978); Hirst v. Commissioner, 63 T.C. 307">63 T.C. 307 (1974), affd. 572 F.2d 427">572 F.2d 427 (4th Cir. 1978); Turner v. Commissioner, 49 T.C. 356">49 T.C. 356 (1968), affd. per curiam 410 F.2d 752">410 F.2d 752 (6th Cir. 1969). Respondent argues that the Sixth Circuit reversed its position in Turner in Johnson v. Commissioner,495 F.2d 1079">495 F.2d 1079 (6th Cir. 1974), holding that the payment of a donor's gift tax liability by the donee constitutes income to the donor. Suffice it to say that we have on several occasions pointed out that the Sixth Circuit did not, in Johnson, overrule Turner. Estate of Henry, supra, at 672-675; Hirst, supra, at 314-315. Therefore, we adhere to our long-standing position and hold that decedent realized no income upon her transfers in trust or upon the trustee's payment of the gift tax liability imposed upon such transfers. There is no dispute concerning the facts relevant to this issue, and, under such facts, petitioner is entitled to judgment as a matter of law. Accordingly, petitioner is entitled to summary judgment on this issue. Issue 2. Valuation707 of Remainder Interest in the 12,800 Shares Transferred to Vanderbilt University in 1968. Petitioner argues that the gift of stock to Vanderbilt was made December 17, 1968, and that the average of the means of the bid and asked prices of the stock on December 17, 1968, and December 16, 1968, is the appropriate value to use in measuring the contribution. However, the parties, in the stipulation of facts, agree that the gift was made "on or about" December 17, 1968, and certain exhibits attached to the stipulation clearly show that the gift was not made until December 18, 1968. Decedent addressed a letter dated December 17, 1968, to the First American National Bank of Nashville containing the following language: Gentlemen: Please deliver 12,800 shares of American Express stock from my Custodian Account to Vanderbilt University. /s/ Frances Hampton Currey The treasurer of Vanderbilt University, by letter dated December 18, 1968, informed the First American Bank of the name in which the stock contributed to the University was to be held and requested the Bank to keep the stock in the University's custodian account. Finally, the journal entry transferring the stock from708 the decedent's to the University's account was not made until December 18, 1968. Section 1.170-1(b) of the Income Tax Regulations then in effect provided: (b) Time of making contribution. Ordinarily a contribution is made at the time delivery is effected. * * * If a taxpayer unconditionally delivers (or mails) a properly endorsed stock certificate to a charitable donee or the donee's agent, the gift is completed on the date of delivery (or mailing, provided that such certificate is received in the ordinary course of the mails). If the donor delivers the certificate to his bank or broker as the donor's agent, or to the issuing corporation or its agent, for transfer into the name of the donee, the gift is completed on the date the stock is transferred on the books of the corporation. * * * It is clear that the contribution did not occur until the stock was transferred from decedent's account to that of the University on December 18, 1968. Not until then was the stock beyond her control. Londen v. Commissioner, 45 T.C. 106">45 T.C. 106 (1965). Because petitioner's argument regarding the stock's fair market value assumes that the transfer took place on December 17, it*709 fails to address the relevant question, i.e., the value of the stock on December 18, not December 17. Therefore, petitioner has not shown that respondent's determination is so erroneous as to entitle petitioner to a judgment as a matter of law on this issue. Issue 3. Attorney's FeesThis Court has no authority to award attorney's fees. Key Buick Co. v. Commissioner, 68 T.C. 178">68 T.C. 178 (1977), affd. 613 F.2d 1306">613 F.2d 1306 (5th Cir. 1980). Petitioner is not entitled to summary judgment on this issue. An appropriate order will be entered. Footnotes1. Petitioner originally, filed a Motion for Judgment on the Pleadings pursuant to Rule 120, which, because material outside of the pleadings (stipulation of facts and attached exhibits and briefs) has been presented to and not excluded by the Court, we must treat as a motion for summary judgment. Rule 120(b).↩2. All section references are to the Internal Revenue Code of 1954, as amended.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4537543/	********************************************* The “officially released” date that appears near the be- ginning of each opinion is the date the opinion will be pub- lished in the Connecticut Law Journal or the date it was released as a slip opinion. The operative date for the be- ginning of all time periods for filing postopinion motions and petitions for certification is the “officially released” date appearing in the opinion. All opinions are subject to modification and technical correction prior to official publication in the Connecticut Reports and Connecticut Appellate Reports. In the event of discrepancies between the advance release version of an opinion and the latest version appearing in the Connecticut Law Journal and subsequently in the Connecticut Reports or Connecticut Appellate Reports, the latest version is to be considered authoritative. The syllabus and procedural history accompanying the opinion as it appears in the Connecticut Law Journal and bound volumes of official reports are copyrighted by the Secretary of the State, State of Connecticut, and may not be reproduced and distributed without the express written permission of the Commission on Official Legal Publica- tions, Judicial Branch, State of Connecticut. ******************************************* SRINIVAS KAMMILI v. SAISUDHA KAMMILI (AC 41576) Alvord, Prescott and Lavery, Js. Syllabus The plaintiff appealed to this court from the judgment of the trial court dissolving his marriage to the defendant, claiming that the trial court inequitably distributed the parties’ marital property, improperly declined to admit many of his exhibits into evidence, and failed to address several of his pretrial motions in a timely manner. Held: 1. The trial court did not abuse its discretion in distributing the marital property, this court having concluded that, based on a consideration of the plaintiff’s arguments and an independent review of the overall distribution and the record, that the court’s distribution of the property was not improper; the trial court could have concluded from the defen- dant’s testimony and other evidence that the defendant did not withdraw funds from the parties’ joint bank accounts in violation of the automatic court orders, and, based on that conclusion and the relevant statutory criteria, decided that it was appropriate to allow each party to retain his or her respective bank accounts as part of the overall distribution of marital property; moreover, because the plaintiff agreed with the trial court that it did not have jurisdiction to distribute property not owned by either party, he waived that part of his claim concerning the distribu- tion of real property owned by the defendant’s father, and, taking into account the financial standing of the parties at the time of trial, the trial court’s order to sell one of the parties’ homes was not improper; furthermore, in light of this court’s decision in Picton v. Picton (111 Conn. App. 143), and having reviewed the trial court’s overall distribution of marital property and the record, the trial court did not improperly order that the plaintiff either return the defendant’s jewelry to her or forfeit $50,000 of his share of the proceeds from the sale of one of their homes. 2. This court declined to review the plaintiff’s claim that the trial court abused its discretion when it declined to admit his exhibits into evidence due to an inadequate record; the plaintiff never requested that any of the excluded exhibits be marked for identification, and he did not point to an adequate substitute in the record that would allow this court to analyze the contents of his excluded evidence. 3. The trial court did not abuse its discretion by not adjudicating the plaintiff’s outstanding pretrial motions until after the trial concluded, the plaintiff having failed to demonstrate that he was harmed by either the timing or substance of the trial court’s decisions; at a pretrial status conference the plaintiff indicated, after the trial court had addressed various discov- ery issues, that he had everything he needed to try the case thereby conceding that he was not harmed by the timing of the court’s adjudica- tion of his discovery related pretrial motions; moreover, the plaintiff did not assert that the court incorrectly denied any of his pretrial motions and could not demonstrate that he was harmed by the substance of the court’s decisions. Argued December 9, 2019—officially released June 2, 2020 Procedural History Action for the dissolution of a marriage, and for other relief, brought to the Superior Court in the judicial dis- trict of Hartford, where the court, Prestley, J., rendered judgment dissolving the marriage and granting certain other relief, from which the plaintiff appealed to this court. Affirmed. David V. DeRosa, for the appellant (plaintiff). Steven R. Dembo, with whom were Caitlin E. Koz- loski, and, on the brief, P. Jo Anne Burgh, for the appel- lee (defendant). Opinion PRESCOTT, J. The plaintiff, Srinivas Kammili, appeals from the judgment of the trial court dissolving his marriage to the defendant, Saisudha Kammili. The plaintiff makes numerous claims1 on appeal, including that the trial court (1) improperly declined to admit many of his exhibits into evidence, (2) failed to address several of his pretrial motions in a timely manner, and (3) inequitably distributed the marital property, specifi- cally, the parties’ bank accounts, real property, and certain gold jewelry.2 We disagree with the plaintiff and, accordingly, affirm the judgment of the court. The record reveals the following facts and procedural history. The plaintiff commenced this marital dissolu- tion action on March 30, 2017. The parties tried the case to the court on January 25 and 26, 2018. Although the plaintiff was represented by an attorney when he commenced this action, he ultimately represented him- self at trial. The trial court issued a memorandum of decision on April 3, 2018, in which it dissolved the parties’ marriage and, among other things, distributed the parties’ assets.3 The court, in its decision, also entered additional orders concerning, inter alia, eleven outstanding pretrial motions. On April 19, 2018, the plaintiff filed a motion to rear- gue, in which he raised, inter alia, many of the claims he brings in this appeal. The court denied the plaintiff’s motion to reargue. This appeal followed. Additional facts will be set forth as necessary. I The plaintiff first argues that the trial court improp- erly declined to admit ‘‘at least [twenty]’’ of his exhibits into evidence because he failed to comply with the trial management order.4 Moreover, the plaintiff asserts that the trial court’s refusal to admit his exhibits harmed him because it prevented the court from comprehending his assertion that certain real property in India, which was owned in whole or in part by individuals other than the parties to the action, should nonetheless be distributed as marital property.5 Ultimately, the plaintiff claims that the court’s refusal to admit many of his exhibits consti- tuted an abuse of discretion. We decline to review this claim. We begin by stating the well settled principles con- cerning this court’s ability to review a party’s eviden- tiary claims. ‘‘It is the responsibility of the appellant to provide an adequate record for review.’’ Practice Book § 61-10 (a); see also Practice Book § 60-5. Importantly, if a party challenging an evidentiary ruling on appeal ‘‘failed to have [an excluded exhibit] marked for identifi- cation, it is not part of the record and [this court is] unable to review the ruling which excluded it from admission into evidence.’’ Carpenter v. Carpenter, 188 Conn. 736, 745, 453 A.2d 1151 (1982).6 Moreover, ‘‘[a]lthough we allow [self-represented] litigants some latitude, the right of self-representation provides no attendant license not to comply with relevant rules of procedural and substantive law.’’ (Emphasis added; internal quotation marks omitted.) Traylor v. State, 332 Conn. 789, 806, 213 A.3d 467 (2019). In the present case, the court admitted four of the exhibits that the plaintiff offered at trial. As for exhibits that the trial court excluded, the plaintiff never requested that any of these exhibits be marked for iden- tification. Indeed, in his reply brief, the plaintiff admits as much. Because the plaintiff failed to request that his excluded evidence be marked for identification, and he has not pointed us to, nor are we aware of, an adequate substitute in the record that would allow us to analyze the contents of his excluded evidence, we conclude that the record is inadequate to review his eviden- tiary claim.7 II The plaintiff next claims that the trial court abused its discretion by not considering eleven of his pretrial motions in a timely manner. The plaintiff asserts that the court improperly delayed consideration of his pretrial motions because he failed to comply with the trial man- agement order. He does not assert, however, that the court ultimately decided the motions incorrectly. In essence, the plaintiff argues that, by not hearing his motions in a timely manner, he was precluded from obtaining certain information from the defendant through discovery and that this prevented him from providing the court with the information that it needed to distribute marital assets equitably. We disagree. We review a party’s challenge to a court’s decision regarding docket management for an abuse of discre- tion. See, e.g., Aldin Associates Ltd. Partnership v. Hess Corp., 176 Conn. App. 461, 476, 170 A.3d 682 (2017). Although a trial court has broad discretion in managing its docket; see GMAC Mortgage, LLC v. Ford, 144 Conn. App. 165, 182, 73 A.3d 742 (2013); ‘‘a trial court must consider and decide on a reasonably prompt basis all motions properly placed before it . . . .’’ Ahneman v. Ahneman, 243 Conn. 471, 484, 706 A.2d 960 (1998). The following additional facts are relevant to our resolution of this claim. On October 10, 2017, the court ordered that all pending pretrial motions were to be considered at trial.8 In its memorandum of decision, the court decided ten of the plaintiff’s pretrial motions and one of the defendant’s pretrial motions.9 The court denied all pending pretrial motions, except for one of the plaintiff’s motions, which the court granted in part.10 Of the plaintiff’s pretrial motions that the court denied, only two can be read as pertaining to discovery issues that may have required resolution prior to trial. The remaining motions that the court denied in its memoran- dum were either moot11 or were of a nature that they did not need to be resolved before trial.12 The plaintiff’s claim that he was harmed by the timing of the court’s adjudication of his pending pretrial motions fails for two reasons. First, to the extent that the plaintiff argues that he was harmed by the court’s deciding his pretrial motions pertaining to his discovery requests in its memorandum of decision that it issued after the trial had concluded, his argument is unpersua- sive. Indeed, at a status conference held on December 1, 2017, the plaintiff indicated, after the court had addressed various discovery issues, that he had every- thing that he needed to try the case. Moreover, the plaintiff concedes in his appellate brief that ‘‘[t]here was extensive discovery, including interrogatories and depositions . . . [and that] [t]here was very little that each side did not know about the other sides’ position, given the extent of discovery.’’ In light of these state- ments, the plaintiff has conceded that he was not harmed by the timing of the court’s adjudication of his discovery related pretrial motions. Second, the plaintiff does not assert that the court incorrectly denied any of his ten pretrial motions. Because he does not argue that the court incorrectly denied any of these motions, the plaintiff cannot demon- strate that he was harmed by the substance of the court’s decisions. Therefore, because the plaintiff has failed to demonstrate that he was harmed by either the timing or substance of the trial court’s decisions on his pretrial motions, we reject his claim that the trial court abused its discretion by not adjudicating his outstand- ing pretrial motions until after the trial concluded. III The plaintiff next claims that the trial court’s orders pertaining to the distribution of marital property were improper for various reasons. Specifically, the plaintiff argues that the trial court’s distribution of the parties’ bank accounts,13 real property, and certain gold jewelry constituted an abuse of discretion. We disagree. Before addressing the plaintiff’s claim and each of its parts, we set forth our well settled standard of review of a trial court’s orders pertaining to the distribution of marital property. Our Supreme Court has stated: ‘‘The standard of review in family matters is well settled. An appellate court will not disturb a trial court’s orders in domestic relations cases unless the court has abused its discretion or it is found that it could not reasonably conclude as it did, based on the facts presented. . . . It is within the province of the trial court to find facts and draw proper inferences from the evidence pre- sented. . . . In determining whether a trial court has abused its broad discretion in domestic relations mat- ters, we allow every reasonable presumption in favor of the correctness of its action. . . . [T]o conclude that the trial court abused its discretion, we must find that the court either incorrectly applied the law or could not reasonably conclude as it did.’’ (Internal quotation marks omitted.) Powell-Ferri v. Ferri, 326 Conn. 457, 464, 165 A.3d 1124 (2017). Furthermore, ‘‘[i]n reviewing the trial court’s [orders distributing marital property] under [the abuse of discretion] standard, we are cogni- zant that [t]he issues involving [these] orders are entirely interwoven. The rendering of judgment in a complicated dissolution case is a carefully crafted mosaic, each element of which may be dependent on the other.’’ (Internal quotation marks omitted.) Kunajukr v. Kunajukr, 83 Conn. App. 478, 481, 850 A.2d 227, cert. denied, 271 Conn. 903, 859 A.2d 562 (2004). In fashioning orders that distribute marital property, ‘‘General Statutes § 46b-81 (c) directs the court to con- sider numerous separately listed criteria. . . . [Sec- tion] 46b-81 (a) permits the farthest reaches from an equal division as is possible, allowing the court to assign to either the husband or wife all or any part of the estate of the other. On the basis of the plain language of § 46b-81, there is no presumption in Connecticut that marital property should be divided equally prior to applying the statutory criteria.’’ (Emphasis added; internal quotation marks omitted.) Desai v. Desai, 119 Conn. App. 224, 238, 987 A.2d 362 (2010). The following facts are relevant to our resolution of this claim. On August 29, 2017, the trial court issued a pendente lite order regarding funds contained in a brokerage account owned by both parties. At the defen- dant’s request, and with the plaintiff’s agreement, the court ordered that the brokerage account be liquidated. The court also ordered the parties to use the proceeds from the sale of stocks held in the brokerage account to cover expenses such as tuition for one of the parties’ children, health insurance for both parties and their children, and the mortgage payments on the marital home. In addition, the court ordered that, after these expenses were paid, any remaining proceeds from the stock sales were to be divided evenly between the parties. After a trial in which various issues concerning prop- erty distribution were addressed, the court distributed the marital property in its memorandum of decision. The court ordered that the parties retain control over their own bank accounts. In the most recently filed financial affidavits that were before the trial court at the time of trial, the plaintiff averred that he had a total net value of -$168.50 in his bank accounts, and the defendant averred that she had a total net value of $1013 in her bank accounts.14 In addition, the court distributed the parties’ real property in the United States and India. First, with respect to the properties in the United States, the court awarded three properties to the defendant, two proper- ties to the plaintiff, and ordered that one property be sold. Specifically, the court awarded the defendant the marital home in Windsor (Windsor home), which the court found had a fair market value of $365,000. The court also ordered the plaintiff to immediately vacate the home in Illinois (Illinois home) so that this property could be sold. In its memorandum, the court found that this property had a fair market value of $630,000 and noted that it already had been marketed by a real estate agent but had not yet sold at the time of trial. Per the court’s order, the proceeds of this property’s sale were to be used to cover ‘‘all outstanding real estate and closing costs, outstanding tax liabilities on any of the United States properties . . . 100 [percent] of the appraisal fees for any appraisals done in this case . . . [and] [a]ttorney’s fees of up to $10,000 per party . . . .’’15 After covering these liabilities and expenses, any remaining proceeds from the sale of the Illinois home were to be split evenly between the parties. The court ordered, however, that ‘‘[i]f the plaintiff has not paid his share of the child’s college expenses, as ordered and agreed upon previously, or made any other pay- ments ordered during the pendente lite period, that amount shall be deducted from his share of the pro- ceeds [from the sale of the Illinois home] and paid to the defendant.’’16 Aside from the Windsor and Illinois homes, there were four other properties in the United States that the parties owned. The court ordered that the plaintiff and the defendant each receive two of these four remaining properties. Of the four properties, the plaintiff received two properties with a total fair market value of $142,400, and the defendant received two properties with a total fair market value of $170,000. With respect to the real property in India, the court ordered that ‘‘each party shall retain any properties held jointly with family members or gifted specifically to that party.’’ There were six properties in India that either the parties did not co-own with a family member or that were not specifically gifted to a party. Of the six properties, the court awarded two to the defendant, one to the plaintiff, and ordered that three be sold and that the proceeds of those sales be divided equally between the plaintiff and the defendant. In effect, the court awarded properties with a total fair market value of $525,229.50 to the plaintiff and properties with a total fair market value of $911,034.50 to the defendant. As for personal property, the court found that the plaintiff had the defendant’s jewelry. The court awarded the defendant ‘‘[a]ny gold jewelry or jewelry belonging to [her] or the children . . . .’’ Moreover, the court ordered the plaintiff to ‘‘return to the defendant any other gold or jewelry that he . . . removed from Con- necticut or that is in his possession.’’ The defendant testified that this jewelry was valued at $200,000 and requested that the court order the plaintiff to pay her $200,000 if he failed to return the jewelry to her. The court ordered, in its memorandum of decision, that, ‘‘[i]f [the plaintiff] claims that he does not have the gold jewelry or fails to return it within [thirty] days, the defendant shall receive the first $50,000 of the proceeds to which the plaintiff is entitled from the sale of the Illinois [home].’’ In support of his claim that the court’s distribution of marital property constituted an abuse of discretion, the plaintiff sets forth multiple arguments. He first argues that the trial court improperly ordered the par- ties to retain their own bank accounts17 because, in doing so, the court failed to account for the approxi- mately $80,000 which, he asserts, the defendant with- drew from bank accounts held in joint name in violation of the automatic orders filed on April 6, 2017.18 More- over, the plaintiff asserts that, even though the defen- dant testified that she withdrew this money from the parties’ joint bank accounts to cover expenses, she had, in fact, already been awarded funds to cover these expenses in the court’s August 29, 2017 order liquidating the brokerage account. Thus, the plaintiff contends that, because the defendant removed money from the joint bank accounts in violation of the automatic orders to cover expenses for which she was already provided funds, the trial court should have awarded him some compensation for the funds that the defendant with- drew. We are not persuaded by the plaintiff’s argument. At trial, the defendant testified that she removed funds from the joint bank accounts between early 2016 and May, 2017 to cover certain expenses. She also testi- fied, however, that she had done so with the plain- tiff’s consent. We are mindful that, in fashioning orders concerning the distribution of marital property, the trial court is in the best position to assess the evidence and testimony before it. See Leo v. Leo, 197 Conn. 1, 4, 495 A.2d 704 (1985); Desai v. Desai, supra, 119 Conn. App. 237–38. Thus, the trial court in the present case could have concluded from the defendant’s testimony and other evidence before it that the defendant did not withdraw funds from the joint bank accounts in violation of the automatic orders and, based on this conclusion and the relevant statutory criteria, decided that it was appro- priate to allow each party to retain his or her respective bank accounts as part of the overall distribution of marital property. Moreover, having considered the court’s overall distribution of marital property, and based on our independent review of the record, we conclude that the court’s order distributing to each party his or her respective bank accounts was not improper. The plaintiff next argues that the trial court’s distribu- tion of real property between him and the defendant was improper because the court failed to include certain real property as part of its distribution of marital prop- erty, declined to award him one of the homes in the United States that the parties owned, and did not ade- quately weigh his financial contribution in obtaining assets prior to the marriage. We are not persuaded for the reasons that follow. In support of this argument, the plaintiff first asserts that the trial court incorrectly failed to award certain real property in India that was owned by the defendant’s father. At trial, the plaintiff requested that the trial court consider evidence purporting to establish that certain real property owned by the defendant’s father was, in fact, marital property. The court stated, however, that it did not have the authority to distribute property owned by someone other than the plaintiff or the defen- dant.19 Importantly, the plaintiff agreed with the court that it did not have jurisdiction to award property owned by neither party.20 Because the plaintiff agreed with the trial court that it did not have jurisdiction to distribute property owned by neither party, the plaintiff has waived the part of his claim concerning the distribu- tion of real property owned by the defendant’s father, and, accordingly, we decline to review it. See O’Hara v. Mackie, 151 Conn. App. 515, 522, 97 A.3d 507 (2014) (‘‘[w]hen a party consents to or expresses satisfaction with an issue at trial, claims arising from that issue are deemed waived and may not be reviewed on appeal’’ (internal quotation marks omitted)).21 The plaintiff next asserts that the court improperly required him to transfer all interest he had in the Wind- sor home to the defendant while requiring him to vacate the Illinois home so that it could be sold. In essence, the plaintiff contends that, in distributing the marital property, it was improper for the court to not award him one of the homes. In addressing this assertion, we are mindful that the trial court has broad discretion in awarding marital property, even if its orders result in an unequal property distribution. Desai v. Desai, supra, 119 Conn. App. 238 (‘‘§ 46b-81 (a) permits the farthest reaches from an equal division as is possible, allowing the court to assign to either the husband or wife all or any part of the estate of the other’’ (internal quotation marks omitted)); see also Elliott v. Elliott, 14 Conn. App. 541, 543, 548, 541 A.2d 905 (1988) (trial court did not abuse discretion in awarding 65 percent of proceeds of sale of marital residence to defendant and 35 percent to plaintiff). Thus, the fact that the defendant was awarded one of the homes and the plaintiff was not awarded one does not necessarily mean that the court’s distribution of marital property was improper, as the plaintiff implies. In the present case, the court ordered that the pro- ceeds from the sale of the Illinois home be used to cover the parties’ tax liabilities and other expenses. After these liabilities and expenses were covered, each party would then receive an equal share of the remaining proceeds. Indeed, based on the financial affi- davits of both parties, which demonstrated that the parties had substantial liabilities, the court reasonably could have concluded that the Illinois home needed to be sold to provide the parties with cash to satisfy their liabilities. Taking into account the financial standing of the parties at the time of trial, and based on our independent review of the court’s overall distribution of marital property and the record, we conclude that the court’s order to sell the Illinois home was not improper. The plaintiff also asserts that the overall award of property was improper because the trial court did not consider the plaintiff’s financial contribution in obtaining assets prior to the marriage. In essence, the plaintiff argues that the court’s distribution was improper because the court was required to, but ulti- mately did not, ‘‘consider the contribution of each of the parties in the acquisition, preservation or apprecia- tion in value of their respective estates,’’ as required by § 46b-81 (c). Section 46b-81 (c) enumerates several factors that a trial court must consider when fashioning an order distributing marital property. The contribution of each party to the purchase of property is but one factor. See General Statutes § 46b-81 (c). ‘‘There is no . . . requirement that the court specifically state how it weighed these factors or explain in detail the impor- tance it assigned to these factors.’’ Desai v. Desai, supra, 119 Conn. App. 238. Moreover, when a trial court states in its memorandum of decision that it has consid- ered the factors listed in § 46b-81 (c) in fashioning an order distributing marital property, the ‘‘judge is pre- sumed to have performed [his or her] duty unless the contrary appears [from the record].’’ (Internal quotation marks omitted.) Picton v. Picton, 111 Conn. App. 143, 152, 958 A.2d 763 (2008), cert. denied, 290 Conn. 905, 962 A.2d 794 (2009). In its memorandum of decision, the trial court stated that it ‘‘fully considered the criteria of . . . § 46b-81 . . . as well as the evidence, applicable case law, the demeanor and credibility of the parties and witnesses and arguments of counsel in finding the facts and in reaching the conclusions reflected in [its] orders . . . .’’ The plaintiff has neither pointed us to, nor are we aware of, anything in the record that would dispute the accuracy of this statement. Thus, we reject the plaintiff’s assertion that the trial court improperly failed to consider the factors set forth in § 46b-81 (c) when fashioning its orders to distribute the marital property. The plaintiff’s final argument is that the trial court improperly awarded all of the jewelry in his possession to the defendant and ordered that he forfeit $50,000 of his share of the proceeds of the sale of the Illinois home if he failed to return the jewelry to the defendant. We are not persuaded by this argument. In reviewing this part of the plaintiff’s claim, we are mindful that ‘‘the [trial] court, as the trier of fact and thus the sole arbiter of credibility, [is] free to accept or reject, in whole or in part, the testimony offered by either party.’’ (Internal quotation marks omitted.) Remillard v. Remillard, 297 Conn. 345, 357, 999 A.2d 713 (2010). In the present case, the trial court chose to credit the defendant’s evidence and testimony demon- strating that the plaintiff took the jewelry belonging to her and the children from a safe deposit box and would not return it until she was obedient to him. The court also discredited the plaintiff’s evidence and testimony, which, according to the plaintiff, tended to show that the defendant had the jewelry and that he did not. The court, as the sole arbiter of credibility, was free to credit the defendant’s testimony and discredit the plaintiff’s testimony in arriving at its factual finding that the plain- tiff had the jewelry. See id. Having concluded that the plaintiff had the jewelry, the court ordered that he return it to the defendant as part of the court’s overall distribution of marital property. On appeal, the plaintiff has failed to articulate a reason to support a conclusion that, in light of the court’s overall distribution of marital property, the court’s decision to award all of the jewelry to the defen- dant was improper. Moreover, having considered the court’s overall distribution of marital property, and based on our independent review of the record, we conclude that the court’s decision to award the defen- dant all of the jewelry belonging to her and their chil- dren was not improper. As for the trial court’s decision to require that the plaintiff either return the jewelry to the defendant or forfeit $50,000 of his share of the proceeds from the sale of the Illinois home, this court previously has held that a trial court, in a marital dissolution case, may, within its discretion, include an order of this nature as part of its overall distribution of marital property. See Picton v. Picton, supra, 111 Conn. App. 150–51, 153–54. In Picton, we concluded that the trial court properly exercised its discretion by ordering that the plaintiff could retain possession of a vacation home he owned, provided that he pay the defendant $700,000 within ninety days of judgment being entered. See id., 148, 154. If, however, the plaintiff failed to make this payment within ninety days, then the plaintiff was required to ‘‘immediately list the property for sale . . . [and] [f]rom the net proceeds of that sale . . . pay to the defendant the sum of $700,000 plus interest from the date of judgment at the statutory rate for judgments.’’ (Internal quotation marks omitted.) Id., 148. In the present case, the defendant submitted into evidence a list and photographs of the jewelry at issue. The court also had before it the defendant’s testimony, in which she stated that the jewelry was worth $200,000.22 In light of this court’s decision in Picton, and having reviewed the trial court’s overall distribution of marital property and the record, we conclude that the trial court did not improperly order that the plaintiff either return the defendant’s jewelry to her or forfeit $50,000 of his share of the proceeds from the sale of the Illinois home. Having considered all of the plaintiff’s arguments, and based on our independent review of the trial court’s overall distribution of marital property and the record, we conclude that the court’s distribution of marital property was not improper. Thus, we conclude that the court did not abuse its discretion in distributing the marital property as it did. The judgment is affirmed. In this opinion the other judges concurred. 1 Within each of these claims, the plaintiff asks this court to consider several issues. In his claim concerning his pretrial motions, for example, the plaintiff argues that the court abused its discretion by failing to address eleven of his pretrial motions in a timely manner. Although the number of claims that a party may bring on appeal is not limited by rule, we are mindful of what our Supreme Court has stated regarding the merits of an appeal that sets forth a multiplicity of issues. ‘‘[A] torrent of claimed error . . . serves neither the ends of justice nor the [plaintiff’s] own purposes as possibly meritorious issues are obscured by the sheer number of claims that are put before [the court]. ‘‘Legal contentions, like the currency, depreciate through over-issue. The mind of an appellate judge is habitually receptive to the suggestion that a lower court committed an error. But receptiveness declines as the number of assigned errors increases. Multiplicity hints at lack of confidence in any one [issue]. . . . [M]ultiplying assignments of error will dilute and weaken a good case and will not save a bad one. . . . ‘‘Most cases present only one, two, or three significant questions. . . . Usually . . . if you cannot win on a few major points, the others are not likely to help. . . . The effect of adding weak arguments will be to dilute the force of the stronger ones.’’ (Citations omitted; footnote omitted; internal quotation marks omitted.) State v. Pelletier, 209 Conn. 564, 566–67, 552 A.2d 805 (1989). 2 Within each of his first two claims, the plaintiff alleges that ‘‘[t]he [c]ourt violated [his] constitutional right to due process . . . .’’ Although the plain- tiff states his constitutional right to due process was violated, he placed this claim under the same headings in which he claimed that the court abused its discretion and almost all of his analysis under these two headings focuses on whether the court abused its discretion. Indeed, the plaintiff provided nothing more than bare assertions and minimal analysis concerning his constitutional claims. Because he has not adequately briefed his constitu- tional claims, we decline to review them. See State v. Buhl, 321 Conn. 688, 722–29, 138 A.3d 868 (2016). 3 The trial court issued a corrected memorandum of decision on April 17, 2018. All references throughout this opinion are to the court’s corrected memorandum. 4 The trial management order for all trials of family matters states, in relevant part, the following: ‘‘Counsel and self-represented parties are ordered to exchange with each other, and give to the Family Caseflow Office, the following documents that comply with the Trial and Hearing Management Order so that they are received not less than 10 (ten) calendar days before the assigned trial or hearing date. . . . * ‘‘2. A list of all pending motions, including motions to be decided before the start of the trial or hearing such as motions in limine and motions for protective order . . . * ‘‘6. A list of exhibits each party reasonably expects to introduce in evi- dence . . . * ‘‘If a party does not follow this order, the party may have sanctions imposed by the court, which may include a monetary sanction, exclusion of evidence, or the entry of a nonsuit, default or dismissal.’’ (Emphasis omitted.) In response to the plaintiff’s failure to comply with the trial management order, the defendant filed a motion in limine in which she ‘‘move[d] that the plaintiff be precluded from offering any testimonial or documentary evidence in the . . . trial . . . . The court ‘‘grant[ed] [the defendant’s] motion in limine in part.’’ The court explained its decision by stating the following: ‘‘With respect to the exhibits, if [the plaintiff] attempts to offer exhibits, I’m going to take it on a case-by-case [basis]. . . . With respect to witnesses, he has none.’’ (Emphasis added.) At trial, the court admitted four of the plaintiff’s exhibits into evidence. 5 The plaintiff claims that ‘‘at least [twenty]’’ of his exhibits were excluded from evidence at trial because the court granted, in part, the defendant’s motion in limine for the plaintiff’s failure to comply with the trial manage- ment order. Our independent review of the transcript, however, did not uncover any examples of the court explicitly stating that it was excluding an exhibit that the plaintiff offered because he violated the trial management order. Moreover, the trial transcript is riddled with instances in which the plaintiff drew the court’s attention to a document but never offered it as an exhibit for admission into evidence. 6 This court may, however, review a claim regarding the exclusion of an exhibit that was not marked for identification ‘‘if the record reveals an adequate substitute for that exhibit.’’ Finan v. Finan, 287 Conn. 491, 495, 949 A.2d 468 (2008). Examples of what might constitute an adequate substitute in the record include a formal offer of proof, an excluded exhibit being attached to a motion that was before the court, and other evidence in the record that would allow this court to decipher the contents of the excluded exhibit. See id., 495–96. 7 In the alternative, the plaintiff asserts that, because he was a self-repre- sented litigant, the court was required, but failed, to mark, sua sponte, his excluded exhibits for identification, even though he did not request that these exhibits be marked. This assertion, however, contradicts our well settled case law stating that, ‘‘[a]lthough we allow [self-represented] litigants some latitude, the right of self-representation provides no attendant license not to comply with relevant rules of procedural and substantive law.’’ (Inter- nal quotation marks omitted.) Traylor v. State, supra, 332 Conn. 806. Thus, the fact that the plaintiff represented himself at trial bears no weight on our ultimate conclusion that the plaintiff failed to provide an adequate record for this court to review his evidentiary claim. 8 Moreover, the court, on November 14, 2017, and January 23, 2018, repeated its order that it would take up pending motions at the time of trial. 9 The trial court did not address the plaintiff’s motion for order filed on October 19, 2017, in which the plaintiff requested that the court award him damages from the attorney who had represented him for a period of time in the present case. This motion was neither on the calendar nor marked ready. Thus, this motion was not properly before the court and, accordingly, we do not address it in this opinion. 10 The plaintiff’s motion for order pendente lite filed on October 6, 2017, was ‘‘granted, in part, as to return of the plaintiff’s personal property such as trophies or other memorabilia that the defendant has in her possession.’’ 11 The court denied as moot the following nondiscovery related pretrial motions of the plaintiff: a motion for modification of child support and visitation; a motion to consolidate and refinance all loans belonging to the parties; and a motion to order the defendant to make minimum payments on all credit card bills and loans in the names of both him and the defendant. The court, however, addressed the issues raised in these motions—child support, visitation rights, and the distribution of debts—in its memorandum of decision. 12 Of the plaintiff’s remaining pretrial motions, the court denied the follow- ing: two motions alleging breach of fiduciary duty, breach of contractual obligation to a third party beneficiary, and breach of implied contract; a motion to vacate the court’s August 29, 2017 order to liquidate a brokerage account belonging to the parties and to order that the defendant return $72,000 to a joint bank account; and a motion to order that the defendant cease making statements that were false and misleading and to sanction the defendant and her attorney for engaging in such conduct. 13 The term ‘‘bank accounts’’ used throughout this opinion refers to the checking and savings accounts attested to in both parties’ financial affidavits. The term ‘‘brokerage account’’ used throughout this opinion refers to an account containing stocks that the court ordered the parties to liquidate in its August 29, 2017 pendente lite order. 14 The most recent financial affidavits before the court at the time of trial were the plaintiff’s May 22, 2017 affidavit and the defendant’s January 15, 2018 affidavit. 15 The court noted that the $10,000 allocated to cover the defendant’s attorney’s fees did ‘‘not include the $7500 that was previously awarded to the defendant during the pendente lite period.’’ 16 As later discussed in this opinion, the court also ordered the plaintiff to forfeit the first $50,000 of his share of the proceeds from the sale of the Illinois home to the defendant if he failed to return certain gold jewelry to her within thirty days. 17 The plaintiff also argues, in a somewhat contradictory fashion, that the court made no orders distributing cash held in the parties’ bank accounts. In its memorandum of decision, the trial court stated: ‘‘Retirement and Bank Accounts: The parties shall each retain their own pension/retirement accounts.’’ (Emphasis added.) Importantly, the plaintiff did not file a motion for articulation in which he asked the court to clarify whether the court’s orders distributed the parties’ bank accounts in addition to the retirement accounts. Because the plaintiff failed to file a motion for articulation in which he requested that the court clarify whether it distributed the parties’ bank accounts, we construe the order to include both retirement and bank accounts in light of the heading used by the court. 18 The automatic orders state in relevant part that ‘‘[n]either party shall cause any asset, or portion thereof, co-owned or held in joint name, to become held in his or her name solely without the consent of the other party, in writing, or an order of the judicial authority.’’ 19 Moreover, the plaintiff, at trial, conceded that this property was owned by the defendant’s father. 20 ‘‘The Court: You cannot pursue any order on those properties [in this court]. . . . ‘‘[The Plaintiff]: I know that, Your Honor.’’ 21 The plaintiff argues that the court failed to distribute properties that were gifted to the defendant or that she co-owned with a family member. With respect to this property, the court ordered that ‘‘each party shall retain any properties held jointly with family members or gifted specifically to that party.’’ Thus, the trial court did, indeed, distribute these properties and awarded them to the defendant because they were either gifted to her or she co-owned them with a family member. Moreover, the plaintiff also received property as a result of the court’s order concerning property that was gifted or co-owned with a family mem- ber. Indeed, the court found that the plaintiff ‘‘owned’’ two properties that he gifted to his parents but which would ‘‘return to him in a will.’’ The court awarded these properties to the plaintiff. For these reasons, the plaintiff’s argument is meritless. 22 The plaintiff asserts that the court improperly valued the jewelry at $50,000 without expert testimony. We disagree. The defendant, who owned the jewelry, testified that it was worth $200,000. She also requested that the court order the plaintiff to pay her $200,000 if he failed to return the jewelry to her. The trial court partially credited her testimony as to the value of the jewelry and valued it at $50,000, which is less than the amount that the defendant stated in her testimony. See Porter v. Porter, 61 Conn. App. 791, 799–800, 769 A.2d 725 (2001) (court’s valuation of marital property was not clearly erroneous finding, even though court’s valuation of property was less than valuation of property offered in testimony from both parties). A court, in valuing personal property, may rely on the testimony of its owner as to its value. See Wolk v. Wolk, 191 Conn. 328, 333, 464 A.2d 780 (1983) (concluding that court ‘‘improperly admitted [party’s testimony] since [he] was neither the owner of the jewelry nor an expert’’ (emphasis added)); Saporiti v. Austin A. Chambers Co., 134 Conn. 476, 479–80, 58 A.2d 387 (1948) (stating that ‘‘[t]estimony of the [party] as to the value of the furniture was proper, although no qualification other than his ownership of it was shown’’). Thus, the plaintiff’s argument is unavailing.	01-04-2023	05-29-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621454/	Elliott S. Nichols and Anne D. Nichols, Petitioners, v. Commissioner of Internal Revenue, RespondentNichols v. CommissionerDocket No. 104322United States Tax Court1 T.C. 328; 1942 U.S. Tax Ct. LEXIS 9; December 22, 1942, Promulgated 9 Decision will be entered under Rule 50. The mortgagees of real estate, upon default of the mortgagor, foreclosed on the property and bid it in at public sale at a price greatly in excess of the fair market value but slightly less than the amounts of principal and interest due from the mortgagor. At the time of the sale the mortgagor was hopelessly insolvent and had no assets except the mortgaged real estate, the fair market value of which was less than the mortgagees' investment in the real property. Held, that the petitioner, one of the mortgagees, derived income to the extent of interest included in the bid. Loss allowed under regulations 77, art. 193. Raymond K. Dykema, Esq., and Paul R. Trigg, Jr., Esq., for the petitioners.Philip M. Clark, Esq., for the respondent. Disney, Judge. Smith, J., dissenting. Turner, J., dissenting. Tyson, J., agrees with this dissent. DISNEY328 The respondent has determined an income tax deficiency for 1933 of $ 62,969.87 on the joint return filed by the petitioners for that year. The only question for our determination is the amount of taxable income, if any, realized on a transaction in which petitioner10 Elliott S. Nichols and his associates foreclosed on a mortgage on real estate, which they had previously sold, and bid in the property at a price somewhat less than the principal and interest due from the 329 mortgagor but greatly in excess of the fair market value of the property at that time. The petitioners reported a loss on the transaction, computed on the basis of the fair market value of the property at the time of the foreclosure sale, while the respondent has determined that petitioners realized taxable income to the extent of the interest due, and other income, based on the bid price.The facts have been stipulated in part. The written stipulation is made a part of our findings of fact.The term petitioner will be used hereinafter to refer to the husband, Elliott S. Nichols. His wife, Anne D. Nichols, is a party to this proceeding only by reason of having filed a joint return with the petitioner. Such return was filed with the collector of internal revenue for the district of Michigan.FINDINGS OF FACT.On May 27, 1925, the petitioner purchased a one-fourth vendor's interest in a certain land contract entered into on September 10, 1924, between John M. Reid, as11 vendor, and Lake Erie Land Co., as vendee. For such one-fourth interest petitioner paid $ 20,000 in cash and assumed one-fourth, or $ 38,125, of Reid's unpaid obligations on the land. In September 1925 the petitioner purchased an additional one-fourth interest in the contract from Reid for a like consideration.The land in question comprised a tract of approximately 650 acres situated about 35 miles from Detroit, Michigan, and bordering on Lake Erie. About one-fourth of the tract was farm land and the balance was mostly marsh land and lagoons. There were several small wooded areas and about 25 acres of open water.The total purchase price under the land contract of September 10, 1924, was $ 390,000, of which $ 100,000 was paid in cash and the balance was to be paid annually in varying amounts not later than September 1, 1932.The Lake Erie Land Co. acquired the property for development purposes, intending to convert it into a high class residential subdivision. It had the entire tract platted and undertook extensive dredging and other development operations. Several lagoons were dredged and a roadway was constructed through the property. Lots were offered for sale to the public12 on a long term purchase plan, the deeds to be delivered when the purchase price was fully paid, and a few of the lots were sold.In 1925 the name of Lake Erie Land Co. was changed to Lagoona Beach Co.During 1925 and 1926 the petitioner received $ 17,500 as his share of the payments made under the land contract of September 10, 1924. 330 In his income tax returns for those years he reported 19.82 percent of those amounts as taxable income and the balance as a return of capital, the cost of his interest in the property being 80.18 percent of his share of the principal amount ultimately due.On July 13, 1926, resolutions were passed by the stockholders of the Lagoona Beach Co. reciting in substance that $ 255,000 principal and $ 5,000 interest was the balance unpaid on the land contract; that it would be greatly to the advantage of the company to defer payment of the installment due September 1, 1936, and to rearrange the maturity date of other installments; that certain provisions of the land contract were burdensome; and that the vendors were willing to rescind the old contract and enter a new one, to sell the land at a price of $ 440,000, with $ 135,000 credit for previous13 payments, leaving $ 305,000 payable at dates stated, a deed to be issued and a mortgage given. The agreement so described was carried out, the old contract was rescinded, the land was deeded outright to the Lagoona Beach Co., and promissory notes payable in seven installments aggregating $ 305,000 and a mortgage securing same were executed to the petitioner and his associates under date of August 3, 1926.In carrying out this change the petitioner paid off that portion of Reid's obligations on the property which he had previously assumed, amounting to $ 56,375.21, and the balance of Reid's obligations thereon in the same amount. He borrowed the money required for those payments.No payments were ever made by the Lagoona Beach Co. on any of its purchase money notes. By December 1929, and at all times thereafter, the Lagoona Beach Co. was "hopelessly insolvent." Its only property consisted of the mortgaged real estate. Its corporate charter was forfeited, for failure to file annual reports or pay the fees in connection therewith, on September 1, 1930. Execution on various judgments against the company were returned unsatisfied and on February 10, 1930, its property was placed in14 the hands of a receiver.On July 7, 1930, petitioner and his associates instituted foreclosure proceedings on their mortgage on the property. On October 29, 1932, judgment was rendered, including a holding of personal liability on the part of the Lagoona Beach Co. in default of payment of which the property should be sold to "raise the amount decreed to be due the plaintiffs." Pursuant to court order the property was sold at public sale on January 5, 1933, and bid in by the Union Guardian Trust Co. as trustee for the mortgagees at a price of $ 435,000. This was the only bid submitted. The petitioner and his two associates, and their attorney in the foreclosure, attended the foreclosure sale, petitioner and his two associates driving together to the town where it was held. The subject of bidding was taken up informally among 331 the three. "We just said bid the purchase price." The bid was the amount due, but they neglected to add extra interest at the time of foreclosure. The petitioner did not know who made the bid. Market value and collection of deficiency judgment were not considered in fixing the bid. The total amount due on the property at that time, including principal15 and interest, was $ 454,754.72. The court entered a deficiency judgment against the mortgagor for $ 19,754.72. No money was paid on the purchase at the foreclosure sale, the petitioner and his associates merely surrendering their mortgage and mortgage notes in full satisfaction of the bid price. No collection has ever been made of any part of the deficiency judgment and such judgment was always considered and treated by the petitioner as wholly worthless. The decree of foreclosure provided a six-month redemption period, and that at the end of that time the purchasers be let into possession of the property.At the date of the foreclosure sale petitioner's adjusted cost basis of his interest in the property in question, after allowance of foreclosure costs and other incidental expenses, was $ 155,721.05. The fair market value of the petitioner's interest in the property at the date of the foreclosure sale was $ 133,405.35.In his income tax return for 1933, which was made on the cash receipts and disbursements basis, petitioner claimed on the foreclosure transaction a deductible loss "from sales of real estate by contract and mortgage," in the amount of $ 22,410.36, computed as16 follows:Cost$ 169,845.46Less recovery of capital14,029.75Adjusted cost155,815.71Fair market value of the 68.413% interest133,405.35Loss22,410.36In his deficiency notice herein the respondent determined that the petitioner realized income on the transaction as follows:Accrued interest$ 89,809.68Bonus30,785.85Profit on foreclosure18,731.00The accrued interest represents 68.413 percent of the following amounts:Accrued interest represented by note of the mortgagor$ 5,000.00Accrued interest included in the court's decree126,275.75Total131,275.75The bonus is the same percentage of the $ 45,000 bonus note given by the mortgagor in 1926.332 The profit on the foreclosure is computed as follows: 68.413 percent of the principal due on land contract $ 255,000 ($ 174,452.05), less the petitioner's cost of his interest $ 155,721.05.OPINION.The petitioner takes the view that the foreclosure sale described in the facts set forth above resulted in a loss to him in the difference between his stipulated adjusted base, $ 155,721.05, and $ 71,833.65, being the fair market value of his 68.413 percent interest in the property17 purchased by him, based upon a value of $ 105,000. His view is that the transaction amounted to a mere exchange of notes receivable for land.The respondent takes the position that under the doctrine of Helvering v. Midland Mutual Life Insurance Co., 300 U.S. 216">300 U.S. 216, income was realized on the accrued interest and "bonus" covered by the petitioner's bid at the foreclosure sale, and that profit was realized on the foreclosure in the difference between the petitioner's basis and the amount of principal indebtedness included in the bid at the foreclosure sale.The Midland Mutual case, supra, unless distinguished, requires the inclusion, in the income of a mortgagee bidding in the property upon sale of the mortgaged property, of accrued interest included in the bid. The principle is not confined, as the petitioner argues, to cases involving insurance companies. The language in the Midland Mutual case is broadly applied to mortgagees. In Manomet Cranberry Co., 1 B. T. A. 706, where a mortgagee, not an insurance company, bid in the mortgaged property at foreclosure sale for the amount of principal and interest, 18 we held that the mortgagee realized income to the extent of the interest bid. In Ewen MacLennan, 20 B. T. A. 900, wherein a mortgagee, an individual, foreclosed and purchased the property for a bid price equal to the unpaid principal and accrued interest, the amount of accrued interest paid or applied as a credit was held to be taxable income to the petitioner. We held to the same effect in insurance cases in American Central Life Insurance Co., 30 B. T. A. 1182; and Missouri State Life Insurance Co., 29 B. T. A. 401; affd., 78 Fed. (2d) 778. In T. Eugene Piper, 45 B. T. A. 280, we expressly followed the Midland Mutual case in a proceeding involving individual petitioners and held that the mortgagees received interest income to the extent of the accrued interest included in their bid in purchasing the property upon foreclosure. We therefore decline to make a distinction between the present case and those involving insurance companies.In the Piper case, supra, as herein, the property purchased was of a fair market value19 less than the bid. In Manomet Cranberry Co., 333 , evidence was offered as to the value of the property, but in the light of our opinion we considered it unnecessary to make any findings with respect to value. The fair market value of the property foreclosed was less than the bid, in the Midland Mutual case, supra, and in Missouri State Life Insurance Co., supra, and in both cases it was held that the fair market value of the properties acquired was immaterial. It is apparent therefore that the present situation can not be distinguished from those in the Piper case, and the other above cited cases, so far as concerns the element that fair market value is less than the bid at the foreclosure sale.The petitioner, however, further seeks to distinguish the instant proceeding because of the insolvency of the mortgagor in this matter. Such therefore is the pivotal question here. He argues that insolvency of the mortgagor did not appear in the Midland Mutual case, and that certain statements in the opinion indicate that the lack of such insolvency on the part of the mortgagor was a determinative20 factor in the opinion. It is true that therein the Court said: "If the bid had been insufficient to allow full payment of the mortgaged debt, principal and interest, the company would have been entitled to a judgment for the deficiency"; also, that a stranger "would be obliged to pay in cash the amount of his bid, while the formality of payment in cash is ordinarily dispensed with when the mortgagee acquires the property on his own bid"; and again that: "The reality of the deal here involved would seem to be that respondent valued the protection of the higher redemption price as worth the discharge of the interest debt for which it might have obtained a judgment." We can not, however, agree with the petitioner that the above quotations demonstrate that the opinion of the Court in the Midland Mutual case depended upon solvency of the debtor or ability to collect from him to the extent of the amount bid. In our view the opinion there is bottomed upon the theory that the petitioner there shall be taxed on the basis of the legal effect of a sale to him, though made through foreclosure. Although referring to a possible judgment for a deficiency, the Court does not refer to a collectible21 deficiency, and states that "Income may be realized upon a change in the nature of legal rights held, though the particular taxpayer has enjoyed no addition to his economic worth. Compare Lynch v. Hornby, 247 U.S. 339">247 U.S. 339, 344, 346." Again, the Court further lays down the principle that "There is nothing unfamiliar in taxing on the basis of the legal effect of a transaction," and points out in detail that the legal effect of purchase by the mortgagee is the same as that where a stranger purchases. Ledyard v. Phillips, 47 Mich. 305">47 Mich. 305, 308, is cited to the effect that a purchasing mortgagee "enjoys the same rights as purchaser as would a third party." In 334 Hadley Falls Trust Co. v. United States, 110 Fed. (2d) 887, the court considered the decision in the Midland Mutual case to depend "upon the circumstance that the price bid by the mortgagee was entirely within its control and that it should accordingly be bound thereby." The Court in the Midland Mutual case points out that upon purchase by the mortgagee the debt is discharged by means of a credit, and continues:* * 22 The amount so credited to the mortgagor as interest paid would be available to him as a deduction in making his own income tax returns. It would be strange if the sum deductible by the mortgagor debtor were not chargeable to the mortgage creditor as income received. Where the legal effect of a transaction fits the plain letter of the statute, the tax is held payable, unless there is clearly revealed in the act itself or in its history a definite intention to exclude such transactions from the operation of its applicable language. * * * [Citing many cases.]Under this language it is incumbent upon the petitioner to demonstrate a definite intention to exclude from the applicable language of the statute as to income (as well as the cases cited above) a transaction where the mortgagor was insolvent. An insolvent mortgagor may have taxable income, and would be entitled to the deduction of interest credited against his debt, under the above language of the Court, equally with a solvent debtor. In Harold M. Blossom, 38 B. T. A. 1136, we allowed a mortgagor a deduction as for interest paid, to the extent that an amount equal to interest was bid by the23 mortgagee at foreclosure sale. In National Life Insurance Co. v. United States, 4 Fed. Supp. 1000, involving a bid of accrued interest, and where the Court held such bid to result in income to the mortgagee, it appears that although there was no specific finding of insolvency, the mortgagee "concluded that there was little likelihood of its being able to collect principal or interest without foreclosures, and that in many cases the mortgagors had moved away from the lands leaving them idle."In Bingham v. Commissioner, 105 Fed. (2d) 971, the court, in deciding whether there was a sale or exchange (of capital assets) within the Revenue Act of 1932, section 101 (c) (2), where a mortgagor transferred the mortgaged property in payment of the debt, held that it was immaterial whether the mortgagor was financially able to pay. Conversely, by this logic it appears to follow that the fact that there was a sale through mortgage foreclosure, with the effect given to it by the Midland Mutual case, is not to be considered affected by inability of the mortgagor to pay. It is a sale none the less, a mortgage foreclosure24 sale, Helvering v. Hammel, 311 U.S. 504">311 U.S. 504, and purchase price was in legal effect paid -- by the mortgagee as purchaser.The petitioner further relies upon Hadley Falls Trust Co. v. United States, supra, where it was held, under Regulations 74, article 335 193, that there was a right to a deduction for loss equal to the difference between mortgage obligations applied to purchase price and the fair market value of the property at the time of sale. In that case, however, as is shown from the opinion rendered by the District Court, 22 Fed. Supp. 346, the obligations owned by the mortgagee and applied upon the bid price included only principal amount, so that the present question as to whether accrued interest bid constitutes realization of income was not there involved. We declined to consider the Hadley Falls Trust Co. case as controlling in T. Eugene Piper, supra, wherein, although insolvency of the mortgagor is not discussed nor found as a fact, the evidence showed that the petitioner considered the mortgagor would have nothing with which to pay, 25 that there was no possibility of his being "financially rehabilitated" and did not think that the payment of interest could be obtained. We therefore found that market value was immaterial, as above noted, and held the petitioner taxable upon interest bid. West Production Co., 41 B. T. A. 1043, also relied upon by the petitioner, likewise involved no bid of accrued interest, and therefore is not authority upon the present question.After examination of the authorities submitted and others, we are of the opinion that the fact of insolvency on the part of the mortgagor herein does not constitute a material distinction from the situation in T. Eugene Piper, supra, nor require a different conclusion from that which we reached therein. Moreover, as to the petitioner's argument that reality must be so considered as to require us to discern simply that he had an investment which was exchanged for real estate of a lower value, resulting in loss, we point to the answer of the Supreme Court to the same argument in the Midland Mutual case:The company argues that taxation is a practical matter; that we should be governed by26 realities; that the reality is, that all the company got was the property; and that the property was worth less than the principal of the debt. The "reality" of the deal here involved would seem to be that respondent valued the protection of the higher redemption price as worth the discharge of the interest debt for which it might have obtained a judgment. * In the present case, the record does not clearly show the reason for the bid higher than actual value. Though the petitioner testified that there was no connection between market value and bid and that neither the possibility of redemption nor deficiency judgment was considered by the mortgagees at the time, he further stated that the subject was informally taken up among the three mortgagees, that the amount of the bid was the amount due, but that they neglected to add extra interest at the time of foreclosure. He and the other mortgagees drove together to the town where the sale was held and were in attendance at the sale and "We just said bid the purchase price." All this obviously 336 fails to show that there was no reason for the bid higher than actual value. On the contrary, it indicates intent to prevent anyone27 else from securing the property at a price less than the investment therein. It thus appears that the mortgagees agreed, in substance, not to let anyone else acquire the property for less than the indebtedness, including interest. That there was only one bid proves little or nothing. The mortgagees' high bid may have been the opening bid, made at once, precluding even a slightly less offer by any other bidder. It did in fact protect against redemption at any lower value, affected the mortgagor's right to deduction of interest, and therefore affected the tax consequences. Nor do we think that the evidence negatives the idea that the law as to redemption at bid price was considered, in spite of the petitioner's testimony, for a representative of the attorneys foreclosing was present at the sale. It is plain that the matter was in the hands of the attorneys, and the petitioner did not know who actually made the bid. We are unable to conclude that the possibility of redemption at bid price was not contemplated in the consummation of the foreclosure sale, as it was in the Midland Mutual case. The realities of the instant situation do not preclude, in our opinion, the theory28 of realization of income by the bid of accrued interest by the mortgagee.We conclude and hold that the respondent did not err in including interest bid in the income of the petitioner. We do not include in such interest the $ 5,000 accrued upon $ 255,000 principal at the time of the change from a land contract to a mortgage in 1926, or the $ 45,000 "bonus" added to the then indebtedness. The parties at that time entered into a new transaction, and we regard as interest only that which accrued upon the $ 305,000.The fact that we hold petitioner to have received income to the extent of accrued interest bid, is not decisive of the whole case; for there remains the question as to whether the provisions of Regulations 77, article 193, 1 here apply, requiring examination of the question of gain or loss to the mortgagees to the extent of the difference 337 between amount bid and fair market value of the property purchased.29 Respondent argues in effect that the effect of the Midland Mutual case is to require use of bid price as setting fair market value and he regards as gain the amount by which the principal amount bid exceeded the petitioner's base. Such view disregards the regulation, for the regulation on its terms particularly provides that the bid price is only presumptively fair market value. It has been in effect since 1926, during which time the statute upon which it is based has been repeatedly reenacted by Congress. It has received the approval of the courts, Hadley Falls Trust Co. v. United States, supra;Malden Trust Co. v. Commissioner, 110 Fed. (2d) 751; Helvering v. New President Corporation, 122 Fed. (2d) 92. The Treasury Department, in G. C. M. 19573, C. B. 1938-1, p. 214, approved it, pointing out the right to both a deduction for worthless debt and to a loss, where the mortgagee purchases; and I. T. 3121, C. B. 1937-2, p. 138, is to the same tenor. In Vancoh Realty Co., 33 B. T. A. 918, 926, we quoted the regulation and30 considered it to require allowance of deduction both for bad debt and loss between fair market value and face value of obligations applied to mortgage purchase. We have held that the Midland Mutual case does not preclude inquiry as to the fair market value of the property foreclosed. West Production Co., supra;Huey & Philp Hardware Co., 40 B. T. A. 781. We therefore hold that the regulation must be applied here, and proceed to ascertain loss or gain to the mortgagees accordingly.We have above held the mortgagees to have received income to the extent of accrued interest bid. The regulation provides clearly for gain or loss of the difference between fair market value of the property and the amount of obligations applied to purchase or bid price "(to the extent that such obligations constitute capital or represent an item the income from which has been returned by him)." The face amount of such obligations bid herein was $ 435,000, but they constituted, as to the petitioner's share, capital of only $ 155,721.05, the stipulated adjusted cost basis of petitioner's interest in the principal amount of the notes. With reference31 to such base, Regulations 77, article 193, says: "Accrued interest may be included as part of the deduction only when it has previously been returned as income." Only the original cost base may be deducted. We hold that there was gain or loss to the petitioner of the difference between such $ 155,721.05 and the fair market value of petitioner's interest in the property. Considering all of the evidence, we conclude and hold that the petitioner's interest in the property had, on the date of sale, a value of $ 133,405.35, the value ascribed to it by 338 the petitioner in his return filed March 15, 1934. The petitioner was in the business of real estate.The question then arises as to whether the loss (thus ascertained) is capital or ordinary, under section 101 (c) (2), Revenue Act of 1932. I. T. 3121, supra, calls it a capital loss, as does I. T. 3159, C. B. 1938-1, p. 188. The respondent, in his contention that the gain computed by him is ordinary, relies on Bingham v. Commissioner, 105 Fed. (2d) 971. John H. S. Lee, 42 B. T. A. 920; and Joseph A. Guthrie, 42 B. T. A. 696.32 Those cases did not involve mortgage foreclosure, the Bingham and Lee cases involving compromises and surrender of property for cancellation of obligations prior to foreclosure sale, and the Guthrie case collection of an undivided interest purchased in an estate, upon distribution by the executor after sale of the property. No case squarely applicable is cited and we find none.We think the effect of Regulations 77, article 193, so far as concerns the gain or loss there allowed, contemplates capital gain or loss. The property has been acquired through the application of capital upon purchase price, and in that sense an exchange of capital assets has taken place. The apparent intent and the effect of the regulation is to permit adjustment of base in the taxable year when foreclosure takes place. We hold that the petitioner's loss is capital and limited under section 117 (a) (2) of the Revenue Act of 1932, to capital gains.Decision will be entered under Rule 50. SMITH; TURNER Smith, J., dissenting: In his income tax return for 1933 the petitioner reported a net loss of $ 10,784.07. In the determination of the deficiency the respondent has found an adjusted 33 net income of $ 152,896.78 and an income tax liability of $ 62,969.87. Contributing to the adjusted net income are the following amounts, all of which are in issue in this proceeding:(a) Net loss disallowed$ 22,410.36(b) Accrued interest (added)89,809.68(c) Bonus (added)30,785.85(d) Profit on foreclosure (added)18,731.00Total161,736.89All of the amounts in issue stem from the foreclosure sale of land of the Lagoona Beach Co., which was bid in by an agent for the mortgagees at a price of $ 435,000. The Court sustains the petitioner's contention with respect to items (c) and (d), above. It admits that the petitioner did sustain a net loss of $ 22,410.36 but finds that the 339 deductible net loss must be limited by section 117 (a) (2) of the Revenue Act of 1932. With this conclusion I am in accord. I am not, however, in accord that the correct amount of the net loss was $ 22,410.36, as more fully explained below. The Court also reduces the accrued interest to be added to the petitioner's net income from $ 89,809.68 to $ 86,389.03, which is 68.413 percent of the accrued interest included in the Court's decree of $ 126,275.75.The Court finds that34 the fair market value of the petitioner's interest in the real estate acquired at the foreclosure sale was $ 133,405.35. I think that the amount was much less. To prove his case the petitioner introduced in evidence the testimony of three expert real estate men who gave their opinion as to the fair market value of the entire property at the date of the foreclosure sale. The highest appraised value given by any witness was $ 105,000. The petitioner contends, and I think correctly, that the fair market value of the property was not in excess of $ 105,000, 68.413 percent of which is $ 71,833.65. The petitioner, therefore, contends that the actual loss sustained by him upon the transaction was the difference between $ 71,833.65 and the stipulated cost of his interest in the mortgage notes, $ 155,721.05, or $ 83,887.40. There was no countervailing evidence as to the fair market value of the land. I think, therefore, that the net loss was actually $ 83,887.40.In its opinion the Court states that the high bid price made by the agent for the mortgagees at the foreclosure sale, namely, $ 435,000, "indicates intent to prevent anyone else from securing the property at a price less than35 the investment therein. It thus appears that the mortgagees agreed, in substance, not to let anyone else acquire the property for less than the indebtedness, including the interest. That there was only one bid proves little or nothing. The mortgagees' high bid may have been the opening bid, made at once, precluding even a slightly less offer by any other bidder." As a Judge of the Court who heard the witnesses in this case I emphatically dissent from this view. There is not a particle of evidence to support it. At the hearing of this proceeding the petitioner testified as follows:A. I thought the property was then worth about two hundred thousand dollars, to have bid and your idea of the net value of the property?A. I thought the property was then worth about two hundred thousand dollars. I think I was very optimistic, because the first time we tried to sell it after then, which was in 1934, we authorized the sale at one hundred fifty thousand dollars and the man thought he had a propspect but wasn't able to move it.Q. You told us now what your thought was about the market value of the property. I am asking you what influenced your conception of the market value of the property? 36 Was it the amount of the bid?A. No connection at all.Q. Can you tell me what consideration was given in connection with the fixing of the bid to possibilities of redemption?A. We didn't consider it.340 Q. You understand what the term redemption means?A. Yes, somebody comes in and pays us. That wasn't in the picture.Q. What can you tell us about a consideration given at that time to a deficiency judgment?A. Oh, no thought of it at all.Q. Why not?A. Other creditors had not been able to collect anything. What could we collect?Q. Hopeless?A. Hopeless, certainly. There was no chance. The only thing we looked to was the land.The argument of the attorney for the petitioner in his brief is that the Lagoona Beach Co. notes had no value in excess of the value of the land and that the bid price of $ 435,000 was made with the full knowledge on the part of the mortgagees that the notes could be surrendered in payment of the bid price. The evidence is to the effect that this was done and that no cash was paid in on the bid price.All of the evidence goes to show that the Lagoona Beach Co. notes had no value in excess of the value of the land which secured them; also that37 there was no probability that the defunct Lagoona Beach Co. or parties in interest would ever redeem the property at a price in excess of its value. It was immaterial to the petitioner and his associates whether the property was bid in at its fair market value or at an amount in excess of that value which could be paid by the surrender of the notes.The only argument of the respondent upon this point is that it was immaterial what the fair market value of the property was at the time of the foreclosure sale. His argument is that the petitioner and his associates bid $ 435,000 for the property and that that amount must be accepted as its fair market value. The Court has not sustained the respondent's contention upon this point. It has found the fair market value of the land to be $ 200,000 at the time of the foreclosure sale and that the petitioner's proportionate part of that fair market value is $ 133,405.35.We have then this situation: The petitioner sustained a loss upon the foreclosure transaction. Yet this Court holds that the petitioner derived taxable income from the transaction represented by accrued interest in the amount of $ 86,389.03.This result gives me much puzzlement. 38 Without the receipt of any money or of any property equaling the petitioner's investment in the mortgage notes, the petitioner is held liable to income tax upon a large amount of accrued interest which he did not receive. In the words of Nicodemus, "How can these things be?"The incidence of the income tax is upon "gains, profits, and income." Without any gain or profit and without the receipt of anything that has the semblance of income, how can it be said that a man 341 has received taxable gain? Is a man taxable upon a transaction which results in a loss? The taxpayer made his return upon the cash basis. In Avery v. Commissioner, 292 U.S. 210">292 U.S. 210, it was held that a shareholder's dividends were received in the calendar year in which the shareholder received his check. In that case it was stated as a fact that the shareholder kept his accounts on the cash receipts and disbursements basis. The Supreme Court held that if we give the words of the statute, section 201 (e) of the Revenue Act of 1921, their ordinary meaning, "clearly the dividends under consideration were not actually received by the taxpayer during 1924 and 1929 * * And, 39 unless Congress has definitely indicated an intention that the words should be construed otherwise, we must apply them according to their usual acceptation."By many decisions of the Supreme Court we are told that questions involving income tax liability should be construed according to truth and substance and not mere form. The income tax is imposed upon true gains. The amount taken as a tax is simply a portion of the amount of the income received.In this case the petitioner is not paying tax upon any amount received. In truth and substance the petitioner was no richer after the foreclosure sale than he was before. He did not receive the wherewithal to pay the tax which this Court finds to be due. The conclusion of the Court seems to me to lack the touch of reality. It is contrary to fact.Were it not for the decision of the Supreme Court in Helvering v. Midland Mutual Life Insurance Co., 300 U.S. 216">300 U.S. 216, the deficiency in income tax determined by the Commissioner would at most be nominal. Indeed, but for that opinion it is probable that the respondent would not have determined a deficiency to be due from the petitioner. That case involved 40 the question of whether a life insurance company, which is taxable under entirely different provisions of the income tax law from other corporations or individuals, was taxable upon interest which was paid by a credit against the purchase price of property bid in by a mortgagee on a foreclosure sale. The Court did not know what the fair market value of that property was. It expressly stated that there was no evidence as to the fair market value of the property before it.I am unable to understand the soundness of the application of the Supreme Court's opinion in the above cited case to the present. In Hadley Falls Trust Co. v. United States, 110 Fed. (2d) 887, the Circuit Court of Appeals for the First Circuit, referring to Helvering v. Midland Mutual Life Insurance Co., supra, said: "Although the language of the court is very broad, we can not believe that it was intended to preclude examination into the fair market value of property under all circumstances, especially in a case where the agency 342 required to engage in the process of valuation, viz., the Treasury Department, has itself been responsible41 for the rule making valuation necessary." In that case the court took a common sense view of the matter and decided the issue for the taxpayer. In my opinion that is what this Court should do in this case and not force the taxpayer to bear the expense of an appeal.The Court finds that article 193 of Regulations 77 is applicable to this proceeding. That regulation provides that "If the creditor subsequently sells the property so acquired, the basis for determining gain or loss is the fair market value of the property at the date of acquisition." It thus appears that upon a subsequent sale of the property purchased at the foreclosure sale the basis for the computation of gain or loss is $ 133,405.35. The petitioner will, therefore, never be permitted to include as a part of the basis upon the sale of the property the accrued interest of $ 86,389.03 which the Court holds is taxable income to this petitioner for 1933. It seems to me plain that the Congress never intended such a result.Turner, J., dissenting: There is little doubt that it would be impossible to convince the man on the street that gain has been realized by a mortgagee through his acquisition of mortgaged property42 at a foreclosure sale where the fair market value of the property at the time of such acquisition is substantially less than his investment in the mortgage and the mortgage notes. The Supreme Court said in Farmers Loan & Trust Co. v. State of Minnesota, 280 U.S. 204">280 U.S. 204, that "Taxation is an intensely practical matter and laws in respect of it should be construed and applied with a view of avoiding, so far as possible, unjust and oppressive consequences." Were there nothing further in the books, we might well conclude that article 193, supra, is a reasonable interpretation of the statute and that the sale of mortgaged property and the satisfaction of the mortgage claim by credit of the selling price thereto are to be ignored and the transaction, for income tax purposes, treated only as an exchange of the mortgage claim for the real estate. In Helvering v. Midland Mutual Life Insurance Co., 300 U.S. 216">300 U.S. 216, however, the Supreme Court has held that where mortgaged property is sold under foreclosure, even though to the mortgagee, and the mortgage claim is satisfied by credit of the purchase price thereto, such sale 43 and credit may not be ignored but must be given full legal effect in determining the income tax consequences to the mortgagee. The Court said:* * * A mortgagee who, at foreclosure sale, acquires the property pursuant to a bid of the principal and accrued interest is, as purchaser and grantee, in a position no different from that of a stranger who acquires the property on a bid of like amount. It is true that the latter would be obliged to pay 343 in cash the amount of his bid, while the formality of payment in cash is ordinarily dispensed with when the mortgagee acquires the property on his own bid. But the rights acquired qua purchaser are the same in either case; and, likewise, the legal effect upon the mortgage debt is the same. In each case the debt, including the interest accrued, is paid. Where the stranger makes the purchase, the debt is discharged by a payment in cash; where the mortgagee purchases the property, the debt is discharged by means of a credit. * In the instant case, however, it is held that Midland Mutual Life Insurance Co. is controlling as to interest but not as to the debt itself. Such a holding is, in my opinion, wholly untenable. 44 Not only is there nothing in the above pronouncements by the Supreme Court which would permit recognition of the sale and credit of the selling price to the mortgage claim only so far as such sale and credit effected the payment of interest, but, to the contrary, the Court plainly and pointedly said, "In each case the debt, including the interest, is paid."Furthermore, I am unable to find in article 193, supra, any statement or even the suggestion of a thought which gives any support to the straddle taken by the majority on the issues in this case. The effect of the regulation is to ignore the foreclosure sale and the satisfaction of the mortgage claim by a credit thereto of the proceeds of the sale and to treat the occurrences as an exchange by the mortgagee of his mortgage claim for the property. See Hadley Falls Trust Co. v. United States, 110 Fed. (2d) 887. That so much of the mortgage claim as represents interest is not to be dealt with separately is shown by the regulation itself by specifically excluding from the computation, in case of loss on the exchange, accrued interest not reported as income, the inference clearly being that otherwise45 the interest features of the mortgage claim are confined within the bounds of the exchange. Either under Midland Mutual Life Insurance Co. there is collection of the debt and the interest thereon to the extent of the proceeds of the sale of the mortgaged property, or, applying the regulation, there is an exchange of property for property, the gain or loss being measured by the difference between the fair market value of the property received and the cost or other basis of the mortgage claim exchanged therefor. Logic and reason require one conclusion or the other; there can be no justification for application of the regulation to one part and Midland Mutual Life Insurance Co. to another part of the same transaction.Hadley Falls Trust Co. v. United States, supra, it seems to me, presents the strongest possible case for application of the regulation. Analyzing the practical results of the purchase by a mortgagee of the mortgaged property at the foreclosure sale, the court justified the treatment of the transaction as an exchange of the property for property as distinguished from the ordinary purchase of property, and concluded that the regulation46 "cannot be held a plain misinterpretation 344 of a clear, unambiguous provision of the statute." The court had already pointed out that the regulation had continued in the same form since it was promulgated under the Revenue Act of 1926, and, if a reasonable interpretation of the statute, it must, under Helvering v. Reynolds Co., 306 U.S. 110">306 U.S. 110, and other cases of the same import, be given the same force and effect as if it were a part of the statute itself. Though it recognized that the regulation and the pronouncements of the Supreme Court in Midland Mutual Life Insurance Co. were in conflict and could not be reconciled, the court further justified its application of the regulation on the ground that the Supreme Court did not have the regulation before it in the case mentioned and did not therefore pass upon its soundness or validity.While it is true that this tribunal and other courts in seeking the answer to questions otherwise difficult have often fallen back on the proposition that the repeated reenactment of a statute without substantial change amounts to legislative approval of a regulation of long standing, they have on numerous47 other occasions rejected regulations equally venerable on the theory that they did not present a reasonable interpretation or application of the statute, and in some instances, even the existence of a regulation has been ignored. In other words, where the regulation and the tax year are concurrent and the regulation is found to be a reasonable interpretation of the statute or principle of law involved, it is applied and the pronouncements argued for by the petitioner as to the force and effect of a regulation of long standing are very solemnly declared; but where the courts have felt that the regulation was not a reasonable interpretation of the statute or the principle of law involved, it has just as positively been overruled, whether hoary with age or of recent promulgation.With all due respect to the court in Hadley Falls Trust Co. in its efforts to find some justification for the application of a practical rule. I am unable to see that the Supreme Court in any manner limited its pronouncement of the law with respect to the satisfaction of a mortgage claim through the sale of the mortgaged property and the crediting of the proceeds therefrom. If I am correct in this view, 48 it is not within the province of this Court to give effect to any regulation promulgated by the respondent, whether practical or impractical or new or old, if contrary to the law so declared. It is my opinion therefore that the Supreme Court has precluded us from applying the regulation in question, and unless and until the Supreme Court itself, or Congress by specific legislation, indicates some other measure for determining gain or loss in transactions such as we are here concerned with, we have no alternative but to 345 apply the rule laid down in Helvering v. Midland Mutual Life Insurance Co., supra.It may well be that, regardless of the correct rule in the instant case, application of the regulation in T. Eugene Piper, supra, was justified even though in apparent conflict with Midland Mutual Life Insurance Co., since that case was governed by the installment sales provisions of the act wherein the Commissioner was specifically directed to promulgate regulations for the computing and reporting of income and losses on installment sales obligations. Be that as it may, that case is no less contradictory*49 in its treatment of interest and principal than the instant case.For the reasons stated, I respectfully note my dissent. Footnotes1. Art. 193. Uncollectible deficiency upon sale of mortgaged or pledged property. -- Where mortgaged or pledged property is lawfully sold (whether to the creditor or another purchaser) for less than the amount of the debt, and the mortgagee or pledgee ascertains that the portion of the indebtedness remaining unsatisfied after such sale is wholly or partially uncollectible, and charges it off, he may deduct such amount (to the extent that it constitutes capital or represents an item the income from which has been returned by him) as a bad debt for the taxable year in which it is ascertained to be wholly or partially worthless and charged off. In addition, where the creditor buys in the mortgaged or pledged property, loss or gain is realized measured by the difference between the amount of those obligations of the debtor which are applied to the purchase or bid price of the property (to the extent that such obligations constitute capital or represent an item the income from which has been returned by him) and the fair market value of the property. The fair market value of the property shall be presumed to be the amount for which it is bid in by the taxpayer in the absence of clear and convincing proof to the contrary. If the creditor subsequently sells the property so acquired, the basis for determining gain or loss is the fair market value of the property at the date of acquistion.Accrued interest may be included as part of the deduction only when it has previously been returned as income.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621456/	Wellman Operating Corporation, Petitioner, v. Commissioner of Internal Revenue, RespondentWellman Operating Corp. v. CommissionerDocket No. 63326United States Tax Court33 T.C. 162; 1959 U.S. Tax Ct. LEXIS 47; October 30, 1959, Filed 47 Decision will be entered for the respondent. Held, petitioner was availed of during the taxable years for the purpose of preventing imposition of surtax upon its shareholders by permitting earnings and profits to accumulate instead of being divided or distributed. Sec. 102, I.R.C. 1939. Mark M. Horblit, Esq., for the petitioner.William T. Holloran, Esq., for the respondent. Raum, Judge. RAUM162 The Commissioner determined deficiencies in petitioner's income tax for the years indicated, as follows:Fiscal year ended --AmountFeb. 28, 1951$ 31,231.08Feb. 29, 195213,807.27Feb. 28, 195311,729.39The principal issue is whether petitioner is subject to tax under section 102, I.R.C. 1939, as having been availed of during the years in question for the purpose of preventing the imposition of surtax upon its shareholders by permitting earnings and profits to accumulate instead of being divided or distributed.FINDINGS OF FACT.Certain facts have been stipulated and are incorporated herein by reference.Petitioner, a Delaware corporation with principal offices in New York City, filed corporation income tax returns for the fiscal years ending February 28, 1951, and February 29, 1952, with the collector 48 of internal revenue for the second district of New York; its return for the fiscal year ended February 28, 1953, was filed with the director of internal revenue for the district of Lower Manhattan, New York.Petitioner was incorporated on February 27, 1942, under the name Automatic Brake Control, Inc. Its name was changed to Aircraft Production Corporation on November 4, 1942.In 1943, Floyd W. Jefferson, Sr. (hereinafter sometimes referred to as Jefferson), learned that petitioner was available to be "taken over." He had no previous connection with petitioner, but was looking for a corporate shell to engage in real estate activities and in the business of rendering textile engineering and advisory services. Jefferson, then 64 years of age, had been engaged in business since 1902. Since 1927, he had been a partner in the firm of Iselin-Jefferson Company, a widely known textile commission house acting as selling agent and factor for textile mills; Iselin-Jefferson also lent money to textile mills, invested in and controlled textile mills, and, 163 at least as late as 1943, rendered engineering services to the mills which it controlled.Jefferson "took over" petitioner on or about June 49 29, 1943, when petitioner's name was changed from Aircraft Production Corporation to Wellman Operating Corporation, and the following officers and directors were elected: James W. Cox, president and director; Jefferson, treasurer and director; Marjorie B. Jefferson (Jefferson's wife), vice president and director; Courtland Palmer, secretary and director; Floyd W. Jefferson, Jr., director; Eugenia Bialek, assistant secretary; Edith Clemente, assistant treasurer.Cox was known to Jefferson as an engineer specializing in textile machinery and having technical and practical knowledge as an operator of textile mills. Since 1933, he had been employed by Iselin-Jefferson, doing agency management and engineering work in the mills which it owned or controlled. When Cox left the employ of Iselin-Jefferson to assume the presidency of petitioner, he also went in business for himself as a textile engineer, and opened an office at 40 Worth Street, New York City; he worked for petitioner only part time until November 1956 when his employment became full time.Edith Clemente was Jefferson's personal secretary at Iselin-Jefferson, and Courtland Palmer was a person active in the organization and incorporation 50 of petitioner in 1942.At a meeting of petitioner's board of directors on June 29, 1943, resolutions were adopted that petitioner purchase from Jefferson, for shares of its no-par common stock at the stated value of $ 100 per share, (a) a 14-story apartment building located at No. 1 E. 88th Street, New York City; and (b) certain scheduled securities theretofore held by Jefferson in his portfolio.Jefferson had purchased the aforementioned apartment building from Bankers Trust Company shortly prior to June 29, 1943; he had been a tenant in the building since 1941, occupying an apartment comprised of the three top floors and penthouse. Prior to transfer of the building to petitioner, Jefferson paid an $ 80,000 purchase money mortgage then outstanding as a first lien on the property. As of May 4, 1943, the apartment building was operating at an annual deficit of approximately $ 3,000.By February 20, 1944, Jefferson had completed the transfer of the scheduled securities and apartment building, at the cost basis thereof to him, for shares of petitioner's common stock, as follows:Petitioner'sItemBasis to Jeffersonshares issuedSecurities151 $ 211,328.502,102Building102,498.871,024Total313,827.373,126164 After the transfer of the apartment building, until March 1, 1950, when it was sold, petitioner "occupied" the penthouse and Jefferson continued to rent the top three floors, as he had done prior to purchase from the Bankers Trust Company. At times Jefferson used the penthouse for his personal convenience. Petitioner held some board of directors meetings in the penthouse, but most of its meetings were held in Jefferson's private office at 90 Worth Street, New York City, the building occupied by Iselin-Jefferson. Some of petitioner's activities were conducted from Cox's private office to which petitioner's records were moved after the sale of the apartment building. Petitioner had no full-time employees before or during the years in question, and, as described below, the nature of its activities was such that petitioner did not need an office of its own.Except for 3 shares temporarily allocated to Courtland Palmer, Jefferson was petitioner's sole stockholder at all times prior to May 9, 1950; as of 52 that date, his holdings of petitioner's stock had increased to 3,187 shares in part as the result of (a) the assignment to him on or about December 13, 1943, of 3 shares theretofore allocated to Palmer and (b) the issuance to him in February 1945 of 48 shares in exchange for his transfer to petitioner of 242 shares of Fitzgerald Cotton Mills preferred stock. On May 9, 1950, Jefferson sold 1,000 shares of petitioner's stock to Fitzgerald Cotton Mills. Jefferson and/or his family owned 100 per cent of the common stock of Fitzgerald Cotton Mills. Thereafter, and during the taxable years in question, Jefferson owned 2,187 shares of petitioner's stock and Fitzgerald Cotton Mills owned the remaining 1,000 shares.As of June 25, 1943, the fair market value of the securities subsequently transferred to petitioner by Jefferson was approximately $ 205,000. Of these securities, all were sold in 1943 and 1944 except (a) a block of shares in Exposition Cotton Mills, valued at $ 64,600 on June 25, 1943, which was sold on January 2, 1946, and (b) certain shares of Package Machinery Co. and Alabama Mills, Inc., valued respectively at $ 4,000 and $ 1,000 on June 25, 1943, which petitioner continued 53 to hold through the taxable years in question. Most of the securities sold by petitioner in 1943 and 1944 were unrelated to the textile business.Petitioner's activities before and during the years in question may, for convenience, be grouped in four principal categories: (a) Investments, loans, and related engineering and managerial services; (b) activities relating to purchase of a textile mill; (c) real estate activities; and (d) merchandising. Responsibility for the conduct of petitioner's affairs was divided among the officers of petitioner roughly according to these categories. Jefferson took charge of investments, loans, and securing related engineering contracts; Cox 165 concentrated on providing the engineering services pursuant to the aforementioned contracts; both Jefferson and Cox investigated the possible purchase of a textile mill; Jefferson and his wife handled most of petitioner's real estate activities; and Jefferson's son, Floyd, Jr., supervised merchandising.Investments, loans, and related engineering contracts. -- Shortly after June 29, 1943, petitioner began rendering engineering, supervisory, and industrial services to textile manufacturers. The mills serviced 54 by petitioner were primarily "small and medium" in size, since most large mills have engineering staffs of their own. Cox visited the respective mills serviced by petitioner at intervals of from 6 weeks to 2 1/2 months. On each visit, Cox inspected the several departments of the mill and, shortly thereafter, submitted a written report on the operation and condition thereof, together with his comments and recommendations, copies of which reports were furnished by petitioner to the mill serviced. Beginning in 1950, Cox occasionally hired an outside assistant to help in such work.Since June 29, 1943, petitioner has received fees in the following amounts for its engineering and advisory services:Fiscal year ended --FeesFeb. 29, 1944$ 14,500.02Feb. 28, 194576,666.70Feb. 28, 194661,749.97Feb. 28, 1947107,000.00Feb. 29, 194829,666.94Feb. 28, 194932,402.51Feb. 28, 195031,495.05Feb. 28, 195138,990.74Feb. 29, 195239,012.77Feb. 28, 195340,695.63Feb. 28, 195434,691.59Feb. 28, 195535,963.29Feb. 29, 195643,578.11Feb. 28, 195748,006.49At the meeting of petitioner's board of directors on June 29, 1943, Jefferson stated that Conestogo Cotton Mills of Lancaster, Pennsylvania, and Fitzgerald Cotton 55 Mills, referred to above, would be receptive to an offer by petitioner of its engineering services. Accordingly, it was resolved that petitioner offer its services to Conestogo Cotton Mills for a minimum fee of $ 5,000 per year, plus a further sum, to be agreed upon, which would represent "a percentage of the amount of business furnished the Conestogo Cotton Mills, Inc. and/or amount of monies saved them in their operations." It was also resolved that petitioner offer its services to Fitzgerald Cotton Mills for a fee of $ 24,000 per year payable monthly. Payments from both mills were to commence October 1, 1943.Of the $ 107,000 in engineering fees received by petitioner in the fiscal year ended February 28, 1947, $ 80,000 represented a payment received from Conestogo in that year; the abnormal size of the payment is explained by a restrictive clause in the contract with 166 Conestogo which obligated petitioner to render certain services over a period of time before the fees attributable to those services would be paid out by Conestogo.Prior to June 29, 1943, Jefferson owned an interest in an offer which had been made to the bondholders and noteholders of Conestogo to purchase their 56 bonds and notes. On June 29, 1943, petitioner offered to purchase Jefferson's interest in this offer, but neither petitioner nor Jefferson ever in fact acquired an interest in Conestogo.Commencing September 1, 1943, and ending January 31, 1945, petitioner received payments of $ 2,000 per month from Fitzgerald Cotton Mills, the stock of which was wholly owned by the Jefferson family. Commencing February 1, 1945, and during the years under review, the payments of $ 2,000 per month were received from Fitzgerald Mills Corporation, a corporation created in December 1944 to take over the physical assets of Fitzgerald Cotton Mills and carry on its manufacturing activities. Floyd Jefferson, Jr., was president of Fitzgerald Mills Corporation. Petitioner did not own any stock in Fitzgerald Cotton Mills prior to February 1945 when it acquired 242 shares of that corporation's preferred stock from Jefferson in exchange for 48 shares of its own stock. When Fitzgerald Mills Corporation was formed, however, petitioner subscribed and paid for 2,750 shares (55 per cent) of its stock at a cost of $ 27,500. On December 3, 1946, petitioner purchased 1,500 shares of the preferred stock of Fitzgerald 57 Mills Corporation for $ 75,000. At the time, Jefferson knew that Fitzgerald Mills Corporation was considering retiring a portion of its outstanding preferred stock at a premium and thought that acquisition of such stock prior to redemption would result in a "good deal" for petitioner. Fitzgerald Mills Corporation subsequently redeemed the 1,500 shares of preferred stock held by petitioner, as follows:Petitioner'sNumber of sharescapital gainDateredeemedon redemptionDec. 11, 19467501 July 28, 1947250$ 13,750Mar. 4, 19491608,800Mar. 7, 1950231,265Feb. 27, 19511256,875Feb. 25, 19521116,105Feb. 2, 1953814,455Total1,500Prior to February 1945, petitioner had received the amount of $ 16,000 in fees for engineering services rendered to the Barret Textile Corporation, operator of mills in Massachusetts. On January 167 19, 1945, petitioner entered into a new 1-year contract with Barret pursuant to which Barret paid fees to petitioner in the amount of $ 500 per month. Neither Jefferson nor petitioner ever owned an interest in Barret.As of February 28, 1951, petitioner held shares of stock in the following corporations:Basis toCorporationShares heldpetitionerAlabama Mills, Inc450 common$ 1,134.00Woodside Mills6,000 common45,002.23Package Machinery Co230 common5,750.00Iselin-Jefferson Co., Inc12,500 common125,000.00Exposition Cotton Mills90 common2,115.00Fitzgerald Mills Corporation2,750 common27,500.00Fitzgerald Mills Corporation192 preferred9,600.00Fitzgerald Cotton Mills242 preferred4,840.00220,941.23With 58 the exception of Package Machinery Co., all of the above-listed corporations were engaged in some aspect of the textile business. Package Machinery had no relation to the textile business, nor to any business activity in which petitioner engaged; Jefferson served on the board of directors of Package Machinery Co., his brother was president and chairman of the board, and the Jefferson family held a "good deal" of stock in the corporation.The 12,500 shares of Iselin-Jefferson stock were purchased by petitioner from Jefferson for $ 125,000 on or about July 8, 1946, following the incorporation of the partnership on July 1, 1946. It had been decided to incorporate Iselin-Jefferson in late 1945 or early 1946; at that time Jefferson had a 40 per cent interest in the partnership and Floyd Jefferson, Jr., was also a partner. Jefferson wanted his family to have "an equal amount of stock with the Iselin family." Under the terms of the incorporation, Iselin-Jefferson voting stock could be issued only to partners. On January 8, 1946, petitioner advanced $ 150,000 to Jefferson in return for Jefferson's 6-month note for $ 150,000, bearing interest at 3 per cent. On July 1, 1946, Jefferson received 59 an undisclosed number of shares (but more than 12,500) of the voting stock of Iselin-Jefferson. On July 8, 1946, he transferred 12,500 of his Iselin-Jefferson shares to petitioner for $ 10 per share, or a total purchase price of $ 125,000 which was offset against the face amount of Jefferson's note ($ 150,000). The record does not reveal the manner in which Jefferson paid the remaining $ 25,000 due on his note.Except for the aforementioned loan to Jefferson in connection with the purchase of Iselin-Jefferson stock, petitioner has never lent any money to Jefferson, his wife, or son.168 Subsequent to the incorporation of Iselin-Jefferson, Jefferson served as its president and later as cochairman of its board of directors. Floyd, Jr., assumed the presidency of Iselin-Jefferson when his father became cochairman of the board. A voting trust was created on or about November 15, 1947, for a period of 10 years whereby Jefferson, Floyd, Jr., and an attorney named John M. P. Thatcher were empowered to vote the Iselin-Jefferson stock then owned by petitioner, Fitzgerald Cotton Mills, Jefferson, his wife, and Floyd, Jr. The record does not reveal when or in what manner Fitzgerald Cotton Mills 60 and Jefferson's wife became stockholders of Iselin-Jefferson.Petitioner purchased 1,500 shares of Woodside Mills from certain minority shareholders on November 4, 1948. These shares increased to 6,000 by February 28, 1951, as the result of an intervening 2-for-1 stock split and a 100 per cent stock dividend declared by Woodside Mills. Woodside Mills was a South Carolina corporation operating five textile mills. Iselin-Jefferson owned the majority of Woodside Mills' outstanding common stock and served as its selling agent.The 90 shares of stock in Exposition Cotton Mills were acquired by petitioner subsequent to January 2, 1946, the date that petitioner disposed of the stock in that company previously transferred to it by Jefferson.Although 61 petitioner held stock in Alabama Mills, Woodside Mills, and Exposition Cotton Mills, it neither rendered engineering services to, nor received engineering fees from, any of these corporations. As explained below, although petitioner did receive certain fees from Iselin-Jefferson, such fees were for services rendered to other corporations employing Iselin-Jefferson as sales agent and were paid by Iselin-Jefferson purely as a matter of business convenience.In addition to its investments in the stocks of companies engaged in the textile business, petitioner also made loans to textile mills or to corporations controlling textile mills. It was petitioner's "established policy" to make no loan to any company unless such company agreed to execute a contract for engineering and managerial services to be supplied by petitioner at a fee. The fee to be paid by the borrowing company was in addition to the interest charged by petitioner on its loan.In January 1950 petitioner made a loan of $ 95,000 to the Ferro Co Corporation of Brooklyn, New York, to aid that company in financing acquisition of a controlling stock interest in the Rhodes-Rhyne Manufacturing Company of Lincolnton, North Carolina. 62 The loan 169 bore interest at 3 per cent per year, was amortizable at the rate of $ 15,000 per year starting December 1950, and was secured by the stock of Rhodes-Rhyne. The stock of Ferro Co was owned by Kenneth Carroad, a New York attorney, and his wife. Originally, Carroad approached Iselin-Jefferson for a loan but, for reasons undisclosed by the record, the executive committee of Iselin-Jefferson was "unwilling" to make the requested advances. Iselin-Jefferson, however, was interested in reacquiring the selling agency for the Rhodes-Rhyne Mill which it had lost in 1946 following a change in ownership of the mill. The problem was worked out as follows: Petitioner agreed to advance the necessary funds to Ferro Co; Iselin-Jefferson was appointed exclusive selling agent for the Rhodes-Rhyne Mill; petitioner was "selected to take over the management of the mill"; and Iselin-Jefferson agreed to pay petitioner, as compensation for managerial and engineering services to be rendered to Rhodes-Rhyne, 1 per cent of the net billings on sales made by Iselin-Jefferson for the Rhodes-Rhyne account. The selling commissions charged to Rhodes-Rhyne by Iselin-Jefferson were "a little higher than 63 average" in view of Iselin-Jefferson's obligation to pay a percentage thereof to petitioner.As of July 2, 1951, the cotton textile industry was in a depressed condition and mills were either running short time or shut down completely. Consequently, Cox became "convinced that there was no use interviewing mills, at the present time, in regard to making loans to mills." Petitioner's minutes show that the depressed state of the industry continued during 1951, 1952, and as late as 1954.In October 1954, John Clark, president of Locke Cotton Mills, Concord, North Carolina, approached Jefferson concerning a loan. Jefferson advised Clark that petitioner would lend $ 25,000 to Locke "with the understanding" that petitioner would receive a service contract from Locke for $ 5,000 per year, payable quarterly. The ensuing negotiations between petitioner and Locke Cotton Mills culminated on February 25, 1955, when petitioner lent $ 73,875 to Locke, secured by mortgages on Locke's assets. Iselin-Jefferson made identical loans to Locke on the same date and in the same amounts as the loans made by petitioner. In connection with these loans, Iselin-Jefferson was appointed exclusive selling agent 64 for Locke and agreed to pay petitioner, as compensation for managerial and engineering services to be rendered to Locke, one-half of 1 per cent of the net billings on all sales made by Iselin-Jefferson for the Locke account.For a period of approximately a week in December 1955, petitioner considered an investment of approximately $ 260,000 in Spray Cotton Mills, Spray, North Carolina. At the time, petitioner was informed 170 that the Alien Property Custodian was in possession of about 2,600 shares of Spray Mill stock, that bids for the stock were to be taken on January 6, 1956, and that a bid of $ 100 per share might be accepted. Jefferson contacted the majority stockholder of Spray Mills to see if a purchase by petitioner of the aforementioned shares, or a loan to the majority stockholder to enable him to acquire such shares, might result in petitioner being granted a service contract by Spray Mills. Petitioner was primarily interested in the service contract. The deal fell through because petitioner could get no assurance of employment, and not because petitioner lacked the necessary funds or resources.Petitioner also made some smaller short-term loans to persons other than textile 65 mills for which it charged amounts in addition to interest; these additional amounts, termed "advisory fees," were in effect additional interest since petitioner did not render any services in connection therewith. Petitioner made one such loan in the amount of $ 5,000 to Eleanor A. N. McWilliams in February 1949 in order to help her launch a career as a lecturer on style. Another such loan was made on September 16, 1949, in the amount of $ 3,000 to John C. Milne, head of a drapery sales agency doing substantial business with Iselin-Jefferson. An "advisory fee" of $ 20 per month was charged to Allen Snyder, Inc., in connection with a $ 10,000 loan at 2 1/2 per cent interest made in late 1951. On September 14, 1953, petitioner's board of directors authorized Jefferson to conclude negotiations with Page, Page & Page, converters of cotton goods, for a 1-year loan of $ 10,000 at 3 1/2 per cent plus a "fee" of $ 10 per month.Activities relating to purchase of a textile mill. -- In March 1944, Cox was designated to make surveys of any textile mill properties he thought might be an "advantageous purchase" for petitioner. Petitioner was primarily interested in mills that were in distressed 66 circumstances and could be purchased at "bargain" prices. To date, petitioner has never purchased a textile mill.On or about July 2, 1947, Cox had discussions with Fred R. Thomas, president of Superba Mills of Hawkinsville, Georgia, concerning the possible purchase of that mill by petitioner, but Cox considered the price asked by Superba's stockholders to be "unreasonable." On October 9, 1947, Cox reported that in view of the high asking price for the Superba mill, he "did not recommend the purchase of this mill at this time"; however, Cox stated his intention to keep in touch with the situation and report to petitioner's board of directors if "it seemed wise to renew negotiations." As of January 8, 1948, Cox "had not found any good textile property, which he could recommend to the company for investment." On or about July 30, 1948, Cox arranged with the president of Russellville Cotton 171 Mills, of Russellville, Georgia, for that company to pay petitioner a commission if petitioner could negotiate a sale of the Russellville mill. On the same date the minutes of the meeting of petitioner's board of directors recite that "it was decided" to enter the business of "buying and selling 67 cotton mills" and Cox was instructed to "work on the matter." On or about September 30, 1948, Cox and Thomas reached an agreement to the effect that, if petitioner itself did not buy Superba Mills, Superba would pay petitioner a commission for arranging a sale of the mill to another company. On July 10, 1951, Cox reported that the majority stockholders of Superba were asking $ 235,000 for the mill, with arrangements to be made for purchasing inventory; that the mill was a "good buy," if it could be purchased for $ 225,000. However, before Cox had an opportunity to present these figures to petitioner's board of directors, the mill had been sold to B. Snower & Co. of Chicago for $ 250,000, with arrangements for purchase of inventory. Jefferson estimated that the Superba mill would have required additional funds for stocking the mill and for working capital. Petitioner never submitted a purchase offer to Superba, nor did it locate another purchaser. The failure of petitioner to obtain Superba Mills was attributable to factors extraneous to the availability of funds or resources.On or about October 9, 1947, Cox talked with M. S. Dayan, president of the Jennings Cotton Mill, Lumberton, 68 North Carolina, concerning the possible purchase of this mill. Dayan advised Cox that 10,000 spindles of the 15,000 spindles in the mill were for sale at $ 35 per spindle, or a total price of $ 350,000, but that he (Dayan) was then engaged in other negotiations and would not give petitioner an option. Petitioner took the proposition "under advisement" and asked Cox to hold further discussions with Dayan; however, the record is silent as to any further discussions and petitioner never made an offer to purchase the Jennings Mill.On February 14, 1952, petitioner learned that the goodwill, patents, copyrights, and certain other assets of the Palmer Brothers Company, Fitchville, Connecticut, were to be sold at public auction. Jefferson thought petitioner should consider buying these assets with the possibility in mind of manufacturing comfortables, tailored bedspreads, and sheets under the Palmer Brothers label; he thought relevant information might be obtained from J. Reid Johnson, former president of Palmer Brothers, that Cox could be helpful in locating personnel for the operation, that a good labor situation existed in Fitchville, that space could be obtained in the Fitchville plant 69 formerly operated by Palmer Brothers, and that Iselin-Jefferson might be employed as selling agent. Although it was originally 172 estimated that $ 100,000 would be sufficient to purchase the assets offered for sale, it was later determined that substantial additional amounts would be required to rehabilitate the plant. Petitioner did not make an offer for the purchase of Palmer Brothers and did not attend the auction sale.On October 8, 1953, Floyd, Jr., reported that the principal stockholders of the Royston Mill, Royston, Georgia, were interested in selling their stock or the physical assets of the mill, and that "it might be a favorable purchase for Wellman"; he estimated that purchase of the stock and assumption of Royston's obligations would cost "more than $ 500,000," but that a large part of this investment could be quickly recovered through the sale of the mill's inventory. He noted that Royston was then suffering substantial losses because of low prices charged by a competitor for tobacco cloth and that he did not know how the immediate losses could be stopped. Floyd, Jr., was simultaneously engaged in negotiations with David Carmel regarding a long-term management contract 70 for petitioner; Carmel, it was hoped, would purchase a large percentage of the production of Royston Mill. Petitioner never offered to purchase this mill, and it was purchased by the Carmel interests prior to December 4, 1953.At an unspecified time during the period 1950-1952, petitioner learned that the fixed assets of Atco Mills, Atco, Georgia, manufacturer of tobacco cloth, were up for sale. The asking price for the mill was $ 500,000, but Jefferson hoped that the price might come down because the owner was in ill health and anxious to sell. Petitioner never made an offer to purchase the mill; interest in the purchase terminated when its owner died.In September of 1951, Cox was "in touch" with the Crescent Corporation and Samarkand Mills, Inc., Rock Hill, South Carolina, and on September 21, 1951, Cox reported that he had been in "further negotiation" with these companies with regard to purchasing a mill. Some conversations were held on October 26, 1951, but on November 13, 1951, Cox reported "no further progress" in these negotiations; he attempted to contact R. A. Postlethwaite of Samarkand Mills several times prior to November 27, 1951, but Postlethwaite was out of town on 71 each occasion. In January 1952 petitioner was invited to have a representative visit the New York office of Samarkand Mills to see the products of the mill; it was decided that Floyd, Jr., should visit Postlethwaite in this connection. On February 14, 1952, Floyd, Jr., stated that he "expected to make an inspection" of Samarkand's products as soon as he returned from a 2 weeks' vacation, but petitioner's minutes contain no mention of any further dealings with Samarkand. Cox reported on May 26, 1952, that although conditions in the textile industry were depressed, the only 173 mills he found for sale were "very old ones in poor condition and not worth considering irrespective of the price." Petitioner never offered to purchase the Samarkand mill.In about 1951, Jefferson was approached by a person named Swergold who, in association with other individuals, was interested in acquiring control of the Victoria Cotton Mills, Rock Hill, South Carolina, a manufacturer of ginghams; Swergold, representing the Cotra Company, had use for the product of the mill. Jefferson had a long acquaintance with the Victoria mill and its owners, having acted as selling agent therefor. Jefferson caused petitioner 72 to form a syndicate with the Swergold group, but a purchase offer submitted by the syndicate for the fixed assets of the mill was rejected and subsequent negotiations broke down. At the time of trial, Jefferson estimated that about $ 500,000 would have been required to purchase the property, but he did not specify the amount of the purchase offer nor the extent of petitioner's interest therein.During an unidentified period, petitioner considered the possibility of purchasing the Sanders Mill in Mobile, Alabama, which the owner, J. W. Sanders, was very anxious to sell. Sanders was asking as much as $ 500,000 for the mill, but petitioner thought all the assets of the mill, including inventory, might be purchased for $ 300,000. Although an offer at the latter figure was "under consideration" by petitioner, it was not "definitely planned" and the Sanders Mill burned down before petitioner's intentions crystallized further.During the period 1951-1952, Jefferson had discussions with Thomas Tifft, owner of the Tifton Mills, Tifton, Georgia, about 20 miles from Fitzgerald, Georgia. Tifft was asking about $ 500,000 for the fixed assets of Tifton Mills, which price Jefferson considered "out 73 of our range." As a result of Jefferson's contact with Tifft, however, Iselin-Jefferson succeeded in obtaining the selling agency for one of Tifft's other mills, the Piedmont Mill in Atlanta, Georgia. Petitioner never submitted an offer to purchase Tifton Mills.Real estate activities. -- The building at 1 East 88th Street, New York City, was sold to William Zeckendorf of Webb & Knapp on March 1, 1950, for $ 156,350; petitioner's adjusted basis in the building at that time was $ 106,795.80, so that its gain on sale was approximately $ 50,000. During the period of its ownership, 1943-1950, petitioner, through a managing agent, managed and leased the building to a number of tenants, and made structural changes in the first floor at a cost of approximately $ 5,000. Petitioner also considered (a) turning the building into a cooperative apartment building; (b) adding three stories to the height thereof; and (c) converting the duplex apartments into simplex apartments. These possibilities were abandoned prior to November 1949. A 174 switch to operation on a cooperative basis would not have required any financial outlay; the addition of stories and conversion to simplex apartments would 74 have involved substantial expenditures.On December 30, 1943, petitioner purchased a commercial building numbered 325-327 Broadway, New York City, for $ 77,875.16. It continued to own and rent this property to various tenants until February 21, 1946, when the building was sold to Iselin-Jefferson for $ 102,078.81, representing a gain to petitioner in the amount of $ 27,556.55; both purchase and sale were cash transactions. The building at 325-327 Broadway adjoined a building owned by Iselin-Jefferson and, after the aforementioned sale, the combination of buildings was known as 90 Worth Street and was occupied by Iselin-Jefferson and its affiliated companies.In the fall of 1946, Durand Taylor, a promoter and manager of real estate, approached Jefferson with a proposal to raze the buildings at 90 Worth Street and construct, in lieu thereof, a multiple-story building to be named the Iselin-Jefferson building; the project was Taylor's conception. Oliver Iselin, Jefferson's former partner and a major stockholder in Iselin-Jefferson, and Jarvis Cromwell, a person associated with Iselin-Jefferson, participated in the ensuing discussions.As a result of the interest generated by his proposal, 75 Taylor, had an architect draw tentative plans for the building; the ground floor was to be leased to a commercial bank; the center segment, about 50,000 square feet, was to be occupied by the "Iselin-Jefferson group" and the top segment was to be general office space for specific renting. Letters of intent were obtained from certain potential lessees.At the time Taylor estimated that the cost of the building, excluding land, would be about $ 3,000,000; he thought a mortgage loan of $ 2,500,000 might be obtained, and that Jefferson, or interests represented by him, would supply the remaining $ 500,000. Taylor knew that Jefferson was connected with petitioner, and during the conversations, Jefferson indicated that petitioner might participate in the project, but the extent of such participation was never defined in terms of a specific amount or commitment. No specific portion of the aforementioned 50,000 square feet designed for occupancy by the "Iselin-Jefferson group" was ever earmarked for petitioner's use.In early 1947, Taylor and Jefferson held discussions with Frazier Wilde, president of the Connecticut General Life Insurance Company, with respect to financing the project. 76 These discussions were general and exploratory in nature and Wilde was never asked whether his company would advance any specific amount as a mortgage loan; however, Wilde evidenced interest in the project on the basis of the preliminary plans.175 Most of the conversations concerning the project, including those with Wilde, were held in Jefferson's private office at 90 Worth Street, the building occupied by Iselin-Jefferson; some of the conferences with Wilde were held in a hotel.Consideration of the project was dropped as an increasing number of textile firms moved from Worth Street to uptown locations; the movement uptown began in 1945 or 1946 and accelerated in the early 1950's.Taylor also approached Jefferson with offers to sell other commercial buildings in the textile area of downtown New York City, including those listed below, but in each case Jefferson rejected the offer.BuildingOfferingYear of offerpriceJ. P. Stevens Bldg$ 600,0001949 or 1950Smith-Hogg Bldg300,0001947John Wolf Bldg325,0001947Sinclair Oil Bldg550,0001946On November 7, 1944, petitioner purchased the "Main Street" property located on South Main Street, Southampton, Long Island, New York, and renovated the buildings 77 thereon at a total cost, including improvements, of $ 85,299.64. The renovations, which included the conversion of a garage and child's playhouse into dwellings, were supervised by Jefferson's wife. The dwellings on the property were all rented by petitioner as furnished houses or apartments. Some summer months Jefferson and his wife rented the main house, and other summer months they rented "Whitegates," another house on the property; Floyd, Jr., rented the garage apartment during some summer months. At other times, the dwellings were rented to other tenants. Petitioner realized net rental losses from the Main Street property during the taxable years in question, as follows:Fiscal year endingNet rental lossesFeb. 28 --(round figures)1951($ 8,837)1952(15,596)1953(8,812)Petitioner sold the Main Street property on February 6, 1953, at a net gain of $ 13,136.30, which gain was attributable solely to basis adjustments resulting from depreciation deductions taken by petitioner in the amount of $ 27,185.94.On December 29, 1949, petitioner purchased a second Southampton property, the "LaMontaigne Property," from Fitzgerald Cotton Mills and improved it at a total cost of $ 60,239.70. The 78 improvements 176 included conversion of a garage into a dwelling under the supervision of Jefferson's wife. Except for the garage apartment which was rented to Floyd, Jr., for one summer, the dwellings were rented to tenants other than the Jefferson family. Petitioner incurred rental losses on this property during the taxable years in question, as follows:Fiscal year endingNet rental lossesFeb. 28 --(round figures)1951($ 1,244)1952(4,172)1953(2,130) The property was sold in two parcels on July 1, 1953, and September 30, 1954, respectively, at a net gain to petitioner of $ 440; the gain was attributable solely to basis adjustments resulting from depreciation deductions taken by petitioner in the amount of $ 10,889.63.On February 9, 1953, petitioner purchased "Fair Winds," also in Southampton, and added improvements, including furniture and furnishings costing $ 17,826.07, at a total cost of $ 87,502.28; Jefferson's wife supervised the conversion of a garage into living quarters. The Jeffersons lived in the main house during some summer months. At other times the living quarters were rented to various tenants. "Fair Winds" was sold on October 14, 1955, at a net gain to petitioner of 79 $ 3,505.50, which gain was attributable solely to basis adjustments resulting from depreciation deductions taken by petitioner in the amount of $ 13,146.18.The purchase and sale by petitioner of the three Southampton properties were cash transactions, no mortgages being given. Jefferson and his wife personally selected all three properties for purchase by petitioner.On September 28, 1950, petitioner purchased the property located at 17 Sutton Place, New York City, for $ 55,000 and added improvements thereto at a cost of $ 22,085.12. The purchase was for cash, no mortgage being given. Petitioner rented the property to Floyd, Jr., for 6 months when it was purchased by him for $ 80,000 -- $ 10,000 in cash and a mortgage of $ 70,000 maturing in 1962 and payable $ 3,500 per year with annual interest at 4 1/2 per cent. During petitioner's 6 months' ownership of the property, it incurred net rental losses of $ 1,041.81.On October 10, 1953, Jefferson and his wife examined four properties in Greenwich, Connecticut, and were particularly impressed by the S. Vere-Smith property which comprised an area of about 37 acres. It was contemplated that if petitioner purchased the property, it would 80 be able to sell 30 acres to a development company at approximately $ 5,000 per acre; that the "gate-house" at the entrance to the property with 1 acre of land could be sold for about $ 40,000; 177 and that the big house and large garage located on the remaining 6 acres could be rehabilitated, furnished, and rented as dwellings. Negotiations for the S. Vere-Smith property proceeded along two lines. During November 1953 petitioner offered $ 179,500 for the entire property; when its offer was rejected, petitioner entered a further bid of $ 185,000, but this offer was also declined. As an alternative to purchasing the entire property, petitioner offered $ 125,000 for 10 acres which included all the houses on the property; however, surveys subsequently taken failed to show a 10-acre plot satisfactory to Jefferson and, on November 30, 1953, Jefferson called off the negotiations. The owner of the property never disclosed an asking price.On February 9, 1954, petitioner purchased the "Doubling Road" property in Greenwich, Connecticut, for $ 57,000; since that time petitioner has expended $ 78,458 for improvements to the property, including $ 51,250.85 for furniture and furnishings. The property 81 was, and still is, rented part time to the Jeffersons and part time to other tenants. Petitioner still owns the property but has sold off two portions of it -- one portion comprising 3.1 acres for $ 13,272, and another portion to a neighboring owner at $ 4,000 per acre.Merchandising. -- Since as early as 1948, petitioner has engaged in the purchase and sale of textiles, and has realized gross profits (or losses) therefrom, as follows:Fiscal year ending Feb. 28 --Net salesGross profit1948$ 6,019$ 767 1949(1) (1) 1950(2) (2) 19513,4041,498 1952(2) (2) 195362,7748,020 195447,4431,781 19559,757133 195618,602(100)195712117 Purchases of textile merchandise at favorable prices require cash. Petitioner's merchandising activities were carried on under the supervision of Jefferson's son who was in close contact with the textile market. On February 14, 1952, in connection with petitioner's merchandising activities, Jefferson suggested that petitioner enter the business of textile converting, and that they hire John Paul Maynard to manage this business. Petitioner's board of directors accordingly voted to employ Maynard on a part-time basis at $ 5,000 82 per year, plus a bonus if the business proved successful. Maynard was also elected a director and vice president of petitioner. It was decided 178 "that the amount of money to be invested in this enterprise should be limited to $ 100,000, unless authorization was given at a later time by the directors for putting a greater amount of money at risk." It appears from petitioner's tax returns that petitioner paid Maynard $ 5,000 in the fiscal year ended February 28, 1953, $ 4,250 in 1954, nothing in 1955 or 1956, and $ 2,800 in 1957. The gross profit of $ 8,020 from merchandising reported for the fiscal year ended February 28, 1953, resulted primarily from the sale of (a) print cloth purchased from Woodside Mills in May 1952, and (b) sheeting purchased from Bibb Manufacturing Company in June 1952.Petitioner sold jewelry during the years indicated at the following prices and at the profit (or loss) indicated:Fiscal year ending Feb. 28 --Sales priceNet profit (or loss)1951$ 1,320$ 12019525,750(3,000)1953(1) (1) 1954(2) 3001955-1957(1) (1) The $ 3,000 loss in 1952 was incurred upon the sale of a marquise diamond ring acquired by petitioner in May 1944 at 83 a cost of $ 8,750.Subsequent to the taxable years under review, petitioner also engaged in additional areas of business.In November 1956, petitioner purchased for $ 10,000, 50 per cent of the outstanding stock of Alemany & Co., a corporation engaged in the manufacture and sale of jewelry, including museum pieces designed by Salvador Dali, the artist, with whom Alemany & Co. had an exclusive contract; petitioner agreed to lend Alemany & Co. the amount of $ 10,000 at 4 per cent interest for working capital, and a prior note for $ 10,000 lent to Alemany by petitioner was canceled. In June 1957, petitioner decided to advance additional working capital to Alemany & Co. until that company should conclude negotiations for the sale of certain jewelry and designs. On February 11, 1958, petitioner purchased three Dali designs from Alemany & Co. for $ 12,500, the latter company to manufacture jewelry pursuant to the designs and sell it "at a reasonable profit" to petitioner.In 1956, petitioner acquired for $ 11,200 a 40 per cent interest in Andrews & Co., Ltd., a Bermuda corporation representing American textile firms and also engaged in the upholstery, drapery, and furniture business; petitioner 84 has subsequently advanced additional amounts to that company for working capital.In April 1957, petitioner purchased the assets of Waverly Printing Co., Portland, Connecticut, for $ 71,761, including inventory and 179 work in process valued at $ 35,767.85; in addition, petitioner purchased a new press for Waverly in May 1957 at a cost of $ 7,400. Waverly has been operated as a "division" of petitioner.In the fall of 1958 petitioner purchased control of the Gorham Press, South Norwalk, Connecticut. Its total investment in this company is approximately $ 75,000.Petitioner paid no rent and had no full-time officers or employees prior to, or during, the years under review. Salaries paid to officers and employees in the years indicated were as follows:Fiscal year ended Feb. 28 --Officers195119521953James W. Cox$ 10,000.02$ 9,999.96$ 10,000.00William L. Walker2,400.002,400.002,400.00J. H. Mayes100.00100.00100.00Marjorie B. Jefferson100.00100.00100.00John Paul Maynard(1) 208.335,000.01Subtotals12,600.0212,808.2917,600.01Other employees3,420.003,420.003,763.28Totals16,020.0216,228.2921,363.29Walker and Mayes were vice presidents of petitioner during the years in question. Walker 85 served as petitioner's "southern representative," investigating and keeping petitioner informed of possible opportunities in that region. Mayes was also manager of the Fitzgerald Mills Corporation. The "other employees" were mostly associated with petitioner's real estate activities, e.g., caretakers, gardeners, electricians, contractors, etc.Petitioner operated its rental properties at a loss during each of the years in question, as follows:Fiscal year endingNet operating lossFeb. 28 --from rentals1951$ 10,808.58195220,082.79195311,909.72Petitioner's net income and net income after taxes for the years in issue were as follows:Fiscal year ending Feb. 28 --Net incomeNet income after taxes1951$ 133,552.41$ 113,567.56195260,118.6055,523.75195364,420.7155,055.82The following schedule gives a breakdown of the principal sources of petitioner's gross income during the years in issue: 180 Fiscal years ending Feb. 28 --195119521953Dividend Income:Alabama Mills, Inc$ 900.00$ 562.50$ 337.50Exposition Cotton Mills90.0090.00112.50Fitzgerald Cotton Mills2,178.002,178.002,178.00Iselin-Jefferson Co., Inc37,500.0037,500.0025,000.00Package Machinery Co322.00368.00368.00Woodside Mills18,000.0010,700.008,000.00Fitzgerald Mills Corp3,408.341,052.50438.75Total dividend income62,398.3452,451.0036,434.75Income from interest2,250.194,752.844,729.44Rental income13,123.8513,759.8411,624.15Total dividend, interest and rentalincome77,772.3870,963.6852,788.34Income from fees:Fitzgerald Mills24,000.0024,000.0024,000.00Iselin-Jefferson (Rhodes-Rhyne)14,555.2314,972.7716,655.62John C. Milne35.51E. N. McWilliams400.00Allen Snyder, Inc40.0040.00Total income from fees38,990.7439,012.7740,695.62Gross profit from sales1,498.20(1) 8,019.73Long-term capital gain64,031.196,105.0016,761.4786 Since 1947, petitioner's earned surplus has increased as follows:Fiscal year ended Feb. 28 --Earned surplusIncrease1947$ 159,741.991948190,599.62$ 30,857.631949212,620.4522,020.831950248,953.8636,333.411951360,023.57111,069.711952414,074.6154,051.041953471,947.1057,872.491954511,209.2739,262.171955539,794.9728,585.701956588,807.6949,012.721957696,573.47107,765.78Total increase in earned surplus,1947-1957536,831.48Petitioner's current ratio (current assets at book cost to current liabilities) during this period varied as follows:Fiscal year ended Feb. 28 --CurrentCurrentCurrentassetsliabilitiesratio1947$ 334,702.74$ 35,685.419 to 11948339,684.7710,384.3933 to 11949356,051.008,293.4343 to 11950392,312.0036,642.0811 to 11951521,705.6128,331.6718 to 11952562,961.906,985.3481 to 11953635,491.7320,185.7331 to 11954568,087.5719,439.4729 to 11955515,449.069,597.4354 to 11956658,925.075,182.01127 to 11957787,996.118,100.0597 to 1181 Petitioner's current assets during this period included "quick assets" (cash, notes, and accounts receivable), stock in domestic corporations, and inventory, as follows:Notes andTotalFiscal year ended Feb. 28 --Cashaccountsquickreceivableassets1947$ 81,945.64$ 3,315.87$ 85,261.51194870,986.284,285.5175,271.791949101,842.6214,446.40116,289.02195070,406.9090,143.12160,550.021951230,154.7370,609.65300,764.381952263,431.5768,089.10331,520.671953364,125.3943,975.11408,100.501954307,497.3333,199.01340,696.341955253,488.9834,568.85288,057.831956402,792.2123,541.63426,333.841957443,554.2447,962.52491,516.76Fiscal year ended Feb. 28 --StocksInventory1947$ 249,441.23(1) 1948237,856.23$ 26,556.751949237,856.231,905.751950229,856.231,905.751951220,941.23(1) 1952231,441.23(1) 1953227,391.23(1) 1954227,391.23(1) 1955227,391.23(1) 1956232,591.23(1) 1957242,591.2353,888.12Jefferson 87 and his wife filed joint income tax returns for the following calendar years showing net income and tax liability as follows:YearNet incomeTax liability1950$ 180,103.80$ 106,738.581951282,728.52154,320.24195275,349.7939,749.86 From June 29, 1943, through the fiscal year ended February 28, 1958, petitioner has not declared any dividends on its stock nor has it paid any salary to Jefferson.On December 16, 1955, respondent notified petitioner of his intention to issue a deficiency notice based on section 102 of the 1939 Code for the taxable years now under review. On January 15, 1956, pursuant to section 534 of the 1954 Code, petitioner submitted a "statement" (incorporated herein by reference) to respondent setting forth certain "grounds" and "facts" in opposition to the section 102 deficiency proposed by respondent. Respondent then mailed to petitioner a notice of deficiency dated April 13, 1956.During the years under review petitioner permitted its earnings and profits to accumulate beyond the reasonable needs of its business.Petitioner was availed of during the years under review for the purpose of preventing the imposition of surtax upon its shareholders, through the medium of 88 permitting its earnings and profits to accumulate instead of being divided or distributed.OPINION.The challenged deficiencies were determined under section 102 of the Internal Revenue Code of 1939, which imposed a special surtax upon corporations formed or availed of for the purpose of preventing the imposition of surtax upon its shareholders by 182 permitting earnings or profits to accumulate instead of being divided or distributed. 189 Although a limited burden of proof in relation to accumulations beyond the reasonable needs of the business may be shifted to the Commissioner pursuant to section 534 of the Internal Revenue Code of 1954, as amended by sections 4 and 5 of Public Law 367, 84th Cong., 1st Sess., the ultimate burden of proving that the corporation was not availed of for the prohibited statutory purpose is and remains upon the petitioner. Pelton Steel Casting Co., 28 T.C. 153">28 T.C. 153, affirmed 251 F. 2d 278 (C.A. 7), certiorari denied 356 U.S. 958">356 U.S. 958. 1. A preliminary issue is raised in this case as to whether the limited burden dealt with in section 534 of the 1954 Code 291 has been shifted. The pleadings show that the Commissioner sent a notice pursuant to section 534(b), and that the taxpayer filed a "statement," purportedly in compliance with section 534(c). Prior to trial petitioner filed a motion for a ruling that its "statement" is in compliance with the requirements of section 534(c), and that "by reason of such compliance, the burden is upon the respondent 90 to prove that the net earnings accumulated with respect to each of the three fiscal years at issue were beyond the reasonable needs of the petitioner's business." However, at the trial, in order that it might be able to present its entire affirmative case first, petitioner stated that, without 183 waiving any rights under that motion, it did not press at that time for a ruling upon the motion. We find it unnecessary to rule upon that motion because regardless of whether there has been any shifting of a limited burden of proof, we are satisfied on the evidence before us that the petitioner was availed of for the purpose of preventing the imposition of surtax upon its shareholders by permitting earnings and profits to accumulate instead of being divided or distributed. However, it may be appropriate to point out certain respects in which petitioner's "statement" and 92 motion are defective.In the first place, the motion requests a sweeping ruling that the burden is upon the respondent to prove that the net earnings accumulated were beyond the reasonable needs of the business. Even if petitioner's "statement" were a proper one, no such broad ruling could be granted, for section 534(a)(2) provides for a shift in the burden only "with respect to the grounds set forth in such statement." And in the second place it is highly doubtful whether the "statement" filed by petitioner is a proper one under the statute.The "grounds" upon which petitioner relies to establish that earnings and profits were not accumulated beyond the reasonable needs of its business were set forth as follows in petitioner's statement:Ground No. 1. The corporation was not created or organized for the purpose of preventing the imposition of the surtax upon its shareholders.Ground No. 2. The corporation was not availed of for such purpose in any of said three years, no part of the earnings accumulated in any of those years being beyond the reasonable needs of its business.In our opinion, these are not "grounds," as that term was intended to be understood in section 534; rather, they 93 are mere reformulations of section 102 itself. To shift the burden to respondent on the issue of "reasonable needs," petitioner's statement of "grounds" must allege reasons for accumulating earnings and profits which, if proved, will tend to establish that the earnings and profits were not accumulated unreasonably. Section 534 expressly requires "a statement of the grounds on which the taxpayer relies to establish that * * earnings and profits have not been permitted to accumulate beyond the reasonable needs of the business." (Emphasis supplied.) The relevant report of the Senate Finance Committee expresses a similar view:in order for the burden of proof to be shifted, the taxpayer * * * must submit a statement indicating why the needs of the business require the retention of earnings and profits, together with facts sufficient to show the basis thereof. [S. Rept. No. 1622, 83d Cong., 2d Sess., p. 315. Emphasis supplied.]Petitioner's allegations that the corporation was not formed or availed of for the proscribed purpose, and that earnings were not accumulated beyond the reasonable needs of the business, are not reasons for accumulating earnings and profits, but rather conclusions 94 184 masquerading as reasons. As such, the statement is deficient for failing to allege appropriate grounds.Nor are the facts alleged by petitioner in its statement sufficient to show the basis of its alleged "grounds." With respect to its real estate activities, petitioner sets forth certain instances when it bought and sold parcels of real estate, but no facts are alleged which would indicate a need to accumulate earnings and profits in order to consummate those transactions. Petitioner also alleges that in certain other instances "the corporation lacked sufficient means" to make purchases, but reveals nothing more than the names of the parcels involved; the statement does not indicate the dates the properties were considered, their estimated costs, any discussions, plans, or actions taken with respect to these properties, nor any other facts indicating a need to accumulate earnings and profits during the years in question.Regarding its loans, investments, and related engineering contracts, petitioner merely recites various loans or investments that it did in fact make, and engineering contracts received as a result thereof; not a single instance is set forth showing that petitioner 95 needed additional funds for this department of its business; the sum of petitioner's allegations on this point is a general statement that in the opinion of the directors additional "capital and surplus" was required to secure profitable engineering contracts from substantial textile manufacturing companies. Petitioner's allegations as to "the business of buying, converting and selling textile fabrics" consist of a single instance where it sold cotton goods at a profit and an allegation that "the directors have had to limit to $ 100,000 the amount to be devoted to that portion of its business." There are no facts alleged to indicate that the amount of $ 100,000 was insufficient for petitioner's merchandising activities, nor any instance set forth where petitioner was required to forego a profitable merchandising opportunity for lack of funds. The same may be said of petitioner's allegations concerning its interest in purchasing a textile mill. Six mills are listed as having been considered by petitioner and an allegation is made that petitioner offered to purchase three of them, but in no instance do the facts show that petitioner lacked the resources to purchase any one of the listed 96 mills. Instead, petitioner contents itself with the general statement that "on several occasions, the corporation could have acquired such a mill, but was prevented by its limited means."In sum, the "specific" allegations in petitioner's statement of "facts" consist of sketchy references to certain transactions, some of which were considered and others of which were consummated; they in no sense substantiate petitioner's general allegations of fact 185 that it was handicapped in its operations by insufficient resources. Such general allegations fail to satisfy the requirements of section 534. See I. A. Dress Co., 32 T.C. 93">32 T.C. 93; Dixie, Inc., 31 T.C. 415">31 T.C. 415, on appeal (C.A. 2); Kerr-Cochran, Inc., 30 T.C. 69">30 T.C. 69, on appeal (C.A. 8).2. Section 102(c) states that "the fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid surtax upon shareholders unless the corporation by the clear preponderance of the evidence shall prove to the contrary." Apart from any issue of burden of proof, we think the record in this case persuasively demonstrates that petitioner's financial position at the beginning 97 of and during the years in question was adequate to meet its business needs, both immediate and anticipated, that additional accumulations were unreasonable, and that the corporation was availed of for the purpose of preventing the imposition of surtax upon its principal shareholder.As of February 28, 1950, the close of the last fiscal year prior to the period under review, petitioner had been a going corporation for more than 6 years during which time it had never paid a dividend in spite of substantial earnings. It had accumulated earnings and profits of $ 248,953.86 and current assets of $ 392,312, including cash of $ 70,406.90, notes and accounts receivable of $ 90,143.12, securities of $ 229,856.23, and a negligible closing inventory. Its current ratio (current assets at book cost to current liabilities) was 11 to 1. During the years under review, petitioner maintained its policy of not paying dividends, although substantial earnings continued. As of the close of the fiscal year ending February 28, 1953, its earned surplus had increased to $ 471,947.10, an increase of $ 222,993.24 over earned surplus at the beginning of the period. Current assets had increased to $ 635,491.73, 98 including cash of $ 364,125.39, notes and accounts receivable of $ 43,975.11, securities of $ 227,391.23, and no closing inventory. Its current ratio had risen to 31 to 1. These figures are a graphic illustration of the accelerated accumulation of earnings and profits by petitioner, accompanied by increasing liquidity, particularly in the cash account. There were no reasonable business needs sufficient to justify such substantial accumulations.Loans, investments, and related engineering contracts. -- The record does not reveal a single loan or investment made, negotiated for, or contemplated by petitioner during the years under review in order to secure an engineering contract. Nor could Cox recall a single instance, in any year, in which petitioner was compelled to refuse a loan to a soliciting company because of lack of funds. Petitioner's net investment in stocks of other corporations actually declined during the years in question as its preferred stock in Fitzgerald 186 Mills Corporation was gradually redeemed. Similarly, the outstanding balance in "notes and accounts receivable" declined from $ 90,143.12 to $ 43,975 as Ferro Co repaid part of its loan.Most of the stocks owned 99 by petitioner during the years in question were held for Jefferson's convenience rather than for any business need of petitioner. Cf. Kerr-Cochran, Inc. v. Commissioner, 253 F. 2d 121 (C.A. 8), affirming a Memorandum Opinion of this Court. We cannot ignore the fact that Jefferson was in a high tax bracket, whereas the substantial annual dividends received by petitioner from its investments, particularly its stock in Iselin-Jefferson and Woodside Mills, were subject to the 85 per cent dividends-received credit provided by section 26(b)(1), I.R.C. 1939. Cf. Trico Products Corporation, 46 B.T.A. 346">46 B.T.A. 346, 380, affirmed 137 F. 2d 424 (C.A. 2), certiorari denied 320 U.S. 790">320 U.S. 790. Petitioner argues that its investments were necessary to secure or retain engineering contracts, or to maintain a close relationship with corporations whose activities would benefit petitioner in other ways. While this may, to some extent, be true as to petitioner's loans to Ferro Co and Locke, it is patently inapplicable to petitioner's investments in stock of other corporations. For example, no engineering services were rendered to Iselin-Jefferson, Woodside Mills, Alabama Mills, Exposition Cotton Mills, or Package 100 Machinery Company. The facts also demonstrate that in some instances petitioner obtained profitable engineering contracts from corporations in which petitioner owned no stock and to which no advances were made, e.g., Conestogo Cotton Mills and Barret Textile Company. Moreover, whatever business benefits accrued to petitioner from its relationships with Iselin-Jefferson would undoubtedly have accrued even if Jefferson retained all his shares in that company instead of selling a portion to petitioner. Jefferson was cochairman of the board of Iselin-Jefferson and a substantial stockholder; Floyd, Jr., was president of Iselin-Jefferson and also a stockholder; both were voting trustees of all the Iselin-Jefferson stock held by the Jefferson family and corporations controlled by them. A similar statement may be made as to the business necessity of holding Woodside Mills stock inasmuch as that corporation was controlled by Iselin-Jefferson. Petitioner's investments in Iselin-Jefferson and Woodside Mills represented a total investment of $ 170,000, approximately 70 per cent of the total basis of the stocks held by petitioner as of February 28, 1951. Purchase of the Fitzgerald Mills Corporation 101 preferred stock was prompted by the prospect of its anticipated redemption at a premium rather than any purpose relating to petitioner's engineering contract with that company. Fitzgerald Cotton Mills was not even an operating company during the years under review; prior to February 1945, when that 187 company did operate a textile mill, it paid $ 24,000 per year to petitioner for engineering fees, even though petitioner owned none of its stock. Thus, it appears that of petitioner's investments only its common stock interest in Fitzgerald Mills Corporation was even arguably necessary to its engineering business. And, even as to that company, there was no apparent business necessity for purchasing a controlling interest therein, if petitioner's purpose was merely to secure or retain an engineering contract. Fitzgerald Mills Corporation was the successor to Fitzgerald Cotton Mills which was wholly owned by the Jefferson family; petitioner already had an engineering contract with Fitzgerald Cotton Mills when Fitzgerald Mills Corporation was formed; and Floyd, Jr., was the president of Fitzgerald Mills Corporation. It therefore seems probable that Fitzgerald Mills Corporation would have 102 continued to employ petitioner whether or not petitioner purchased a majority of its stock. Furthermore, the amount of petitioner's investment in Fitzgerald Mills Corporation -- $ 27,500 -- seems to bear little relation to the size of its engineering contract -- $ 24,000 per year. The loans to Ferro Co and Locke respectively were made before and after the taxable years in question. Petitioner's prospects for making similar loans during the years under review were minimal in view of the continuing state of depression in the textile industry, as documented by petitioner's minutes and Cox's statement that "there was no use interviewing mills, at the present time, in regard to making loans to mills." And, finally, it appears that the loans to Locke and Ferro Co were the only loans ever made by petitioner -- before, during, or after the years in question -- with respect to engineering contracts. In short, we think petitioner's argument that it needed additional investment funds to carry on the engineering phase of its business is largely fictitious; the fact is that petitioner had more than adequate resources for this purpose, so much so that it was able to carry many investments that 103 had no, or only a remote, connection with its engineering contracts, or other activities. See Jacob Sincoff, Inc., 20 T.C. 288">20 T.C. 288, affirmed 209 F. 2d 569 (C.A. 2).Possible purchase of a textile mill. -- Although petitioner earnestly contends that it needed to accumulate earnings and profits in order to purchase and stock an operating textile mill, there are several dramatic features to the evidence which foreclose a finding consonant with this contention. First, from March 1944 to December 1958, a period of more than 14 years, petitioner did not purchase a textile mill, although during this period petitioner allegedly desired to engage in the business of operating a textile mill. Second, with one exception, petitioner's activities with respect to acquisition of an operating mill never passed the discussion stage. KOMA, Inc. v.188 , 189 F. 2d 390 (C.A. 10), affirming a Memorandum Opinion of this Court. Victoria Mills was the only mill 3 during the 14-year period for which a purchase offer was submitted, but that offer was made by a syndicate which was dominated by Swergold and in which petitioner had only an undisclosed interest. Third, after repeated questioning by the 104 Court in an effort to pin down the precise reason for petitioner's failure to purchase the Superba mill, Jefferson admitted that such failure was attributable to factors extraneous to the availability of funds or resources. The Superba mill was sold to another purchaser for $ 250,000 in July 1951; as of February 28, 1951, petitioner had earned surplus of $ 360,023.57, current assets of $ 521,705.61, and total "quick" assets of $ 300,764.38, including cash of $ 230,154.73. Fourth, although we are prepared to accept as generally true petitioner's contention that substantial amounts are necessary to stock a mill for operation after its fixed assets have been purchased, we are not satisfied that petitioner intended to purchase a mill for purposes of operation during the years under review. In 1948 petitioner's minutes record its decision to enter the business of "buying and selling cotton mills," and petitioner did in fact agree to sell both the Superba and Russellville mills in return for a commission. The depressed state of the industry during the years in question, which prompted Cox to report that as of May 1952 the only mills available were "very old ones in poor condition and 105 not worth considering irrespective of the prices," substantiates our doubts as to the seriousness of petitioner's intentions regarding operation of a mill at that time. Fifth, the evidence does not support petitioner's claim that lack of resources was the reason for not purchasing a mill. Jefferson admitted the contrary with respect to Superba Mills. As an additional example, petitioner's minutes document the fact that a large part of the alleged $ 500,000 required to purchase the Royston Mill could have been quickly recovered through the sale of inventory; and, the fact that sale of inventory was contemplated indicates that petitioner would not have had to expend large amounts to stock that particular mill. Petitioner's minutes, otherwise detailed with respect to mills considered for purchase, nowhere mention lack of resources as an inhibiting element. It seems clear that petitioner's resources on hand at the beginning of, and during, the years in question were more than adequate with which to purchase a mill, wholly apart from the possibility of financing a portion of the purchase price by borrowing from a third 189 party. Viewing the record as a whole, petitioner's allegation that 106 lack of resources handicapped it in its search for a mill leaves us with a sense of unreality; we think such allegation was primarily an afterthought and in no way influenced petitioner's intentions with respect to purchase of a mill during the years in question.Real estate activities. -- We agree with respondent's statement on brief that "petitioner purchased all of the real estate properties it desired, prior to, during and after the years in issue and at no time were its operations in this department hampered or restricted by a lack of funds." The record is plain that in no case did insufficient resources force petitioner to reject or postpone any real estate opportunities otherwise desirable from a business viewpoint.If petitioner lacked resources, why did it spend approximately $ 77,000 in cash to purchase and improve the property at 17 Sutton Place, rent it at a loss to Floyd, Jr., for 6 months, and then sell it to him for $ 10,000 down and a $ 70,000 mortgage? This 107 transaction, which occurred during the years in issue, appears to be completely inconsistent with a present need for liquid resources; it indicates instead that petitioner's real estate activities were not always motivated by business considerations so much as the personal convenience of the Jefferson family. A similar conclusion suggests itself with respect to at least two of the Southampton properties which the Jeffersons rented for their own occupancy in "some summer months" and the Doubling Road property which they similarly continue to rent. In this connection, petitioner's expenses in operating its properties exceeded the rental income therefrom during the years in question.The possibility of erecting a multiple-story office building at 90 Worth Street, which petitioner alleges was still being considered during the years in issue, never went beyond the discussion stage, and the record indicates that most of the discussions took place in 1946 and 1947. Petitioner's minutes do not even mention this project, and Taylor admitted that he approached Jefferson as an individual with substantial assets under his control, rather than as a representative of petitioner. Cf. Dixie, Inc., supra, at 428-429. 108 The only indication that petitioner was at all concerned with the project was Jefferson's statement during the discussions that petitioner might participate therein, but the extent of such participation was never defined. If anything definite can be said about this venture, it is that Iselin-Jefferson would be its primary beneficiary; the benefit to petitioner, if any, would be incidental. In any event, consideration of the project was dropped as a result of the increasing movement of textile firms from downtown New York City to uptown locations, 190 and not for lack of resources. And it seems probable that similar reasons played a part in Jefferson's rejection of the other buildings in the downtown textile area offered to him by Taylor.As far as the S. Vere-Smith property is concerned, there is no proof that petitioner contemplated its purchase during the years in issue. It is first mentioned in the minutes of October 10, 1953, and petitioner's first offer was made in November 1953. Furthermore, petitioner failed to obtain this property for reasons other than a lack of resources and, even if petitioner had succeeded in purchasing the property, it was contemplated that a substantial 109 part of its investment would be recovered through resale of most of the acreage.In short, petitioner has failed completely to substantiate its allegation that insufficient resources limited its real estate activities.Merchandising. -- Petitioner's merchandising ventures during the years in question, in cotton goods and jewelry, were at best sporadic. Although the minutes document petitioner's decision in February 1952 to enter the converting business and hire Maynard at $ 5,000 per year, the record is clear that petitioner's plans in this regard were not restricted by insufficient resources. Petitioner never refused an opportunity to purchase merchandise which it thought it could resell at a profit, it had no closing inventory in any of the fiscal years with which we are concerned, and, from all that appears in the record, the amount of $ 100,000 allocated to this phase of its business was more than adequate.Throughout its business history petitioner has accumulated its earnings and profits for no apparent business need. The most substantial source of these accumulations has been income from dividends and interest which, during each of the years under review, exceeded its income 110 from engineering fees. Petitioner's rental income during this period was more than offset by expenses of operating its real estate holdings, and the only significant gain from sale of a property was that realized on disposition of the apartment building transferred to petitioner by Jefferson in 1943 or 1944. The corporation was utilized in substantial measure for Jefferson's personal convenience, the substantial accumulations of earnings enabled him to avoid imposition of surtax, and we conclude on all the evidence that petitioner was availed of during the years in question for the purpose of preventing the imposition of the surtax upon its shareholders.Decision will be entered for the respondent. Footnotes1. This is a stipulated figure. According to a schedule dated June 25, 1943, and incorporated in petitioner's minutes of Feb. 20, 1944, the securities had a basis to Jefferson of $ 210,207.16.1. Not available.↩1. Not available.↩2. None.↩1. None.↩2. Not available.↩1. None.↩1. None.↩1. None.↩1. SEC. 102. SURTAX ON CORPORATIONS IMPROPERLY ACCUMULATING SURPLUS.(a) Imposition of Tax. -- There shall be levied, collected, and paid for each taxable year (in addition to other taxes imposed by this chapter) upon the net income of every corporation * * * if such corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders or the shareholders of any other corporation, through the medium of permitting earnings or profits to accumulate instead of being divided or distributed, a surtax * * ** * * (c) Evidence Determinative of Purpose. -- The fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid surtax upon shareholders unless the corporation by the clear preponderance of the evidence shall prove to the contrary.↩2. SEC. 534. BURDEN OF PROOF.(a) General Rule. -- In any proceeding before the Tax Court involving a notice of deficiency based in whole or in part on the allegation that all or any part of the earnings and profits have been permitted to accumulate beyond the reasonable needs of the business, the burden of proof with respect to such allegation shall -- (1) if notification has not been sent in accordance with subsection (b), be on the Secretary or his delegate, or(2) if the taxpayer has submitted the statement described in subsection (c), be on the Secretary or his delegate with respect to the grounds set forth in such statement in accordance with the provisions of such subsection.(b) Notification by Secretary. -- Before mailing the notice of deficiency referred to in subsection (a), the Secretary or his delegate may send by registered mail a notification informing the taxpayer that the proposed notice of deficiency includes an amount with respect to the accumulated earnings tax imposed by section 531. * *(c) Statement by Taxpayer. -- Within such time (but not less than 30 days) after the mailing of the notification described in subsection (b) as the Secretary or his delegate may prescribe by regulations, the taxpayer may submit a statement of the grounds (together with facts sufficient to show the basis thereof) on which the taxpayer relies to establish that all or any part of the earnings and profits have not been permitted to accumulate beyond the reasonable needs of the business.↩3. Although Jefferson testified that an offer was also made for the Superba mill, we have concluded on the basis of Cox's testimony and the minutes of petitioner's board of directors that no such offer was ever made.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621457/	JIMMIE L. and GOLDIE PENIX, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Penix v. CommissionerDocket Nos. 25919-85, 41225-85, 6182-86, 10110-87, 16546-87, 23727-87United States Tax CourtT.C. Memo 1991-332; 1991 Tax Ct. Memo LEXIS 383; 62 T.C.M. (CCH) 182; T.C.M. (RIA) 91332; July 22, 1991, Filed 383 Decisions will be entered under Rule 155 in all cases except docket No. 41225-85, and an appropriate order will be issued in that case. James T. Burnes, for the petitioners in docket Nos. 41225-85, 10110-87, 16546-87, and 23727-87. Richard H. Halley, pro se. Shirley M. Francis, for the respondent. DAWSON, Judge. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION These cases were assigned to Special Trial Judge John J. Pajak pursuant to section 7443A(b) and Rule 180 et seq. 2 (All section references are to the Internal Revenue Code as amended and in effect for the taxable years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.) The Court agrees with and adopts the Special Trial Judge's opinion which is set forth below. 384 OPINION OF THE SPECIAL TRIAL JUDGE PAJAK, Special Trial Judge: These six consolidated cases were selected as test cases for the Southampton Music Company master recording program. 3 Respondent determined deficiencies and additions to petitioners' Federal income taxes as follows: Jimmie L. and Goldie PenixAdditions to Tax Under SectionYearDeficiency6653(a)6653(a)(1)6653(a)(2)66591979$ 1,226.00$ 61.30 -- --$ 367.80 19803,546.00177.30-- --1,063.8019814,110.00--$ 205.501,233.0019824,566.00--228.00935.001983837.00--41.85-- Robert V. and Merla J. HaleAdditions to Tax Under SectionYearDeficiency6653(a)6653(a)(1)6653(a)(2)66591978$ 1,903.00$ 98.00 -- --$ 586.00 19792,059.00103.00-- --618.0019804,019.00201.00-- --1,206.0019815,486.00-- $ 274.001,646.0019822,308.00-- 115.00649.00385 Richard H. and Sonya H. HalleyAdditions to Tax Under SectionYearDeficiency6653(a)6653(a)(1)6653(a)(2)66591979$ 10,825.00$ 541.00-- --$ 3,248.0019804,833.00242.00-- --1,450.0019817,795.00--$ 390.002,339.00198216,162.00--808.004,849.00Ferdinand D. and Karen L. MehlickAdditions to Tax Under SectionYearDeficiency6653(a)6653(a)(1)6653(a)(2)66591980$ 13,311.00$ 666.00----$ 3,993.00198120,485.00--$ 1,024.006,145.0019828,501.00--425.002,550.00198311,544.00--577.003,463.00386 Eric H. and Patricia AccomazzoAdditions to Tax Under SectionYearDeficiency6653(a)6653(a)(1)6653(a)(2)66591979$ 12,315.00$ 615.75-- --$ 3,694.5019808,654.00432.70-- --2,596.2019814,282.00-- $ 214.101,284.60198217,974.00-- 898.704,779.90198311,891.00-- 594.553,546.60Mike S. and Linda M. NaresAdditions to Tax Under SectionYearDeficiency6653(a)6653(a)(1)6653(a)(2)66591980$ 5,420.00$ 271.00-- --$ 1,626.0019817,648.00-- $ 382.402,294.4019825,884.00-- 294.201,765.2019838,750.00-- 437.502,625.00387 Respondent also determined that petitioners Hale, Halley, Mehlick, Accomazzo, and Nares are liable for the increased rate of interest under section 6621(c) (formerly section 6621(d)), for all tax years at issue. Respondent raised section 6621(c) in an amendment to answer for petitioners Penix for all tax years at issue, but on brief conceded that this section does not apply with respect to their tax year 1983. Respondent also filed a motion for damages (now penalties) under section 6673 for each of the consolidated cases. 388 This Court must decide: (1) Whether petitioners are entitled to expense deductions or partnership losses and investment tax credits related to their respective master recording leases; (2) whether petitioners are liable for the additions to tax under section 6653(a) and under section 6653(a)(1) and (2) in the applicable years; (3) whether petitioners are liable for the additions to tax under section 6659; (4) whether petitioners are liable for the increased interest under section 6621(c); and (5) whether petitioners are liable for damages (now penalties) under section 6673. FINDINGS OF FACT Some of the facts have been stipulated and are so found. Petitioners Jimmie L. and Goldie Penix resided in Emmett, Idaho, when they filed their petition. Petitioners Robert V. and Merla J. Hale resided in Port Oxford, Oregon, when they filed their petition. Petitioners Richard H. and Sonya H. Halley resided in Folsom, California, when they filed their petition. Petitioners Ferdinand D. and Karen L. Mehlick resided in Vista, California, when they filed their petition. Petitioners Eric H. and Patricia Accomazzo resided in Moraga, California, when they filed their petition. Petitioners 389 Mike S. and Linda M. Nares resided in Glendora, California, when they filed their petition. In February 1982, Jerry W. Hendricks (Hendricks), Forrest F. Andreason (Andreason), and Bryson R. Reinhardt (Reinhardt) organized Southampton Music Company (formerly known as Sound Leasing Company). Southampton Music Company (Southampton) was formed to acquire master sound and video recordings of artistic productions for leasing to investors. 4Hendricks, Andreason, and Reinhardt formed Intrasound Music Company (Intrasound) and Cumberland Productions, Inc., (Cumberland) to acquire title to the master recordings from vendors and then to sell the masters to Southampton. Cumberland also was to produce master recordings. Indigo Music Corporation (Indigo) was formed by Hendricks, Andreason, and Reinhardt to produce records and390 tapes from the master recordings and/or to distribute the records and tapes. When investors entered into lease agreements with Southampton, Southampton recommended that the investors contract with Indigo for distribution. Southampton sent Indigo lists of such investors. Indigo then solicited distribution agreements from the investors. Intrasound and Cumberland purchased master recordings from various vendors for $ 704 to $ 30,000, and shortly thereafter sold the master recordings to Southampton for $ 400,000 to $ 3,000,000. Sometimes, Southampton purchased the master recordings from Intrasound and Cumberland before the latter had purchased the master recordings. During 1982, Intrasound and Cumberland paid various vendors $ 1,018,203 for master recordings which they then sold to Southampton for a total of $ 110,250,000. During 1983, Intrasound and Cumberland paid a total of $ 621,135 to acquire or produce master recordings which they then sold to Southampton for a total of $ 103,285,000. When Cumberland produced master recordings, its cost was $ 12,500 or less per master recording. Cumberland sold these same master recordings to Southampton for $ 400,000 to $ 1,360,000. Southampton391 paid for each of the master recordings with a small amount of cash and a large purported promissory note (note). Southampton provided potential investors with promotional booklets. One is a 66-page promotional booklet, entitled "Southampton Music Company: 1982-83 Program." This promotional booklet emphasized the tax benefits of investing in a master recording rather than any economic benefits that could be expected. The booklet included a 37-page tax opinion by Joseph Wetzel, an attorney in Portland, Oregon. The tax opinion discussed the tax benefits of the investment and potential tax problems that could be raised by the Internal Revenue Service and ways to avoid them. Mr. Wetzel's tax opinion was based on the assumption that Southampton would purchase master recordings from unrelated persons or firms in arm's-length transactions. The promotional booklet also contains a chart entitled "Table of Advance Lease Payments and First Year Tax Benefits" with four levels of escalating investments with escalating tax benefits. For example, according to the chart, a cash investment of $ 31,000 in a $ 400,000 master recording would yield in the first year an investment tax credit of $ 392 40,000 and a tax deduction of $ 26,000. The booklet also stated that custom packages of equipment having a higher purchase price were available. Petitioners Penix, Hale, Mehlick, Accomazzo, and Nares became partners in different small partnerships or joint ventures (hereinafter referred to as partnerships) with other investors. In most cases, these petitioners did not meet their respective partners until after signing the lease agreements or only spoke with them on the telephone, or in some instances never spoke with them at all. Petitioners Halley invested as individuals. Petitioners Penix, Hale, and Halley signed master recording leases in 1982. Petitioners Nares and Mr. Mehlick signed master recording leases in 1983. Petitioners Accomazzo signed two master recording leases in 1982 and Mr. Accomazzo signed one in 1983. Each lease was for a different master recording from Southampton. The lease agreements all were for a term of 5 years and 10 months. For each master recording, the following shows the acquisition cost for Intrasound and Cumberland, the price paid by Southampton, and the amount of cash paid by Southampton: MasterAcquisitionSouthampton'sSouthampton'sRecordingCostPurchaseCashPricePaymentTurner Brothers$ 3,500 $ 400,000 $ 4,250 Andres Segovia2,000400,0006,250New Dawn3,500400,0004,250Quinton Stacey* 1,360,00022,000Carter Family12,296850,00010,250Owen Brothers12,296850,00010,250Hugh X. Lewis12,5001,360,00022,000Early Rock2,500400,0004,000393 In comparison to the purchase price, Southampton paid Cumberland or Intrasound a very low cash down payment and gave a purported note for the balance. The notes were secured by the respective master recordings and interest was to accrue at 9 percent per year. Under the terms of the note, no payments of interest or principal were due for 12 years and 1 day, except for one-half of the "Gross Receipts, License Fees and Other Income" received on the master recordings by Southampton. (No note for the Owen Brothers master recording was in the record, but it appears that Southampton used the same form for such purposes.) Southampton never made any payments on the notes and no legal action was ever taken against Southampton for nonpayment. The following shows the master recordings leased by petitioners, their percentage interests in the respective partnerships (except for the Halleys who were not involved in a partnership), the investments (including distribution costs) in their respective394 master recording leases, and the claimed values on their returns for investment tax purposes: PetitionersMasterPercentageInvestmentClaimedRecordingsInterest ValuePenixTurner Brothers30.0 percent$ 9,300 $ 120,000HaleAndres Segovia20.0 percent6,20080,000HalleyNew Dawn100.0 percent31,000400,000MehlickQuinton Stacey50.0 percent39,000680,000AccomazzoCarter Family and20.9 percent21,700355,300Owen Brothers AccomazzoHugh X. Lewis20.0 percent15,600272,000NaresEarly Rock70.0 percent21,700280,000Although there are variances in the cases, the transaction was as follows. Generally, petitioners would deduct most of the prepaid rent and distribution costs in the year of investment. Southampton passed to the investors their respective shares of an investment tax credit based upon Southampton's purchase price. The investors claimed these investment tax credits in the year of investment and carried them back to prior taxable years, and one carried an investment tax credit forward to a subsequent taxable year. None of the petitioners had experience in the music or recording industry or in record distribution at395 the time they entered into the lease agreements for their master recordings. None of the petitioners had training in financial, accounting, or tax matters. They either consulted with no one or only with persons or entities associated with Southampton regarding the operation of a record production business. Some discussed the matter with other Southampton investors. Petitioners did not seek independent appraisals of the master recordings or seek the advice of anyone with experience in the music or recording industry regarding their investments in master recordings. Except for petitioners Mehlick who never saw an appraisal, the only appraisals of the master recordings petitioners read were provided to them by Southampton or its agents. None of the petitioners consulted with an independent tax attorney about the investment and its alleged tax benefits before signing their respective master recording lease agreements. In each case, petitioners did not research the marketability of their respective master recordings. Some of the petitioners were consulted as to the type of music, and in one case the artist they desired, for their respective master recordings, but none knew the 396 selections before they signed their master recording leases. None of the petitioners were provided with their respective master recordings for inspection prior to signing the respective lease agreements. None of the petitioners prepared an income/expense projection for their respective master recordings. They relied on promotional booklets given to various petitioners by the salesmen for Southampton. None of the petitioners checked as to ownership of the title of their respective master recordings. None of the petitioners purchased insurance for their master recordings. Petitioners Hale, Mehlick, Accomazzo, and Nares were unaware of whether their other partners purchased insurance. (The record is silent on this point as to petitioners Penix.) None of the partnerships kept formal records of their alleged business. Petitioners Mehlick, Accomazzo, and Halley kept files of correspondence relating to their master recordings. Petitioners did not negotiate with Southampton regarding the price or the terms of their master recording leases. They all chose Indigo to distribute their master recordings, and none negotiated with Indigo regarding the contract price. All of the petitioners397 received either none or a small number of records and/or tapes of their respective master recordings. Petitioners Penix: Mr. Penix was a truck driver or logger at the time of the Penixes' investment. These petitioners did not appear at either trial. The Penixes filed Federal income tax returns for 1979 through 1983. On their 1982 return, the Penixes deducted $ 5,550 as a loss from their Southampton partnership. The Penixes claimed $ 12,000 of tentative regular investment credit and used $ 3,118 as an investment tax credit in 1982. They carried back unused investment tax credit in the amounts of $ 1,226, $ 3,546, and $ 4,110 to 1979, 1980, and 1981, respectively. On their 1983 return, the Penixes deducted $ 3,995 as a loss from their Southampton partnership. In a notice of deficiency sent to the Penixes for 1979 through 1983, respondent disallowed the partnership losses of $ 5,500 and $ 3,995 claimed in 1982 and 1983, respectively. Respondent also disallowed the $ 3,118 of investment tax credit taken in 1982, and the $ 1,226, $ 3,546, and $ 4,110 of investment tax credit carried back to 1979, 1980, and 1981, respectively. Petitioners Hale: Mr. Hale, a former United398 States Air Force officer, was retired at the time of the Hales' investment. Mr. Hale asked that classical music be featured on his master recording. Mr. Hale selected Andres Segovia as his artist because he was internationally known. Mr. Hale did not retain Mr. Richard AuFranc, a friend who was an attorney and a CPA, until after he received notice of an audit from the IRS in September 1983. About the time of his investment in Southampton, Mr. Hale had asked Mr. AuFranc about the necessary requirements for claiming an investment tax credit but did not ask him for an opinion about Southampton because he had made up his mind to invest. Mr. Hale was not pleased with the distribution efforts of Indigo, and he contacted Southampton a number of times, sometimes with Mrs. Hale. The Hales filed Federal income tax returns for 1978 through 1982. The Hales carried over $ 4,782 of unused investment tax credit from another investment to 1982. On their 1982 return, the Hales deducted $ 5,200 as a loss from a Southampton partnership on Schedule E of their return. The Hales twice deducted the $ 5,200 on Schedule C of their 1982 return, listing the amounts as $ 4,000 for rent on business property399 and $ 1,200 for distribution cost. The Hales claimed $ 8,000 as tentative regular investment credit from their Southampton investment, which when added to the $ 4,782 carry-over and a $ 63 investment credit on other properties, resulted in a tentative regular investment credit of $ 12,845. The Hales listed $ 12,845 as an investment tax credit on their 1982 return and improperly offset $ 334 of tax from recapture of investment credit, the only tax shown as due on that return. In a notice of deficiency sent to the Hales for 1980, 1981, and 1982, respondent disallowed for 1982 the $ 5,200 partnership loss, the $ 4,000 deduction for rent on business property, and the $ 1,200 deduction for distribution cost. Respondent also allowed only the $ 63 investment credit for 1982, thereby disallowing the $ 8,000 investment tax credit attributable to the Southampton investment, as well as the carried-over amount. Respondent sent a separate notice of deficiency to the Hales for 1978 and 1979. Petitioners Halley: Mr. Halley had been a school teacher and principal who retired in 1986. Tax considerations played an important role in the decision to invest in the master recording. The Halleys400 indicated to the salesman they would be interested in classical music or country-western. The New Dawn master recording assigned to them fit that criteria. Ultimately, Mr. Halley obtained 50 copies of the New Dawn record which were given away to people or local radio stations. Although the Halleys were not satisfied with Indigo's distribution, they neither hired another distributor nor sued Indigo. The Halleys filed their Federal income tax returns for 1979 through 1982. On Schedule C of their 1982 return, the Halleys deducted a loss of $ 20,000 as rent on business property and $ 6,000 as distribution cost, for a total loss of $ 26,000 from their Southampton investment. The Halleys claimed $ 40,000 of tentative regular investment credit for their Southampton investment. In 1982, they used $ 6,611 of investment tax credit attributable to their Southampton investment. The Halleys carried back unused investment tax credit from their Southampton investment in the amounts of $ 10,825, $ 4,833, and $ 7,795 to 1979, 1980, and 1981, respectively. The Halleys had $ 9,936 of unused investment tax credit attributable to their Southampton investment to carry over into later years. In401 a notice of deficiency sent to the Halleys for 1979, 1980, and 1981, respondent disallowed the $ 10,825, $ 4,833, and $ 7,795 of investment tax credit carried back to 1979, 1980, and 1981, respectively. In a separate notice of deficiency for 1982, respondent disallowed the $ 26,000 loss and the $ 6,611 of investment tax credit attributable to the Southampton investment. Petitioners Mehlick: Mr. Mehlick was employed by Pacific Bell at the time of his investment in 1983. He and a number of Moraga, California, residents met periodically during 1982 and 1983 to discuss investments at a bar and restaurant known as the Moraga Barn. Mr. Mehlick did not invest in Southampton until 1983. One of the other investors, Kenneth Zavala, a Federal Bureau of Investigation (FBI) agent, had conducted a background check of Southampton and told Mr. Mehlick that the investment was a high quality one. Mr. Mehlick wanted country-western as the type of music for his recording. Hendricks and his father-in-law, Robert Amber, selected the master recording for Mr. Mehlick's investment. Beginning on July 22, 1984, Mr. Mehlick wrote letters to Southampton to follow up on his investment in a master recording402 asking about the background of Quinton Stacey, a breakdown of money to be spent on production and advertising, and the goals for this recording for 1984 and subsequent years concerning potential revenue, costs, and profits per year, assessment of the master recording videotape market, and identification of major customers or competitors. He received some generalized responses and never received a promised appraisal of his recording. Petitioners Mehlick filed a partnership return with three others but they do not have, nor did they ever request or receive a copy of the partnership return. The Mehlicks filed their Federal income tax returns for 1980 through 1983. On Schedule C of their 1983 return, the Mehlicks deducted $ 8,320 of the rent on business property as a loss from their Southampton investment. The Mehlicks claimed $ 68,000 of tentative regular investment credit, and used $ 8,488 of investment credit in 1983. The Mehlicks carried back unused investment tax credit in the amounts of $ 13,311, $ 20,485, and $ 8,501 to 1980, 1981, and 1982, respectively. The Mehlicks had $ 17,215 of unused investment tax credit to carry over into later years. In a notice of deficiency 403 sent to the Mehlicks for 1980, 1981, 1982, and 1983, respondent disallowed the $ 8,320 loss claimed in 1983. Respondent also disallowed the $ 8,488 of investment tax credit taken in 1983 and the $ 13,311, $ 20,485, and $ 8,501 of investment tax credit carried back to 1980, 1981, and 1982, respectively. Petitioners Accomazzo: Mr. Accomazzo, who had attended high school, was in the service station business at the time of the investments in Southampton. He and a number of Moraga, California, residents (including petitioner Ferdinand Mehlick) invested in Southampton. They would meet periodically at a local bar and restaurant known as the Moraga Barn to discuss investments. One of them, Kenneth Zavala, an FBI agent, on his own behalf, ran a criminal check on the president of Southampton and made inquiries of a California corporation licensing section in Sacramento, the Better Business Bureau and the California Bar Association. Prior to Mr. Accomazzo's investment in 1983 (but not before the 1982 investment), Mr. Zavala told Mr. Accomazzo the corporation was solvent and had no problems. The initial source of Mr. Accomazzo's funds for investment in Southampton was bank savings. 404 The Accomazzos filed Federal income tax returns for the taxable years 1979 through 1983. On their 1982 return, the Accomazzos deducted $ 4,200 as distribution cost and $ 14,045 as rent. These expenses were attributable to their Southampton investment, but they commingled them among the Schedule C expenses for Mr. Accomazzo's service station. The Accomazzos claimed $ 35,530 of tentative regular investment credit from their 1982 Southampton investment. In 1982, they used $ 7,975 of the investment tax credit attributable to their Southampton investment. The Accomazzos carried back unused tax investment credit in the amounts of $ 12,315, $ 8,654, and $ 4,282 to 1979, 1980, and 1981, respectively. They carried over $ 2,304 of unused investment tax credit to 1983. This carry-over and these carry-backs totaled $ 35,530 of the investment tax credit from the Accomazzos' 1982 Southampton investment. On their 1983 return, the Accomazzos deducted $ 10,400 as a Southampton partnership loss and $ 578 as Southampton interest. The Accomazzos also deducted rent of $ 3,511 attributable to their Southampton investment, which they commingled among the Schedule C expenses for Mr. Accomazzo's 405 service station. The Accomazzos claimed an additional $ 27,200 of tentative investment credit attributable to their 1983 Southampton investment. In 1983, the Accomazzos used $ 6,720 of the investment tax credit attributable to their Southampton investments, leaving a balance of $ 22,784 of unused investment tax credit from the 1983 Southampton investment to carry over into later years. In a notice of deficiency sent to the Accomazzos for 1979, 1980, and 1981, respondent disallowed the $ 12,315, $ 8,654, and $ 4,282 of investment tax credit carried back to 1979, 1980, and 1981, respectively. In a separate notice of deficiency for 1982 and 1983, respondent disallowed for 1982 the $ 4,200 distribution cost deduction, the $ 14,045 rent deduction, and the $ 7,975 of investment tax credit attributable to their Southampton investment. Respondent also disallowed for 1983 the $ 10,400 partnership loss, the $ 578 interest deduction, the $ 3,511 rent deduction, and the $ 6,720 of investment tax credit attributable to their Southampton investments. Petitioners Nares: Mr. Nares was a systems analyst for the City of Los Angeles Fire Department when the Nares invested in Southampton. Mr. 406 Nares requested that he be provided with a rock-and-roll master recording because he believed such music would be in demand. In order to finance his investment in Southampton, Mr. Nares borrowed $ 21,000 from his bank secured by a lien against his residence. Mr. Nares' personal accountant knew nothing about master recordings and did not give the Nares an opinion before or after they signed their lease agreement as to whether they were entitled to the claimed deductions and credits, or whether they had a bona fide profit objective, or whether there was any substance to Southampton. The accountant relied on the Nares for the documents which supplied the figures he put on their returns. Mr. Nares neither provided a personal computation of a break-even point nor the number of sales required to make such a computation. Mr. Nares filed a 1983 partnership return with respect to the master recording, but the Nares used a Schedule C attached to their 1983 return to report their master recording deductions. The Nares filed Federal income tax returns for 1980 through 1983. On Schedule C of their 1983 return, the Nares deducted $ 40 in advertising, $ 205 in car and truck expenses, $ 2,540407 as interest on business indebtedness, $ 11,667 as master recording rent, $ 250 as loan costs, and $ 4,200 as distribution costs for a total loss of $ 18,902 from their Southampton investment. On their 1983 return, the Nares claimed $ 28,000 of tentative regular investment credit, and used $ 3,363 as an investment tax credit. The Nares carried back unused investment tax credit in the amounts of $ 5,420, $ 7,648, and $ 5,884 to 1980, 1981, and 1982, respectively. The Nares had available $ 5,685 of unused investment tax credit to carry over into later years. In a notice of deficiency sent to the Nares for 1980, 1981, 1982, and 1983, respondent disallowed the $ 18,902 Schedule C loss claimed for 1983. Respondent also disallowed the $ 3,363 of investment tax credit taken in 1983, and the $ 5,420, $ 7,648, and $ 5,884 of investment tax credit carried back to 1980, 1981, and 1982, respectively. OPINION The first issue is whether petitioners properly claimed either expense or loss deductions and investment tax credits with respect to their investments in master recording leases either individually or through partnerships. 5408 Petitioners bear the burden of establishing they are entitled to the claimed deductions and credits. 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). It is well settled that, where a transaction is entered into without any purpose other than to obtain tax benefits, the form of the transaction will be disregarded and the tax benefits denied. Law v. Commissioner, 86 T.C. 1065">86 T.C. 1065, 1093 (1986). It is also well settled that a transaction must have economic substance which is encouraged by business realities, is imbued with tax-independent considerations, and is not shaped solely by tax-avoidance features that have meaningless labels attached. Frank Lyon Co. v. United States, 435 U.S. 561">435 U.S. 561, 583-584, 55 L. Ed. 2d 550">55 L. Ed. 2d 550, 98 S. Ct. 1291">98 S. Ct. 1291 (1978). As a threshold matter, a reasonable opportunity for economic profit exclusive of tax benefits must exist before a transaction will be recognized for tax purposes. Gefen v. Commissioner, 87 T.C. 1471">87 T.C. 1471, 1490 (1986). We focus on the transactions in their entirety in determining whether they lack economic substance. These cases are factually similar to other cases decided by this Court in which deductions409 and credits related to master recordings were disallowed. Rybak v. Commissioner, 91 T.C. 524 (1988); Morrissey v. Commissioner, T.C. Memo 1989-646">T.C. Memo 1989-646. In those cases we analyzed the objective factors and concluded that the transactions lacked economic substance. Likewise, if we conclude the transactions in issue lack economic substance, they will be disregarded for Federal income tax purposes. Collins v. Commissioner, 857 F.2d 1383">857 F.2d 1383, 1385 (9th Cir. 1988), affg. a Memorandum Opinion of this Court; Sochin v. Commissioner, 843 F.2d 351">843 F.2d 351, 354 (9th Cir. 1988), affg. Brown v. Commissioner, 85 T.C. 968 (1985). We first must decide whether tax motivation is apparent in the transactions. If tax motivation is apparent, we then must decide whether a significant business purpose existed for the taxpayers to obtain the claimed benefits. Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086, 1116 (1987), affd. without published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186">856 F.2d 186 (4th Cir. 1988), affd. sub nom. Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93 (9th Cir. 1989),410 affd. without published opinion 865 F.2d 1264">865 F.2d 1264 (5th Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868 F.2d 865">868 F.2d 865 (6th Cir. 1989). Indicia of tax motivation are: (1) Tax benefits were the focus of promotional materials; (2) the investors accepted the terms of purchase without price negotiation; (3) the assets in question consist of packages of purported rights, difficult to value in the abstract and substantially overvalued in relation to tangible property included as part of the package; (4) the tangible assets were acquired or created at a relatively small cost shortly prior to the transactions in question; and (5) the bulk of the consideration was deferred by promissory notes, nonrecourse in form or in substance. * * Rose v. Commissioner, 88 T.C. 386">88 T.C. 386, 412 (1987), affd. 868 F.2d 851">868 F.2d 851 (6th Cir. 1989). The transactions in the instant cases clearly indicate obvious tax motivation because the promotional booklets emphasized the tax benefits investors could obtain; petitioners executed leases and distribution agreements without price negotiation; the master recordings were grossly overvalued; the411 master recordings were purchased by Southampton shortly before the transactions in question for negligible amounts; and the bulk of the consideration was deferred by notes non-recourse in substance. Since we have concluded that petitioners' transactions were tax motivated, we must decide whether petitioners' investments in the Southampton program lack economic substance and should be disregarded for Federal income tax purposes. Factors to be considered include: (1) Lack of arm's-length dealings between petitioners and the promoters, (2) relationship between fair market value and price, and (3) petitioners' investment activities. Patin v. Commissioner, 88 T.C. at 1117-1124; Rose v. Commissioner, 88 T.C. at 415-422. The absence of arm's-length negotiations is a key indicator that a transaction lacks economic substance. Rose v. Commissioner, 88 T.C. at 416; Helba v. Commissioner, 87 T.C. 983">87 T.C. 983, 1005-1007 (1986), affd. without published opinion 860 F.2d 1075">860 F.2d 1075 (3rd Cir. 1988). Southampton's promoters, Hendricks, Andreason, and Reinhardt, formed Intrasound and Cumberland, from which Southampton412 allegedly purchased the master recordings. Southampton recommended only Indigo, also formed by Hendricks, Andreason, and Reinhardt, to the investors as a production/distribution company. There was a lack of arm's-length dealings between Intrasound/Cumberland and Southampton, and between Southampton and Indigo. These entities were created to structure tax write-offs for sale to investors. Petitioners did not negotiate with Southampton regarding any of the terms of their master recording leases nor with Indigo regarding any of the terms of the production/distribution contracts. There were no arm's-length negotiations between petitioners and Southampton or Indigo. Petitioners paid the requested amounts to get the substantial deductions and credits offered under the Southampton program. The prices for the master recordings claimed by petitioners were grossly exaggerated. The quick sale of the master recordings from Intrasound and Cumberland to Southampton inflated the claimed value of the master approximately 65 to 200 times the price paid by Intrasound and Cumberland. Petitioners offered no evidence of any circumstances which caused the claimed increases in value. The purported413 purchase prices paid by Southampton were largely financed by notes payable for 12 years and 1 day from income from the master recordings purchased for nominal amounts. No payments on the notes were ever made by Southampton and no legal action was ever taken against Southampton for nonpayment. "If we cannot conclude at the outset of the transaction that payment of the note is likely, then the note is too contingent to be recognized for tax purposes." Waddell v. Commissioner, 86 T.C. 848">86 T.C. 848, 904 (1986), affd. 841 F.2d 264">841 F.2d 264 (9th Cir. 1989). We believe there never was any intent to make payments on these Southampton notes, and they are not to be recognized for tax purposes. Thomas Bonetti, the president and owner of Cumpari Inc., Celebrity Licensing Inc., and Janus Records Inc., testified as an expert witness for respondent. Mr. Bonetti had about 30 years of experience in the recording and music industries. Mr. Bonetti is an expert in appraising master recordings. Mr. Bonetti used the potential stream of income approach to value the recordings. He considered the artist, the material, the packaging, and the production and engineering. He also synthesized414 information obtained from other sources in the recording industry. Mr. Bonetti appraised the total potential profit for six of the seven master recordings on an optimistic approach, without amortizing for acquisition costs or discounting to present values, as follows: Master RecordingPotential ProfitCarter Familyless than$ 15,000.00Owen Brothersless than3,000.00New Dawnless than3,000.00Andres Segovialess than8,000.00Hugh X. Lewis7,500.00Turner Brothersless than7,500.00Quinton Stacey3,000.00Petitioners offered into evidence an appraisal of Leo de Gar Kulka, president of Kulka, Inc. Mr. Kulka had over 30 years of experience in the recording and music business. Kulka appraised the following master recordings: Andres Segovia, Carter Family, Hugh X. Lewis, New Dawn, Turner Brothers, and Owen Brothers. Mr. Kulka was asked to research and appraise the above master recordings 4 days prior to the due date of the report. Mr. Kulka projected sales by comparing the recordings with artists he believed were of similar vintage. Mr. Kulka made numerous assumptions of how the master recordings would be packaged and marketed, without any evidence that415 petitioners actually followed these assumptions. Mr. Kulka could not provide an appraisal for New Dawn, Turner Brothers, and Owen Brothers, due to a lack of knowledge about the artists and their past activities. Mr. Kulka projected total product sales expectancy over a 5-year period for three of the master recordings as follows: Master RecordingPre-Tax Net ProfitAndres Segovia$ 381,150.00Carter Family278,966.50Hugh X. Lewis248,422.24We find Mr. Bonetti's appraisals most credible and persuasive. Buffalo Tool & Die Mfg. Co. v. Commissioner, 74 T.C. 441">74 T.C. 441, 452 (1980). Further, we give no credence to Mr. Kulka's estimated unit sales potential of the master recordings. His estimates were so exaggerated as to be unbelievable. Chiu v. Commissioner, 84 T.C. 722">84 T.C. 722, 730 (1985); Dean v. Commissioner, 83 T.C. 56">83 T.C. 56, 75 (1984); Fuchs v. Commissioner, 83 T.C. 79">83 T.C. 79, 99 (1984). We find that the values of the master recordings are no more than that appraised by respondent's expert, and the values of petitioners' shares are as follows: Actual Fair Petitioners'PetitionersMaster RecordingMarket ValueShareAccomazzoCarter Family$ 15,000$ 3,135Owen Brothers3,000627Hugh X. Lewis7,5001,500HaleAndres Segovia8,0001,600HalleyNew Dawn3,0003,000MehlickQuinton Stacey3,0001,500NaresEarly Rock3,0002,100PenixTurner Brothers7,5002,250416 We further conclude that the prices paid by Southampton and by petitioners grossly exceeded the actual fair market values of the master recordings. Petitioners' actions indicate a lack of serious investment activity. Petitioners who had partnerships had limited or no knowledge of the other partners. None of the petitioners had experience in the recording industry or in record distribution. Petitioners failed to investigate whether their respective partners had any similar experience. Petitioners lacked any experience in financial, accounting, or tax matters, yet failed to obtain independent consultation on these matters regarding their investments. Petitioners relied solely on appraisals provided by Southampton and never questioned the value determined by the appraisers. Petitioners did not conduct their activities in a way to show that a business existed. Petitioners417 failed to research the marketability of their respective master recordings, to inspect their master recordings prior to investing, and to confirm ownership of the title of the master recordings. No formal records were kept by petitioners evidencing an ongoing business and none of the petitioners prepared income/expense projections for their master recording activities. Petitioners accepted Southampton's prices for the master recordings and Indigo's prices for production/distribution, without any negotiation. In essence, petitioners accepted all terms presented by the Southampton promoters, looking only at the tax benefits set out in the promotional booklets. Petitioners' only interest was to obtain potential tax savings. In an analogous case involving book manuscripts, Barnard v. Commissioner, 731 F.2d 230">731 F.2d 230, 232 (4th Cir. 1984), affg. Fox v. Commissioner, 80 T.C. 972 (1983), the Court of Appeals commented: The long and the short of it all is that the parties demeaned themselves in entering so dishonest a venture, unquestionably structured to garner for each of the taxpayers tax advantages to which they were not entitled and devoid of 418 any realistic business purpose. In this case we confront only risk-takers who believed they proceeded on a no-loss path; [Fn. ref. omitted.] if they got away with it, well and good from their misguided point of view, and, if they did not, they would be no worse off than had they never sought the unjustified benefits in the first place. * * Based upon the foregoing analysis, we hold that petitioners' investments in the Southampton program are devoid of economic substance and were entered into solely for the income tax benefits. The investments are to be disregarded for Federal income tax purposes. We uphold respondent's disallowances as to the expense and loss deductions, the investment tax credits, and the investment tax carrybacks and carryover claimed with respect to the Southampton program. In view of our holdings, we need not discuss any alternative argument raised by respondent. Additions to Tax Section 6653Sections 6653(a) and 6653(a)(1), as applicable, impose additions to tax equal to 5 percent of the underpayment of tax if any part of the underpayment is due to negligence or intentional disregard of rules or regulations. Section 6653(a)(2), in the years applicable, 419 imposes an addition to tax in the amount of 50 percent of the interest due on the portion of the underpayment attributable to negligence. For the purposes of these sections, negligence is the failure to use due care or to do what a reasonable and ordinarily prudent person would do under the circumstances. Zmuda v. Commissioner, 731 F.2d 1417">731 F.2d 1417, 1422 (9th Cir. 1984), affg. 79 T.C. 714">79 T.C. 714 (1982); Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). Respondent's determination of negligence is presumed correct, and petitioners bear the burden of proving otherwise. Hall v. Commissioner, 729 F.2d 632">729 F.2d 632, 635 (9th Cir. 1984), affg. a Memorandum Opinion of this Court; Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 791 (1972). It was petitioners' reliance upon the purported values of the master recordings and factual statements made by Southampton and its agents that generated the investment tax credits and deductions in these cases. The purported value of the master recordings is the very thing that petitioners in these cases did not verify. See Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086, 1130 (1987),420 affd, without published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186">856 F.2d 186 (4th Cir. 1988), affd. sub nom. Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93 (9th Cir. 1989), affd. without published opinion 865 F.2d 1264">865 F.2d 1264 (5th Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 865">868 F.2d 865 (6th Cir. 1989). See also Rybak v. Commissioner, 91 T.C. 524">91 T.C. 524, 565-566 (1988). At the supplemental trial, we heard from five of the six sets of petitioners (there was no appearance by petitioners Penix) and have detailed our findings of fact. Basically, petitioners relied upon the promotional information furnished by Southampton, including the appraisals, and the tax opinion letter by Mr. Joseph Wetzel. Mr. Wetzel's letter advised persons like petitioners to seek their own tax adviser and observed that the Internal Revenue Service "will challenge some, many, or all of the tax benefits which a lessee claims." None of the petitioners consulted with an independent tax attorney about the investment and its alleged tax benefits before signing their respective master recording leases. Petitioners did not try to get421 independent appraisals of the master recordings or seek the advice of anyone with experience in the music or recording industry. Under these circumstances, petitioners' actions were not reasonable and prudent, and the underpayments of tax attributable to the Southampton claims were due to negligence. Accordingly, the additions to tax under sections 6653(a) and 6653(a)(1) are sustained in full and the additions to tax under section 6653(a)(2) are sustained as to the underpayments due to negligence. Section 6659We next consider whether petitioners are liable for the addition to tax determined under section 6659 for valuation overstatements. Section 6659 provides for an addition to tax equal to 30 percent of the underpayment of tax attributable to an overvaluation of more than 250 percent. Sec. 6659(a) and (b). The underpayment attributable to the valuation overstatement must be at least $ 1,000. Sec. 6659(d). A valuation overstatement exists if the fair market value (or adjusted basis) of property claimed on a return equals or exceeds 150 percent of the amount determined to be the correct amount. Sec. 6659(c). In McCrary v. Commissioner, 92 T.C. 827">92 T.C. 827 (1989),422 and Todd v. Commissioner, 89 T.C. 912 (1987), affd. 862 F.2d 540">862 F.2d 540 (5th Cir. 1988), this Court concluded that the tax liability was not attributable to a valuation overstatement by application of the formula whereby the underpayment for purposes of section 6659 is computed only after taking into account other proper adjustments. The same formula was applied by the Ninth Circuit, the circuit to which an appeal would lie in most of the dockets in this case, in Gainer v. Commissioner, 893 F.2d 225 (9th Cir. 1990), affg. a Memorandum Opinion of this Court, where the parties stipulated that the item in issue had not been placed in service during the taxable year in issue. McCrary involved a master recording lease program where the taxpayers had conceded prior to trial that they were not entitled to the investment tax credit because the agreement was a license and not a lease. In the instant cases, after the original trial and after respondent filed his brief and after petitioners Hale, Mehlick, Accomazzo, and Nares filed their brief on the deficiency issues, those petitioners in a letter from their counsel to respondent, offered423 to concede that the leases were tantamount to licenses and petitioners Hale offered to concede that their master recording was not placed in service in the year in which the credits were claimed, and therefore all those petitioners would concede the investment tax credit issue. These offers of concession were made shortly before the supplemental trial on the additions to tax, and respondent refused these belated concessions because, among other things, the issues relating to the deficiencies for these test cases had been tried at the original trial. At the supplemental trial, these offers of concession solely on the investment credit issue were again made by counsel on behalf of those petitioners. Respondent again made clear that respondent rejected such concessions. We agreed with respondent and concluded that we would not accept such concessions. Those petitioners had ample opportunity to concede those issues prior to the filing of their post-trial brief on the deficiency issues. (Those petitioners in their reply brief refer to the fact that Todd and McCrary were raised in their supplemental pretrial memorandum. That memorandum was not received and filed by the Court424 until more than 6 weeks after their post-trial brief.) It is obvious that these concessions were offered in an attempt to avoid the additions to tax under section 6659 under the formula applied in Gainer, McCrary, and Todd. We have previously declined to accept similar concessions. Morrissey v. Commissioner, T.C. Memo 1989-646">T.C. Memo 1989-646; Pacheco v. Commissioner, T.C. Memo 1989-296">T.C. Memo 1989-296; Looney v. Commissioner, T.C. Memo 1988-332">T.C. Memo 1988-332. We detailed in our findings of fact that petitioners made investments of $ 6,200 to $ 39,000 and claimed values of $ 80,000 to $ 680,000 for investment tax credit purposes. Where, as here, a transaction lacks economic substance, the taxpayer takes a zero basis in the asset upon which the taxpayer claims entitlement to investment tax credit. Zirker v. Commissioner, 87 T.C. 970">87 T.C. 970, 978 (1986). Petitioners' claims of investment tax credits are attributable to an asset in which they had no basis. Because petitioners overvalued their respective master recordings for more than 250 percent, petitioners are liable for the section 6659 additions to tax for valuation overstatements 425 attributable to the disallowed investment tax credits and their carrybacks and carryover at the rate of 30 percent of the underpayments of tax attributable to the disallowed investment tax credits. 6Deductions of rental, distribution costs, interest, and related expenses were not dependent upon a determination of basis or fair market value. Disallowance of these expenses does not support a section 6659 addition to tax. Soriano v. Commissioner, 90 T.C. 44">90 T.C. 44, 61-62 (1988); Zirker v. Commissioner, 87 T.C. at 980-981.426 Section 6621(c)Section 6621(c) provides for an interest rate of 120 percent of the adjusted rate established under section 6601 if there is a "substantial underpayment" (an underpayment which exceeds $ 1,000) in any taxable year attributable to one or more "tax motivated transactions." The increased rate applies to interest accrued after December 31, 1984, even though the transaction was entered into prior to that date. Solowiejczyk v. Commissioner, 85 T.C. 552">85 T.C. 552 (1985), affd. without published opinion 795 F.2d 1005">795 F.2d 1005 (2d Cir. 1986). Among the transactions enumerated in the statute as "tax motivated" is "any sham or fraudulent transaction." Sec. 6621(c)(3)(A)(v). Transactions, such as those entered into by petitioners with Southampton, which lack economic substance or business purpose, are sham transactions under section 6621(c)(3)(A)(v). McCrary v. Commissioner, 92 T.C. at 857; Patin v. Commissioner, 88 T.C. at 1128-1129. Therefore, to the extent the disallowed Southampton claims exceed $ 1,000, section 6621(c) would be applicable. Section 6673Lastly, we consider respondent's motions for the427 imposition of penalties under section 6673. That section provides for a penalty not to exceed a stated amount (now $ 25,000) to the United States when it appears to the Tax Court that proceedings before it have been instituted or maintained primarily for delay, that the taxpayer's position in such proceedings is frivolous or groundless or that the taxpayer unreasonably failed to pursue available administrative remedies. Respondent argues that such imposition of a penalty is appropriate here because these cases involve an abusive tax shelter scheme. We do not absolve petitioners from their obligation to look behind the benefits promised in the offering materials. However, in the exercise of our discretion, and on this record, we decline to impose penalties in these cases, and respondent's motions will be denied. Serious consideration of the application of the penalty provisions of section 6673 can be expected in future cases involving similarly situated taxpayers. Footnotes1. Cases of the following petitioners are consolidated herewith: Robert V. and Merla J. Hale, docket No. 41225-85; Richard H. and Sonya H. Halley, docket No. 6182-86; Ferdinand D. and Karen L. Mehlick, docket No. 10110-87; Eric H. and Patricia Accomazzo, docket No. 16546-87; and Mike S. and Linda M. Nares, docket No. 23727-87.↩2. Trial of these cases was held before Special Trial Judge Hu S. Vandervort. John W. Andrews represented all of the petitioners at the trial. Subsequently, the cases were reassigned to Special Trial Judge John J. Pajak. John W. Andrews was withdrawn as counsel by Orders of the Court. A supplemental trial on the additions to tax and damages (now penalties) issues was held before Special Trial Judge Pajak↩.3. All issues relating to petitioners Penix, Halley, Mehlick, and Nares arose from petitioners' investments in the Southampton Music Company master recordings. Petitioners Accomazzo conceded issues of unreported income for 1982. Issues unrelated to the Southampton program in petitioners Hales' case were severed prior to the trial of this case, and only a medical expense issue remains unresolved. Our discussion herein will be limited to petitioners' claimed Southampton deductions and credits and the pertinent disallowances by respondent, unless otherwise indicated.↩. 50 percent of the interest due on the underpayments due to negligence of $ 4,110.00, $ 4,566.00, and $ 837.00, respectively.↩. 50 percent of the interest due on the underpayments due to negligence of $ 5,486.00 and $ 2,308.00, respectively.↩. 50 percent of the interest due on the underpayments due to negligence of $ 7,795.00 and $ 16,162.00, respectively.↩. 50 percent of the interest due on the underpayments due to negligence of $ 20,485.00, $ 8,501.00, and $ 11,544.00, respectively.↩. 50 percent of the interest due on the underpayments due to negligence of $ 4,282.00, $ 16,763.00, and $ 11,891.00, respectively.↩. 50 percent of the interest due on the underpayments due to negligence of $ 7,648.00, $ 5,884.00, and $ 8,750.00, respectively.↩4. Use of terms such as "lease," "invest," "acquire," and "price" should not be construed as carrying any conclusion as to the actual substance or legal effect of the documents or transactions described.↩. Not disclosed in the record.↩5. Even though Mr. James T. Burnes does not represent petitioners Halley in docket No. 6182-86, in his brief filed on behalf of those petitioners he does represent, Mr. Burnes asserts that the notices of deficiency sent to the Halleys are invalid under Scar v. Commissioner, 814 F.2d 1363">814 F.2d 1363 (9th Cir. 1987), revg. 81 T.C. 855">81 T.C. 855 (1983). Because an appeal of the Halleys' case lies with the Ninth Circuit, we deem it appropriate to address this assertion. First, neither the Halleys' then counsel nor Mr. Richard H. Halley, who was a witness at the original trial, ever raised this assertion. Mr. Halley did not raise any such assertion at the supplemental trial. Second, we believe the facts in the Halley case distinguish it from those in the Scar case. In Scar v. Commissioner, 814 F.2d at 1368↩, the Ninth Circuit concluded that: "the Commissioner must consider information that relates to a particular taxpayer before it can be said that the Commissioner has 'determined' a 'deficiency' in respect to that taxpayer." [Footnote omitted.] As can be seen in our findings of fact, the disallowances related exactly to the amounts claimed by the Halleys. The notices of deficiency refer to the amounts of taxable income shown on the Halleys' returns and state that the adjustments were discussed with the Halleys' then representative. The only error is a reference to "CHILDREN'S CLASSICS/MPO TRUST (Master Recording only)" on a schedule in each of the two notices of deficiency. The Halleys and their then representative were not misled by what appears to be an identical typographical error in the two notices of deficiency, which considered information that related to the Halleys and made the deficiency determinations in issue.. Because no evidence was presented, in the context of this case we find that Early Rock had an actual fair market value of no more than $ 3,000.00↩6. Section 6659 applies for returns filed after December 31, 1981. Although some petitioners filed returns for 1979, and some petitioners filed returns for 1980 prior to December 31, 1981, they are liable for the additions to tax under section 6659 because the underpayments of tax for those years are attributable to the carryback of unused investment tax credits claimed on the returns for the year 1982 and/or 1983, as relevant to the particular petitioners. Nielsen v. Commissioner, 87 T.C. 779">87 T.C. 779↩ (1986).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621458/	BADIAS & SEIJAS, INC. (A Liquidated Corporation), Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBadias & Seijas, Inc. v. CommissionerDocket No. 5319-75.United States Tax CourtT.C. Memo 1977-118; 1977 Tax Ct. Memo LEXIS 324; 36 T.C.M. (CCH) 518; T.C.M. (RIA) 770118; April 25, 1977, Filed Charles L. Ruffner,Sydney S. Traum and H. P. Forrest, for the petitioner. Curtis O. Liles, III, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined deficiencies in the Federal income tax of petitioner, Badias & Seijas, Inc. in the amounts of $102,345.03, $96,513.97 and $96,562.18325 for the calendar years 1969, 1970 and 1971, respectively. Respondent also determined additions to tax under section 6653(b), I.R.C. 1954, 1 in the amounts of $51,172.52, $48,256.99 and $48,281.09 for the calendar years 1969, 1970 and 1971, respectively. Some of the issues raised by the pleadings have been disposed of by agreement of the parties leaving as the sole issue for decision whether petitioner adopted a plan of liquidation on or before the date of sale of its operating assets, and within 12 months from the date of adoption of such plan distributed all assets to its shareholder in complete liquidation so that section 337 is applicable. FINDINGS OF FACT Petitioner Badias & Seijas, Inc. is a dissolved Florida corporation. It was dissolved by the State of Florida on July 2, 1973.On the date of dissolution the sole shareholder of petitioner was Felipe Valls, who resided then and at the time the petition in this case was filed in Miami, Florida. Petitioner filed its Federal corporate income tax returns for the calendar years 1969, 326 1970 and 1971 with either the District Director of Internal Revenue at Jacksonville, Florida or with the Director, Internal Revenue Service Center at Chamblee, Georgia. Petitioner was incorporated under the laws of the State of Florida on April 12, 1965, for the purpose of operating a restaurant business in Miami, Florida. The authorized, issued and outstanding stock of petitioner was 100 shares of common stock. At the end of 1969, Mr. Seijas and Mr. Garcia owned 50 shares each of the common stock in petitioner.During 1970, Felipe Valls acquired a 50 percent interest in petitioner resulting in equal ownership with Mr. Seijas. In October 1971, Mr. Valls purchased Mr. Seijas' common stock of petitioner for $31,400. This transaction resulted in Mr. Valls owning 100 percent of the authorized, issued and outstanding common stock of petitioner. On November 5, 1971, Florentino Perez entered into a contract with petitioner acting by its president, Felipe Valls, to purchase the business known as Badias Restaurant, which was the sole operating asset of the corporation. When Mr. Valls decided to sell the restaurant business, he intended to sell the corporate stock of petitioner. He327 and Mr. Perez had approximately two business discussions with respect to the sale. Mr. Valls understood that Mr. Perez was unwilling to purchase petitioner's stock because of advice he received from his accountant. An oral agreement was reached between Mr. Valls and Mr. Perez that Mr. Perez would purchase the restaurant, and a price was established. Mr. Perez then went to his attorney to have the papers drafted that would be necessary to effectuate the sale. The documents prepared by Mr. Perez' attorney were for the purchase of the operating assets, other than cash and receivables, of petitioner rather than the stock owned by Mr. Valls. The contract between Mr. Perez and petitioner executed on November 5, 1971, provided in pertinent part as follows: RECEIPT IS HEREBY ACKNOWLEDGED OF THE SUM: Two Thousand Five Hundred Dollars ($2,500.00) as a deposit and part of the purchase price of the following described business upon the terms and conditions stated herein. One certain business known as BADIAS RESTAURANT, located at 1542-1550 S.W. 8th Street, Miami, Florida. Seller agrees to transfer to the buyer all of its right, title and interest in the name, the goodwill, leasehold328 interest, merchandise and all fixtures, equipment and furniture, and rent and utilities deposits located therein. Purchase price shall be Sixty Eight Thousand One Hundred Two Dollars 00/100 ($68,102.00). The terms and conditions of sale are as follows: $2,500.00 in cash at the time of closing from which this deposit is a part. Buyer will execute a Chattel Mortgage and a promissory note for the amount of $65,602.00 to be paid to the seller in 48 monthly installment payments bearing interest of 9% and with a grace period of 45 days for each payment. The first 12 payments will be $800.00 each. It is agreed and understood that this transaction is subject to the buyer obtaining the transfer of certain lease dated September 8th, 1971, between SEVA INC. and BADIAS CEIJAS INCORPORATED. The assignment of the lease must have a statement from the Landlord in regard of that this such lease includes for the same rent the storage room, in a separate building and the tenants rights to use the 100% of the parking lot of the building less two parking spaces. The seller agrees to surrender position of the premises at the time on which this deposit will be signed. It is agreed329 and understood that the seller will sign all the transfer forms and shall cooperate to transfer the beer and wine licenses to the buyer, being responsibility of the seller make all the necessary repairs in order to obtain the approval of the Zoning and Building Department of the City of Miami. (Pink form for transfer beer and wine licenses). Personal Property tax and Insurance Policies will be prorated as of the date of this Deposit Receipt against the first payment of the promissory note to be executed by the buyer to the seller. FELIPE VALLS as sold (sic) stockholder of seller's corporation and as 50% stockholders of SEVA INC., the owner of the building agrees that he will try in all the possible ways that SEVA INC. will grant an option for rent the store located at 1538 S.W. 8th Street, and an option to extended (sic) the actual lease to be assigned, for an additional term of five more years. It is agreed and understood that seller has only the right to use the name of BADIAS RESTAURANT in this particular business, and the transfer of their interest in the name can not be constructed as the sale of the name and only the transfer of their rights of use [of] the name. 330 FELIPE VALLS as seller and as President of International Equipment Inc., will give a guarantee in all the equipment located in this premises for the term of 90 days, on parts except compressors and labor. Buyer must be (sic) increase the fire insurance on this business to a minimum amount owed to seller. It is agreed and understood that seller and buyer accept that there is a concession agreement for the operation of the Cuban Coffee Shop which expires on May 19, 1973. Buyer is acting as an agent of a corporation to be formed in the State of Florida. The seller convenants and agrees to comply with the Bulk Sales requirements of the Uniform Commercial Code. The seller hereby expressly warrants that it has full power and authority to convey the said business according to the terms and conditions as hereinabove set out; and the seller affirms that it has good title to all goods listed on the said property and that there are no outstanding liens, security interest, or encumbrances whatsoever, except those listed herein. That this instrument contains the entire agreement of the parties to this transaction and there are no representation, warranties, or agreements, either331 written or oral, expressed or implied, except those contained herein. Seller agrees not to compete in a similar business for five years within a radius of 10 blocks. It is agreed and understood that the risk of loss pending closing shall be in the buyer's responsibility. At the time of closing the seller agrees to furnish the buyer with an affidavit which shall set forth the following: 1. That the seller is not the plaintiff or defendant in any pending litigation, nor is there any judgment pending against the seller. 2. That the seller is not the subject of any bankruptcy or insolvency proceedings. 3. That at the time of closing there shall be no debts due and owing by the seller to any third party. On November 5, 1971, further documents were executed with respect to the sale. Mr. Perez executed a promissory note in the amount of $65,602 payable to "Badia's - Seijas, Inc., a Florida corporation." The note stated that it was secured by a chattel mortgage on the assets of the restaurant and that the deferred payments were to bear interest at a 9 percent rate. The sum was payable $800 per month for the first 12 payments with the remaining payments consisting of 36332 monthly payments of $1,963.56 each. On the same date, petitioner, by its president, Mr. Valls, executed and delivered a bill of sale of the assets of the restaurant in favor of Mr. Perez. Attached to the bill of sale was an itemized list of all assets of the restaurant setting out approximately 100 different items with an inventory count of each item enumerated. Other documents executed by Mr. Valls as president of petitioner included affidavits prepared by the attorney of the purchaser. One affidavit provided, among other things, that petitioner was the owner of the furniture, merchandise, fixtures, and equipment located at the restaurant and that such items were not encumbered by any liens. The other affidavit provided that Mr. Valls had been elected president of petitioner at a board meeting held on September 9, 1971; that a special meeting of the board of directors had been held on November 5, 1971, at which meeting a resolution for the sale and transfer of the assets of the corporation was adopted; and that the president of the corporation was authorized to execute documents to effectuate the sale by the corporation. Additionally, an assignment of lease, acceptance of assignment333 and consent to assignment were executed by Mr. Valls as president of petitioner to allow the lease on the premises occupied by the restaurant, which were owned by a corporation partially owned by Mr. Valls, to be assigned to the purchaser. Mr. Valls asked the attorney for the purchaser who prepared the documents with respect to the sale to take the documents to his attorney to look over. Subsequent to the purchase date, Mr. Perez transferred the purchased assets to his wholly owned corporation named Badias Restaurant, Inc. Petitioner's cost of the assets sold to Mr. Perez was $44,563.91. The depreciation previously allowed on those assets was $23,066.56, leaving an adjusted basis of $21,497.35. Mr. Perez made the first payment of $800 by a check dated December 6, 1971, made payable to Felipe A. Valls. Payment was made directly to Mr. Valls because Mr. Valls had so requested. The following 13 monthly payments, through January 10, 1973, were made by checks drawn upon the account of Badias Restaurant, Inc. and made payable to Felipe A. Valls. These 14 checks totaled $13,527.12. Mr. Valls intended, when all petitioner's operating assets were sold on November 5, 1971, to take334 for his own use the payments on the note and the funds in petitioner's bank account, which were petitioner's only other assets. On some date subsequent to the sale of the assets to Mr. Perez, the State of Florida, Department of Revenue, Sales Tax Division, conducted an audit of petitioner's business for a period beginning November 1969 through October 1971. As a result of this audit, the Sales Tax Division determined that there was an additional sales tax due from petitioner for the period under audit in the amount of $16,727.43. The total amount including penalties and interest was determined to be $23,042.04. Thereafter, from at least March 1973 through February 1974, Mr. Perez' corporation, Badias Restaurant, Inc., purchased at least 10 cashier's checks at the Riverside Bank of Miami, Florida totaling $19,509.61 payable to the Department of Revenue. Mr. Valls did not acknowledge the sales tax liability and did not agree that the payments to the Department of Revenue could be offset against the liability on the promissory note. Following the payment of these checks, Mr. Perez began making payments to petitioner, rather than to Mr. Valls personally. On February 14, 1974, Mr. 335 Perez' corporation purchased a cashier's check made payable to Badias Seijas, Inc. in the amount of $125.99. From March 1, 1974 through November 5, 1975, 20 checks totaling $39,271.20, each in the amount of $1,963.56 were drawn on the corporate account of Badias Restaurant, Inc. and made payable to petitioner. However, a check drawn on June 23, 1975, in the amount of $1,963.56 was made payable to Felipe A. Valls. Mr. Perez began making the checks payable to petitioner rather than Mr. Valls following the audit by the State of Florida because he had been advised to do so by his accountant. All of the checks drawn by Mr. Perez or caused to be drawn by him and made payable to Mr. Valls or petitioner were actually received by Mr. Valls. 2 All of the checks received from the purchaser were, immediately upon receipt, used to discharge personal obligations of Felipe Valls. Mr. Valls had difficulty in attempting to negotiate some of the checks made payable to petitioner. The bank where he presented the checks for payment would not accept his handwritten endorsement of the corporate name above his own name placed upon the checks. He then had rubber stamps prepared reflecting the name336 of petitioner with Felipe A. Valls shown as president and a stamp bearing "pay to the order of Felipe A. Valls." However, most of the checks made payable to petitioner were negotiated by Mr. Valls, by endorsing the checks in his own handwriting.Thus, Mr. Valls received the proceeds of the checks made payable to petitioner without depositing the checks in the checking account of petitioner. Following the sale of the assets, petitioner's corporate bank account showed reduced activity. The funds in the account were used to pay bills of petitioner and to make distributions to Mr. Valls. The proceeds distributed to Mr. Valls were used to discharge personal obligations or to pay petitioner's obligations, the balance of which had been assumed by Mr. Valls. The corporate account reached a zero balance on August 4, 1972. On August 11, 1972, Mr. Valls deposited $10 to the account which had incurred debit memos of a nominal amount. The account337 was closed on December 7, 1972. Felipe A. Valls, the sole shareholder of petitioner on the date of sale of the assets, was born in Santiago, Cuba. He came to the United States as a permanent resident in December 1960. He initially obtained employment as a salesman for a restaurant supply business, where he worked for approximately 2 years. Following this, petitioner went into business for himself in the form of a sole proprietorship to sell international business equipment. In 1964 Mr. Valls incorporated Feva Corporation, which owned the building where he conducted his equipment business. Mr. Valls has also held an interest as a shareholder in several other closely held corporations. He owned all of the stock of Elliott Trail Investments which was incorporated to obtain financing to commence a business. Mr. Valls owed 50 percent of Flava Plaza Investment Corporation which was incorporated for the purpose of obtaining financing to construct a building for a business. He owns 100 percent of Cova Corporation which was incorporated for the purpose of operating a restaurant. He owns 50 percent of Vallamo Corporation which was incorporated for the purpose of operating a restaurant.338 He owns 50 percent of Elival Corporation, which was formed in 1970, and owns real estate. Mr. Valls also owned 50 percent of Seva Corporation which was formed in 1971 for the purpose of owning the building in which petitioner's restaurant business was operated and leasing that building to petitioner. It is customary for Mr. Valls to consult an attorney for the purpose of drafting any necessary documents after he has decided to enter a business deal. On the Federal corporate income tax return filed by petitioner for the calendar year 1971 the balance sheet totals for the end of the taxable year included as assets those items sold in November 1971. This return did not indicate that it was a final return of petitioner or that any of the assets of the restaurant business had been sold. 3 No interest income was reported on the return. The return was prepared by the same accountant who had prepared petitioner's income tax returns for 1969 and 1970. No formal plan of liquidation339 was adopted by petitioner. Also, there was no written assignment by petitioner to Mr. Valls of the promissory note or chattel mortgage received pursuant to the sale of petitioner's assets. Mr. Valls, on his individual Federal income tax returns filed for 1971 and 1972, did not report any of the proceeds from the sale of the assets of petitioner to Mr. Perez. 4 Mr. Valls discussed with a representative of a bank the possibility of discounting the note petitioner received on the sale of its assets, but did not pursue the matter further when he was advised by the bank representative that the amount received upon discount of the note would be substantially less than its face value. In the statutory notice of deficiency, respondent included in the income of petitioner in 1971 the gain realized upon the sale of the assets of the restaurant business with the following explanation: (c) Sale of Assets It was determined that on November 5, 1971 the assets of the corporation were sold, and from which you realized ordinary income and capital gains. The sale does not340 qualify as a Section 333 liquidation because no required election had been filed, nor does the sale qualify as a Section 337 liquidation because you did not liquidate within the required twelve month period. Thus your taxable income is increased $46,604.65 for 1971, computed as follows: Cost of Assets per Return$44,563.91Less: Depreciation Allowedon Assets23,066.56Adjusted Basis$21,497.35Selling Price$68,102.00Adjusted Basis21,497.35Gains46,604.65Section 1245 Gain -- Ordinary Income$23,066.56Section 1231 -- Capital Gain23,538.09$46,604.65OPINION Section 337(a)5 provides, in general, that if a corporation adopts a plan of complete liquidation and within a 12-month period distributes all assets of the corporation, less those required to meet claims, no gain or loss is recognized to the corporation from the sale or exchange of property within the 12-month period. 341 Petitioner takes the position that under this provision no gain should be recognized from the sale of the operating assets of the restaurant business. It is petitioner's contention that an informal plan of liquidation was adopted on November 5, 1971, the date of sale of the assets, and on the same date the promissory note received from the purchaser upon the sale was equitably assigned by petitioner to its sole shareholder, Felipe A. Valls. Thus, petitioner concludes that a plan of liquidation was adopted and the assets distributed within a 12-month period, thereby meeting the statutory requirements of section 337. It is respondent's position that petitioner did not adopt a plan of liquidation and, in any event, if we should determine that petitioner adopted a plan of liquidation, the assets were not distributed within a 12-month period from the date of the adoption of a plan. 6342 No formal plan of liquidation was adopted by petitioner. However, the failure to adopt a formal plan of liquidation is not dispositive of the issue. It is clear from the cases that the adoption of a plan of liquidation within the meaning of section 337 does not require the adoption of a formal resolution of liquidation by the directors or stockholders. The determination of whether a plan of liquidation existed at the time of the sale of the assets is a question of fact. In Mountain Water Co. of La Crescenta v. Commissioner,35 T.C. 418">35 T.C. 418 (1960), we stated at page 426 that: If all the facts and circumstances indicate that the assets were in fact sold as a part of a plan to liquidate the company and the corporation in fact goes out of business and distributes its assets in complete liquidation within the 12-month period, it would seem that that purpose has been accomplished. * * * In the instant case the record is clear that all the assets of petitioner were in fact sold. The record is also clear that at the time these assets were sold Mr. Valls, petitioner's sole stockholder,343 intended to take the funds from the sale of petitioner's assets and its remaining assets consisting of cash and receivables for his own use. While the record is not completely clear with respect to the intent of Mr. Valls for any further use of the corporate form, on the basis of the record as a whole, we conclude that the preponderance of the evidence supports petitioner's contention that Mr. Valls did not intend to use petitioner's corporate form any further but to let its existence cease or let petitioner "die." These facts are substantially the same as facts we recited in Alameda Realty Corporation v. Commissioner,42 T.C. 273">42 T.C. 273, 281 (1964), as being indicative of a plan to liquidate the corporation. In that case we stated: The facts of the instant case show that after receiving an offer for the purchase of the Finance Building, but being unable to persuade the offeror to buy the Alameda stock instead, Raymond and Irma (the sole stockholders and directors of Alameda) decided to accept the offer and take the money received by Alameda from the sale of the building for their own use. The facts show that this decision was made on or shortly prior to October 6, 1955, when344 Alameda entered into the contract to sell the Finance Building. The facts further show that the Finance Building was Alameda's only operating asset. After Alameda sold the Finance Building, its only asset other than debts due it by Raymond and Irma, was money and Raymond and Irma withdrew this money for their personal use as they planned to do when they agreed to have Alameda sell the building. These facts show a plan of liquidation and distribution of assets. * * * In our view, the facts quoted above parallel the facts in the instant case. Here, Mr. Valls, being unable to sell petitioner's stock, decided to sell petitioner's assets and to take the money received by petitioner from the sale for his own use. The facts show that this decision was made on or shortly prior to November 5, 1971, when petitioner entered into the contract to sell its assets. The facts further show that all of petitioner's assets except accounts receivable and cash were sold. Also, the facts here show that Mr. Valls withdrew from petitioner's bank account for his personal use all petitioner's funds not needed for paying petitioner's debts and took the payments made on the note given for petitioner's345 assets for his own use. There were additional facts in the Alameda Realty Corporation case supporting our conclusion that section 337 applied to the sale of the building owned by that corporate taxpayer that are not present in the instant case. In the Alameda Realty Corporation case the facts showed that the corporation for the year that its assets were sold filed a Federal tax return marked "Final Return," which return showed no assets or liabilities and a distribution of all of its assets to its stockholders. In the instant case, petitioner filed a return for 1971 that showed it still owned the assets which it had in fact sold. Petitioner's return for 1971 was not marked "Final Return" and in no way indicated that its assets had been sold or that any amount had been distributed to its stockholders. Also, in the case of Alameda Realty Corporation, the stockholders of the corporation reported on their Federal income tax return for the year of the sale long-term capital gains from the disposition of their stock in the corporation. Mr. Valls, in the instant case, did not reflect on his return for 1971 any information with respect to the disposition of his stock in petitioner. 346 Respondent on brief suggests that the reason petitioner's tax return and Mr. Valls' tax return were filed as they were for the year 1971 was that Mr. Valls did not intend that tax be paid by either petitioner or by him personally on the disposition of petitioner's assets. The fact that the returns were filed as they were lends some support to respondent's contention in this regard. However, Mr. Valls did offer as a reason for his failure to report the transaction the fact that he thought the note which he believed had been assigned to him by the corporation had no ascertainable fair market value and therefore no amount should be reported by him until he had recovered the basis of his stock in petitioner through payments he received by taking the payments due on petitioner's note. Considering Mr. Valls' lack of expertise it is not beyond belief that Mr. Valls would arrive at such a conclusion.There is no evidence in the record to the contrary. Little support or lack of support of petitioner's contention can be drawn from the manner in which the corporate tax return was filed. Regardless of whether any income was reported from the sale of the corporate assets, petitioner's347 1971 return should not have shown those assets as being on hand at the end of 1971 when they in fact had been sold. The corporate return also contained a number of other errors, such as showing Mr. Valls as only a 50 percent stockholder when in fact he owned 100 percent of the stock. In considering the evidence as a whole, we conclude that the facts here which parallel those in the Alameda Realty Corporation case are the vital facts to show a plan of corporate liquidation and distribution of assets. As was stated in Kennemer v. Commissioner,96 F.2d 177">96 F.2d 177, 178 (5th Cir. 1938), affirming 35 B.T.A. 415">35 B.T.A. 415 (1937): [An] intention to liquidate was fairly implied from sale of all assets of corporation and act of distributing the cash to the stockholders. * * In that case the court referred to the "determining element" as being the intention to liquidate the business coupled with the actual distribution of the cash to the stockholders. Here, as in MountainWater Co. of La Crescenta v. Commissioner, supra, the facts show that the assets348 were in fact sold as a part of a plan for the corporation to "liquidate" in that it would cease business and go out of existence by having its charter revoked by the state, and the corporation did in fact go out of business. On the basis of this record, we conclude that the preponderance of the evidence supports petitioner's position that it had adopted an informal plan of liquidation as of November 5, 1971. However, it is still incumbent upon petitioner to show that its assets were distributed to its stockholders within a 12-month period following the adoption of the plan of liquidation in order for section 337 to be applicable. The record shows that the bank account of petitioner, which constituted petitioner's only asset other than the note received from the sale of its operating assets, was distributed to Mr. Valls within one year following November 5, 1971. The question then is whether the note received by petitioner was distributed to its stockholder, Mr. Valls, within 12 months following November 5, 1971. If the note was not distributed to Mr. Valls, but merely the collection proceeds of the note, then petitioner has failed to meet the requirements of section 337 that349 the corporate assets be distributed to its stockholders within a 12-month period. As petitioner points out, and respondent agrees, Florida law recognizes the doctrine of equitable assignment of a note in cases where doctrine is necessary to effectuate the intent of the parties. An oral assignment is effective as an equitable assignment under Florida law. Sammis v. L'Engle, 19 Fla. 800">19 Fla. 800 (1883). In Asphalt Paving Inc. v. Ulery, 149 So. 2d 370">149 So.2d 370, 375 (Fla. 1963), the court stated: Any words or transactions showing an intention on one side to assign and on the other to receive, if supported by a valuable consideration, will operate as an effective equitable assignment. [Citation omitted.] * * * The direction by Mr. Valls to Mr. Perez to make the payments on the note to him, coupled with Mr. Valls' position as president and sole stockholder of petitioner and his use of the funds received for his own purposes, is sufficient in our view under Florida law to show an equitable350 assignment of petitioner's note to Mr. Valls. Certainly, Mr. Valls as president and sole stockholder of petitioner would have been better advised to have made a formal assignment of petitioner's note to himself.However, in spite of the many business operations in which Mr. Valls had been engaged, it was apparent that he did not truly understand the niceties of the distinction between corporate ownership and individual ownership of property, or the formalities with which transactions should be undertaken to assure the intended result is attained. On this record we conclude that the direction by Mr. Valls to Mr. Perez at the time he, on behalf of petitioner, executed the sale of petitioner's assets to Mr. Perez to pay him personally for the assets amounted to an equitable assignment of petitioner's note to Mr. Valls. The consideration for the assignment was of course petitioner's stock which Mr. Valls at that time planned in effect to surrender by permitting the corporate life to expire and the charter to be taken by state law. While the facts in the instant case are not as clear-cut as have been facts in some prior cases, from the record as a whole we conclude that petitioner351 did adopt a plan of liquidation prior to or on the date of the sale of its assets and did, within 12 months, distribute all of its assets to its stockholders.Therefore, the sale of petitioner's assets falls within the provisions of section 337. Decision will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. There remains a dispute between Mr. Valls and Mr. Perez as to whether the payments made to the Florida Department of Revenue for delinquent sales tax reduced the principal and interest due on the promissory note executed on November 5, 1971.↩3. The return included none of the information specified under sec. 1.337-6(a), Income Tax Regs.In↩ addition, Form 966 which is required to be filed under sec. 6043 was not filed.4. Mr. Valls reported interest income of $89 on his 1971 return, but the source of this interest is not shown.↩5. For the taxable year in issue sec. 337, in relevant part, provided as follows: SEC. 337. GAIN OR LOSS ON SALES OR EXCHANGES IN CONNECTION WITH CERTAIN LIQUIDATIONS. (a) General Rule.--If-- (1) a corporation adopts a plan of complete liquidation on or after June 22, 1954, and (2) within the 12-month period beginning on the date of the adoption of such plan, all of the assets of the corporation are distributed in complete liquidation, less assets retained to meet claims, then no gain or loss shall be recognized to such corporation from the sale or exchange by it of property within such 12-month period. (b) Property Defined.-- (1) In general.--For purposes of subsection (a), the term "property" does not include-- (A) stock in trade of the corporation, or other property of a kind which would properly be included in the inventory of the corporation if on hand at the close of the taxable year, and property held by the corporation primarily for sale to customers in the ordinary course of its trade or business, (B) installment obligations acquired in respect of the sale or exchange (without regard to whether such sale or exchange occurred before, on, or after the date of the adoption of the plan referred to in subsection (a)) of stock in trade or other property described in subparagraph (A) of this paragraph, and (C) installment obligations acquired in respect of property (other than property described in subparagraph (A)) sold or exchanged before the date of the adoption of such plan of liquidation. (2) Nonrecognition With Respect to Inventory in Certain Cases.--Notwithstanding paragraph (1) of this subsection, if substantially all of the property described in subparagraph (A) of such paragraph (1) which is attributable to a trade or business of the corporation is, in accordance with this section, sold or exchanged to one person in one transaction, then for purposes of subsection (a) the term "property" includes-- (A) such property so sold or exchanged, and (B) installment obligations acquired in respect of such sale or exchange. Sec. 337(a)↩ was amended by the Tax Reform Act of 1976, 90 Stat. 1520, P.L. 94-455.6. It should be noted that in the statutory notice of deficiency respondent has asserted that section 1245 is applicable, thereby bringing about the imposition of the recapture rules of that provision. Petitioner has raised no issue with respect to this determination. The application of the recapture provisions of section 1245 takes precedence over the nonrecognition provisions of section 337 so that if we determine the statutory requirements of section 337 have been met, petitioner is still required to recognize gain in the amount of $23,066.56. Section 1.1245-6(b), Income Tax Regs.; Clayton v. Commissioner,52 T.C. 911">52 T.C. 911 (1969). See also Troy State University v. Commissioner,62 T.C. 493">62 T.C. 493 (1974). It may be that this amount is included in the following stipulation of the parties: In the tax year 1971 the petitioner's net taxable income is to be increased $23,352.86 considering both additional expenses and unreported gross receipts.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4621391/	Ciro of Bond Street, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentCiro of Bond Street, Inc. v. CommissionerDocket No. 15420United States Tax Court11 T.C. 188; 1948 U.S. Tax Ct. LEXIS 105; August 19, 1948, Promulgated 105 Decision will be entered under Rule 50. Petitioner is a New York corporation with a small capital stock and is wholly owned by a parent corporation located in London, England. Petitioner's invested capital was insufficient to enable it to get started in business. In 1939, the year of its incorporation, the parent corporation made advancements to petitioner of some $ 96,000 to enable it to get started in business. Petitioner at the time of these advancements did not execute to the parent corporation any evidence of such indebtedness, but at the end of the year it wrote letters to the parent corporation acknowledging that it was indebted for the advancements. Held, the letters were not "certificates of indebtedness" as that term is used in section 719 (a) (1) and the advancements can not be included as "borrowed invested capital" under section 719, I. R. C.Harold Manheim, Esq., for the petitioner.J. J. Madden, Esq., for the respondent. Black, Judge. BLACK 188 The Commissioner has determined a deficiency in petitioner's income tax for the year 1940 of $ 169.55, a deficiency in petitioner's declared value excess profits tax for the same year of $ 64.07, and a deficiency in 189 petitioner's excess profits tax for the same year of $ 1,120.92. He has also determined a deficiency in petitioner's excess profits tax for the year 1941 of $ 2,006.46. The petitioner contests only the deficiencies in excess profits tax and as to that determination assigns error as follows:In computing invested capital, the Commissioner failed to include any part of the amount due from taxpayer during the taxable year to Ciro Pearls, Ltd., London as a part of its average borrowed capital.The Commissioner, in making the adjustment against which the petitioner complains in its assignment of error, explained it as follows in his deficiency notice:It is held that in computing equity invested capital, no part of the amount allegedly due Ciro Pearls, Ltd., 107 London, England, should be included as a part of the average borrowed capital.FINDINGS OF FACT.Most of the facts have been stipulated and the stipulation of facts is incorporated herein by reference.The petitioner is a New York corporation, organized on April 24, 1939. It is engaged in the business of selling costume jewelry and pearls. Its returns for the taxable years involved herein were filed with the collector of internal revenue third district of New York.Petitioner is wholly owned by Ciro Pearls, Ltd., a British corporation which has its principal office at London, England.Petitioner was organized in 1939 with a paid-in capital of $ 10,000. The paid-in capital of the petitioner was insufficient to take care of its capital needs. During the taxable years in question petitioner required for its business capital investments of sums substantially in excess of $ 100,000 for the following purposes, among others: For the alteration of its business premises at 711 Fifth Avenue and for furnishing the same, in excess of $ 20,000, and for merchandise inventory between $ 75,000 and $ 100,000. During the year 1939 Ciro Pearls, Ltd., advanced to petitioner the sums of $ 67,657.75108 and # 6,966.6.6. This sterling amount was converted by petitioner into dollars on its books at the rates of exchange prevailing when the advances in question were made, making a total advance in terms of dollars amounting to $ 96,201.10.Petitioner at the time of the advances did not issue in connection therewith any evidence of indebtedness. The amount of this indebtedness was set forth by petitioner in the amount of $ 96,201.10 in its annual statements for the two taxable years rendered by it to Ciro Pearls, Inc., which were retained by the latter without objection. Exhibits "1A" and "2B" attached to the stipulation of facts are letters written by petitioner to Ciro Pearls, Ltd., dated December 30, 1939, certifying for 190 the purpose of audit that at such time there was owing to Ciro Pearls, Ltd., certain sums of money. These letters were as follows:ThirtiethDecember1939Ciro Pearls Ltd.,178, Regent Street,London . . . W. 1.Dear Sirs,For the purpose of your audit we hereby certify that there is owing to you at this date from this Company the sum of 67,657.75 U. S. Dollars.No interest is payable in respect of this indebtedness, which is to be repaid when this109 Company is in a position to do so.Yours faithfully,p. p. Ciro of Bond Street, Inc.[Signed] H. M. PenneyThirtiethDecember1939Ciro Pearls Ltd.,178, Regent Street,London . . . W. 1Dear Sirs:For the purpose of your audit we hereby certify that there is owing to you at this date from this Company the sum of # 6,096.6.6 sterling.No Interest is payable in respect of this indebtedness, which is to be repaid when this Company is in a position to do so.Yours faithfully,p. p. Ciro of Bond Street, Inc.[Signed] H. M. PenneyThe moneys advanced by Ciro Pearls, Ltd., to petitioner were used exclusively for business purposes and represented a necessary part of the capital funds used in petitioner's business.OPINION.The only issue we have to decide in this proceeding is whether the petitioner is entitled, under section 719 (a) (1) of the Internal Revenue Code, 1 to include in borrowed capital sums advanced to petitioner by its parent corporation, Ciro Pearls, Ltd., of London, England.110 Petitioner's brief lays much stress on the fact that the advancements made to petitioner by its parent corporation were made for bona fide business purposes and were fully recognized by petitioner on its books as an indebtedness which it owed its parent corporation. We have no doubts at all as to the bona fide character of the advancements in question nor that they represented an indebtedness of a sort to the parent 191 corporation, but we do not think these advancements represented "borrowed invested capital" as defined in section 719 (a) (1) of the code. The contention which petitioner makes is very similar to that which was made by the taxpayer in Pendleton & Arto, Inc., 8 T.C. 1302">8 T. C. 1302. In that case we pointed out the taxpayer's contentions as follows: * * The petitioner, contending that the statute is satisfied by the situation presented, reviews many cases to demonstrate that there is indebtedness, arguing also that the money advanced to the petitioner had a business purpose, and that the transaction was bona fide. * * We then went on to point out that these things were not enough, that the "borrowed capital" which the statute prescribed111 must be in the form described by the statute. In discussing that particular requirement we said:* * * The statute enumerates certain forms of indebtedness as coming within its bounds. Inclusio unius est exclusio alterius. Other forms were, we think, clearly intended to be excluded. This can only fairly mean that the mere presence of operating capital obtained can not, alone, satisfy the statute, but it must be represented by established forms of debt. Mere open account was not included, and we have heretofore considered it was not intended. Flint Nortown Theatre Co., 4 T. C. 536. Economy Savings & Loan Co., 5 T. C. 543, involving certificates of deposit, does not demonstrate the arrangement here to be a certificate of indebtedness. It has no attribute of an investment security, such as issued by corporations. Regulations 112, sec. 35.719-1 (d), covering the section here involved. * * We then decided that the advancements which the parent corporation had made to the taxpayer in that case did not represent "borrowed invested capital" within the meaning of section 719 (a) (1).Of course, the facts in the 112 instant case are somewhat different from those present in Pendleton & Arto, Inc., supra, but the controlling principle is, we think, the same. Petitioner does not contend that in the instant case there was any bond, note, bill of exchange, debenture, mortgage, or deed of trust mentioned in section 719, but it does contend that the advancements to it by the parent corporation were evidenced by "certificates of indebtedness" within the meaning of that term as used in section 719 (a) (1).Section 35.719-1 (d), Regulations 112, to which we referred in Pendleton & Arto, Inc., supra, reads as follows:The term "certificate of indebtedness" includes only instruments having the general character of investment securities issued by a corporation as distinguishable from instruments evidencing debts arising in ordinary transactions between individuals. * * It seems clear that in the instant case the advancements made by the parent corporation to the petitioner were not evidenced by "certificates of indebtedness" within the meaning of the statute or the foregoing regulations. The only written evidence here to evidence petitioner's113 192 indebtedness to its parent corporation for the advances made to it were letters written for audit purposes and dated December 30, 1939, which are embodied in our findings of fact. It seems clear to us that these letters can not qualify as "certificates of indebtedness" within the meaning of the applicable statute and regulations, and we so hold. Even if the letters to which we have referred qualified as "certificates of indebtedness" in matter of form, they would still be lacking one essential quality, and that is a maturity date. The letters contain this provision: "No interest is payable in respect of this indebtedness, which is to be repaid when this Company is in a position to do so."Clearly, the above language fixes a very indefinite maturity date and does not meet the requirements of that part of Regulations 112, section 719-1 (d), which reads: * * The name borne by the certificate is of little importance. More important attributes to be considered are whether or not there is a maturity date, the source of payment of any "interest" or "dividend" specified in the certificate (whether only out of earnings or out of capital and earnings), rights to enforce payment, 114 and other rights as compared with those of general creditors.Cf. Frankel & Smith Beauty Departments, Inc. v. Commissioner, 167 Fed. (2d) 94, affirming T. C. memorandum opinion.We think the facts of the instant case are clearly distinguishable from the facts of the cases cited and relied upon by petitioner, among which are Brewster Shirt Corporation v. Commissioner, 159 Fed. (2d) 227, and Economy Savings & Loan Co., 5 T. C. 543; modified on other grounds, 158 Fed. (2d) 472. These cases are not controlling on the facts which we have here.We sustain the Commissioner in his disallowance of the "borrowed invested capital" claimed by petitioner.Decision will be entered under Rule 50. Footnotes1. SEC. 719. BORROWED INVESTED CAPITAL.(a) Borrowed Capital. -- The borrowed capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following:(1) The amount of the outstanding indebtedness (not including interest, and not including indebtedness described in section 751 (b) relating to certain exchanges) of the taxpayer which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust * *.↩	01-04-2023	11-21-2020

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